Where’d the 4% rule come from, anyway? (Hint: it wasn’t the Trinity Study.)

Hello to all the Bogleheads who are coming in. When you’ve finished this post you might also be interested in “The 4% rule can ruin your retirement. Don’t let it do your thinking for you!

If your retirement plan involves a safe withdrawal rate, you gotta pay some homage to the guy who came up with the concept.


A short read, but worth taking a look at.

What might’ve been the most important moment in the history of the FI/ER movement got missed by almost everybody. It happened in October of 1994, when the Journal of Financial Planning ran a ten-page article entitled “Determining Withdrawal Rates Using Historical Data” by a California investment manager named William Bengen.

Bengen, a graduate of the Massachusetts Institute of Technology’s aeronautical engineering program, had run a family business for a while before moving out west, earning a master’s in financial planning, and starting a private practice. As he built up his client base he began developing a couple of ideas: “portfolio longevity” and the “maximum safe withdrawal rate”…a term he coined, and that’s still known as “The Bengen Rule.”

His findings proved to be an enormous boost to the FI/ER movement, and time hasn’t diminished their significance one bit. So I’d like to walk you through and comment on his points I consider most salient. But before we get started, do yourself a solid and print a copy of his article by clicking on this link.


Bengen’s theme was this:

“I have quantified portfolio performance in terms of ‘portfolio longevity’: how long the portfolio will last before all its investments have been exhausted by withdrawals. This is an intuitive approach that is easy to explain to my clients, whose primary goal is making it through retirement without exhausting their funds, and whose secondary goal is accumulating wealth for their heirs.” [Italics his.]

That first sentence is still the holy grail of the FI/ER crowd: amassing a self-sustaining portfolio by increasing sources of passive income and decreasing expenses. You can derive every principle of financial independence and early retirement from those few words.


After a brief executive summary Bengen set out a list of baseline market conditions drawn from industry-standard historical data. He calculated that across time the inflation-adjusted return an investor could expect from  a 60/40 stock/intermediate-term Treasury bond split was 5.1% (assuming continual rebalancing.)

Bengen proposed, however, that a financial planner who recommended his clients withdraw 5% of their portfolio’s initial value could very well bankrupt them given the severe market shocks that came along every so often.

He listed the three shocks he considered “the most significant financial cataclysms of the last three quarters of [the twentieth] century”:

  1. The “Little Dipper” of 1929-31: -61% stock return, +10.5% intermediate-term bond return, and inflation of -15.8%.
  2. The “Big Dipper” of 1937-1941: -33.3% stock return, +16.7% intermediate-term bond return, and inflation of +10.5%.
  3. The “Big Bang” of 1973-1974: -37.2% stock return, +10.6% intermediate-term bond return, and inflation of +22.1%.

“As planners,” he wrote, “we know such events are likely to recur in the future.” So when advising clients, he felt it was crucial to take declines like these into account.

You’ll still see that approach in today’s financial calculators. While in his analysis Bengen didn’t use the more rigorous method of repeated random sampling–i.e, a Monte Carlo approach–the fundamental maxim remains: learn from history.


When choosing names for these cataclysms Bengen was obviously inspired by his astronomical studies. But he explained that the names also “reflect[ed] their relative impact on the value and purchasing power of investors’ portfolios.” The “Big Bang” was therefore the most severe: a investment pool eroded both in returns and purchasing power.

It was within the framework of these cataclysms that he outlined several hypothetical “portfolio scenarios.” Each described an investor who retired at a different date with a different asset allocation. All else was held equal.

Unfortunately, holding all else equal blurred the model a bit. Bengen expanded on his assumptions in an appendix to the article, and one that’s of particular importance to the FI/ER crowd was this:

“…the effect of taxes is neglected, as if all the retirement money were stored in a tax-deferred account. Analysis of a taxable account would be considerably more complex.”

Everything in tax-deferred accounts. Does this significantly diminish the usefulness of Bengen’s work for early retirees who live on pre-tax investment proceeds? I don’t think so, even though I’ve discussed the difficulty of managing taxable investments in a different post (“I Have a Big-Ass Tax Problem.”) We know that while these calculations are indeed complex, they’re well within the grasp of educated investors…especially given easy access to market data and the widespread use of spreadsheets.

