Yesterday’s Wall Street Journal has a discussion of the 4% rule for retirees, with the observation that it no longer seems to be working.  What is the rule?  Why is it failing now?

the 4% rule

It’s the product of an extensive study of past securities returns done by a financial planner, William Benger, on his PC during the 1990s.  I began to read about the rule a few years later.  Every source I looked at cited Mr. Bengen’s work, which as far as I can tell everyone had taken at face value and no one had verified.  Weird, but typical of most financial writing.  (Mr. Bengen’s work has since been duplicated by several discount brokers.)

The rule is this:

–at retirement, invest 60% of your savings in the S&P 500 and 40% in 10-year Treasuries;

–withdraw 4% of the starting amount in year 1;

–in subsequent years, adjust the prior-year amount for inflation and withdraw that;

–rebalance annually to restore the 60/40 mix.

If you do so, Mr. Bengen concluded, history showed that you had an overwhelming chance that your retirement savings would last at least 30 years.

is it working today?

Not so well.  10-year Treasuries and stocks have both been yielding around 2% for the past half-decade.  Therefore, withdrawing 4%+ per year starting around the high point for the S&P 500 in mid-2007 would have meant that your nest egg has shrunk by well over 15%.

The WSJ cites T. Rowe Price as saying that had you started the 4% plan in 2000 (another S&P high point) your portfolio would be down by a third–and your chances of it lasting 30 years under the 4% rule reduced to 29%.

why not?

The Journal thinks it’s an issue Mr. Bengen overlooked–that the starting point matters.  Begin at the start of a “Lost Decade” for stocks and you’re in trouble.  One solution is to withdraw 4% plus the inflation adjustment of the current value of the portfolio, not the starting value.  Not so hot for the turn of the century retiree, however..

I have a different take

1.  Look at the historical periods Mr. Bengen analyzed.  He went from 1926 onward.  Up until 1960, the dividend yield on the S&P averaged about 6%.  From that point onward until 2000, the yield was never below 3%.  As to 10-year Treasuries, yields averaged about 3% before 1960.  They were never below 4% subsequently–and reached as high as 15% in 1981.

In other words, unlike today, the interest/dividend payments on the portfolio exceeded the withdrawals almost all the time.  This was partly a function of investor attitudes toward risk–early on, stocks were considered a risky kind of bond and so had a higher yield.  It was also a function of considerably higher inflation.

Yields were high enough that periodic stock market swoons didn’t make that much difference.  Today, risk tolerances and inflation expectations are different.

2.  Just as important, in my view, is the conventional economic wisdom that the way to fight economic slumps is to push interest rates below the rate of inflation.  This temporarily shifts income away from savers and makes credit cheaper and more available to borrowers, whose extra spending restores economic growth.  So retirees get thrown under the bus in support of the common goods.

This time, however, Washington made the economic mess a lot bigger than it should have been.  And continuing dysfunction, including failure to address deficit spending, has made recovery much more difficult.

The Baby Boom clearly doesn’t understand the link between Washington failure and Boomers’ diminished retirement prospects.  Otherwise, there’d be an uproar about having much more effective national fiscal policy.