Is The 4% Withdrawal Rate Safe?

This is us exhausted with our busy schedule!

We are back!  I (Tara) am sorry we've been absent ... between being a new leader of our daughter's Girl Scout Troop, to preparing for a Fall trip to Disney World in 2018, then everything that comes with the holidays ... not to mention our son's birthday in January, and just life in general - things have been busy!  But 2019 is going to be a big year for us regarding FI (decisions, decisions!), and today we bring you ... Is The 4% Withdrawal Rate Safe?

-Tara

This is a popular question that has been discussed extensively in the FI (financial independence) community, and the short answer is yes -- the 4% withdrawal rate is very safe.  

The 4% withdrawal rate comes from The Trinity Study and shows that historically a person could safely withdrawal 4% of their money for 25 - 30 years (a traditional retirement) from investments and never run out of money.

But wait, if you are retiring in your 30’s or 40’s you need that money to last 50 - 60 years.  Will the 4% withdrawal rate still work?  

The short answer is yes.  There is a very high probability that the 4% withdrawal rate will work great in even a 50 - 60 year retirement.  But I don’t want you (or expect you) to just take my word for it.  I am going to introduce you to my favorite FI Calculator: FIRE Simulator.  (Fair warning: This calculator can be addictive.  I’ve spent many afternoons tinkering with our numbers to see how they would hold up in the long run).

What does this calculator do?

It will take your data and run it against all of the years that the stock market has been in existence (From 1871 - Present) to see how your portfolio would hold up throughout history.   

For purposes of this post let’s call a plan successful only if it has a 100% chance of working.  In other words, through all of the ups and downs from The Great Depression, to World Wars, to stagflation in the 1970’s, to the dot-com bust, you could safely withdrawal your money and in 100% of the time you would never run out of money.  

Before we get to our scenarios, lets first go over how to fill out the information.  

Step 1: Enter your planned retirement year, and then enter the year you plan for your retirement to end (umm, you die).  For example, when I run our scenario I usually put in the year 2020 – 2085 because I plan to live to be 105 (shoot for the stars, right?).  We will also use this date range for the purposes of this post.

Step 2: Enter your portfolio value at retirement.  This will obviously be different for everyone, but for the purposes of this post let’s just use good old $1,000,000.

Step 3: Enter the percent you have invested in equities (stock) and bonds.  If you have followed our investment advice so far, this is simply dividing up how much you have invested in VTSAX versus VBTLX.  You also need to enter the fees that you pay on your investments.  Again, if you are invested in VTSAX / VBTLX your fees will be $.04. 

Step 4: Go to the “Spending Plan” area to the right and select “inflation adjusted.”  What this means is that you will give yourself inflation increases of 3% every year.  

Step 5: Put in your initial yearly spending.  This will be your 4% withdrawal.  So for our example of a portfolio with $1,000,000 we will enter in $40,000 ($1,000,000 * .04).

Step 6: There are other fields you can enter in below such as social security, or other spending (such as college for your kids) and other income (part-time work, inheritance, etc).  For now, let’s leave these blank.  We will come back to them.  

Assumptions For All 3 Scenarios:

• $1,000,000 Portfolio Balance
• Allocation of 90% Equity to 10% Bonds
• Fees on investments of $.04
• Inflation adjusted spending of $40,000

Scenario 1: 

For our first scenario we are going to use our assumptions above and run the simulation without adding anything else.  This will give us a good feel for the safety of the 4% withdrawal rate.

Scenario 1 Results: 

97.5% success rate right off the bat.  That’s not too shabby.  Our average ending balance looks great at $22,600,830.  This is a great example of the power of compound interest.  Even while withdrawing 4% per year, our investments were able to continue to grow to what is really an unnecessary amount of money (but I am not complaining!).  That said, our worst case scenario is an ending balance of ($1,983,767).  Overall, these are great numbers and with the use of one of our safety margins we could easily turn this into a 100% success rate.  However, this doesn’t factor in any major expenses that life sometimes throws at us so in Scenario 2 let’s add in college tuition for 2 kids and see what happens.

Scenario 2: 

We have everything set according to the assumptions above, and now we are going to add some extra spending down at the bottom for 2 college tuitions in the amount of $75,000 each.  

Scenario 2 Results:

We see that this plan has an 86.25% chance for success.  Let’s look at some of the numbers from this scenario.  The first one that jumps out is the average ending portfolio balance (while still great) dropped from $22,600,830 to $19,910,212.  Of course, the worst-case scenario is absolutely horrible with an ending balance of ($8,496,314).  We have our work cut out for us to get this success rate up.  

Scenario 3:

In Scenario 3 we are going to tap into one of our safety margins and add some part-time work as part of our early retirement plan.  As we have discussed before, its ridiculous to retire in your 30’s and 40’s and expect to never earn another dollar for the rest of your life.  Keep in mind, we no longer need an income of $100,000 + to make ends meet.  Rather something like $10,000 per year will do.  For this scenario, we will assume that we have an income of $10,000 per year from the year 2022 – 2035 (these dates are completely random).

Scenario 3 Results: 

We have managed to bump our success rate back up to where we started at 97.5% by adding $10,000 worth of side hustle from the years 2022 - 2035.  Our average portfolio ending balance has also gone up to $24,455,720, and our worst-case scenario is now ($3,153,613).  We are on the right track, but we aren’t there yet.  

Scenario 4: 

For this scenario we will keep everything the same from Scenario 3 except we will add a very modest $22,000 per year in social security starting in 2045, and it will carry forward until 2085.

Scenario 4 Results: 

There we go!  Now we have a plan that would not have failed during any point in the history of the stock market.  Not to mention our average ending balance in 2085 is $29,038,982, and our worst-case scenario is $1,381,774.  These are numbers we can live with.   

What are some other ways we could have improved our success rate? 

• Make more with side hustles/part-time work.
• Only take inflation adjustments every 5 years or so.
• Save less for college (maybe $60,000 per child instead of $75,000.)
• Invest the extra time you have as an early retiree in your child's education so that college is completely paid for by scholarships.
• Or have them attend college at a very affordable (basically free) European university.   

So, is the 4% withdrawal rate safe?  At a 97.5% success rate that we illustrated in Scenario 1 I would say, yes, the 4% withdrawal rate is extremely safe.  Does that mean we should just blindly withdrawal 4% every year regardless of the current market situation?  Absolutely not.  Rather, we withdraw our 4% while remaining flexible and tapping our safety margins as needed.  

I recommend that you try your own numbers in this FI Calculator.  It’s a pretty neat tool to use when planning / preparing for something like FIRE.  Good luck!

What do you think?  How do you feel about the 4% rule?

-Erik