A more serious problem with his assumptions is this: he never touches on the sapping effect of commissions, advisory fees, etc. The argument that these sources of friction can be ignored because they’d be constant across all portfolios is simply untrue–a 50/50 stock/bond allocation would have a significant difference in commissions than, say, a 60/40. And naturally investment advisors would charge different amounts and raise their prices over time, at variable rates.


At any rate, Bengen’s analysis was straightforward. He assumed a desired portfolio longevity of fifty years, which at that time was well-beyond the expected lifespan of a “traditional” retiree. He then presented bar charts showing–again, based on appropriate periods of historical data–how long a person who retired in a particular year and withdrew at a certain rate could expect his/her portfolio to last until complete drawdown.

Here’s Bengen’s chart for a withdrawal rate beginning at 4% in the first year:

So for example, at a 50/50 stocks/treasuries balance, retiring in 1926 was likely to result in a fifty-year portfolio longevity at a 4% withdrawal rate…whereas retiring in 1937 under the same conditions would only result in a portfolio longevity of thirty-nine years.

Bengen explained that, “[This figure shows] the effects of some financial events. However, these effects are comparably mild; no client enjoys less than about 35 years before his retirement money is used up.”

The chart’s damned near what you’ll get if you run your own scenario through FIREcalc: a graphic representation of your portfolio’s success rate.

Bengen found a 3% first-year withdrawal rate to be “as exciting as a crewcut,” with a 100% success rate for a fifty-year portfolio longevity. He also confirmed his proposition that a 5% first-year withdrawal rate could lead to a portfolio longevity of only twenty years.

Then he went on to describe the effect of each cataclysm on each withdrawal rate. But I won’t belabor these because his point was proven: portfolio longevity is directly affected when a client adjusts his/her withdrawal rate. That must’ve seemed an obvious conclusion even then, but presenting it and mathematically proving it using real-world data across varying historical timespans was still an important impetus to the FI/ER movement.


Bengen turned next to “Strategies and Applications,” and here we get into the meat of the article. As mentioned, he considered a 3% withdrawal rate to have a 100% success rate, but he qualified that by writing:

“This is also true for withdrawal rates as high as approximately 3.5%, but most clients would find such a low level of withdrawals unacceptable.”

Well…that might be true for traditional retirees, but it’s clearly false for the FI/ER crowd…especially when considered against his 100% non-taxable account restriction. I myself have run a withdrawal rate of between 2.75% and 3.75% (ish) pre-tax for most of the twelve years I’ve been retired. And this statement also dismisses those practicing leanFIRE.

Then Bengen repeats:

“Therefore, I counsel my clients to withdraw at no more than a four-percent rate during the early years of retirement, especially if they retire early (age 60 or younger.)” [Italics his.]

Defining early retirement as less than age 60 is intriguing. It implies a blind spot I’ll discuss more fully in my conclusion: prior to the internet era the FI/ER movement wasn’t anywhere near being in common knowledge…nor was it self-aware. Financial planners unaware of the 4% safe withdrawal rate could hardly be expected to properly advise prospective early-retirees, then, unless they spent a LOT of time on the math–which would’ve been difficult to do in the absence of PCs and spreadsheets.

To get around the difficulty of calculating numbers specific to the particular situation of each client, Bengen developed general outlook charts. For example, for a client with a $400,000 portfolio who wanted to withdraw 4% the first year and increase that rate to track inflation in each subsequent year, he would:

“…show the client…the chart for 6-percent withdrawals–and explain the risks of such an approach.”

Such as:

“If the client expects to live another 30 years, I point out that the chart shows 31 scenario years when he would outlive his assets, and only 20 which would have been adequate for his purposes.”

A 40% chance of success. Again, a proto-FIREcalc, and another reason why Bengen’s work was seminal.

A final strategic point he made was this:

“…as we shall see later, a different asset allocation would improve this, but it would still be uncomfortable, in my opinion.”


So Bengen took up that topic in the next section of his article, “Initial Asset Allocation.” He combined forty charts of portfolio longevity arising from retirement date and withdrawal rate scenarios into one: a “Worst Case Portfolio Life.” Was this the first rudimentary Monte-Carlo analysis of retirement scenarios?

Here’s the chart. (Ibbotson, by the way, was a standard market data source in the early 1990s. Ibbotson Associates has since been acquired by Morningstar.)

Cool, isn’t it? Even given a worst-case scenario, a withdrawal rate of 3% is pretty much bombproof; at 4% and a 50/50 stock/bond allocation you still have a good shot at a portfolio longevity of 35+ years. Comforting to traditional-age retirees; perhaps less so for early retirees unless they manage their withdrawal rate down. Bengen did point out, however, that:

“From the perspective of the highest minimum portfolio longevity, that means you give up very little by increasing stocks from 50 percent to 75 percent of the portfolio.”

And then he made an observation I think is coolest of all, given my moderately high appetite for risk. He presented a chart of a 75/25 stocks/treasuries allocation which demonstrated that:

“Clearly, the heavier weighting in stocks…has produced some fairly significant improvements. Fully 47 scenario years [of 50] result in portfolio longevities of the maximum of 50 years, while only 40 scenarios result in portfolio longevities attained that pinnacle in the earlier chart.”

So he didn’t always consider a 50/50 stocks/treasuries mix optimal. After examining a few more cases of allocation/withdrawal rates, he concluded:

I think it is appropriate to advice the client to accept a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent. Stock allocations lower than 50 percent are counterproductive, in that they lower the amount of accumulated wealth as well as lowering the minimum portfolio longevity.” [Italics his.]

This held true even through the three cataclysms he’d first set out.


In the next section: “Asset Allocation and Withdrawals,” Bengen proposed something many might find controversial. Should retirees become more conservative in their allocations as they get older?

“My research,” he wrote, “indicates strongly that as long as the client’s goals remain the same, there is no need to change the initial asset allocation. It is likely to do more harm than good…”

To show this, Bengen divided retirees into three example classes; again, astronomically-named.

  1. The “Black Holes,” who retired exactly at the bottom of a cataclysm and were tempted to switch to a 100% bond mix.
  2. The “Stars,” who enjoyed…well…stellar returns, and
  3. The “Asteroids,” or those whose results were more or less what they expected.

There’s no need for me to summarize these examples; suffice it to say that Bengen was able to demonstrate historically across all three classes that maintaining a consistent 75/25 stocks/treasuries allocation in good times and bad led to the most consistently sustainable withdrawal rate of 4%, as well as leaving the most wealth behind for one’s heirs…no matter when one’s retirement date happened to fall.


At the very end of his article Bengen wrote something that plays into one of my long-held beliefs:

“The withdrawal dollar amount for the first year [of retirement] will be adjusted up or down for inflation every succeeding year. After the first year, the withdrawal rate is no longer used for computing the amount withdrawn; that will be computed instead from last year’s withdrawal, plus an inflation factor.”

I get behind this idea because as an early retiree for going on twelve years, I’ve found it’s wisest to model the future as if each day is the first day of my retirement.

I mean…you HAVE to look at it that way. Yesterday’s realities and assumptions aren’t today’s operating conditions; what matters is the likelihood today’s realities and assumptions will sustain your retirement in tomorrow’s operating conditions. If it looks like they won’t, you need a job…stat.

Today’s the first day of the rest of your life, yes?


As I get closer to wrapping up, this would be a good time to fess up that I’m a Bengen fanboy.

Reason being that in 1993, when I started my own planning, I had no idea this kind of thinking existed. And if I had, it would’ve not only given my model a boost but also would’ve helped me feel much more confident in the possibility I could actually achieve FI/ER.

Which goes to prove the point I made earlier (and in fact I make often): before the use of PCs and spreadsheets became widespread, and before the proliferation of the internet, it was right up against impossible for people who were interested in FI/ER to find each other and share information. But in a mere twenty-five years knowledge of the 4% rule has gone from being obscure to widespread–hence why I call the FI/ER movement a “movement” in the first place.

And that’s why I’m a Bengen fanboy. Somebody had to be the first to bring the 4% rule to light, and while in the introduction to this paper he credits other financial planners for laying in some of the conceptual framework, he was the one who developed and presented the actual mathematical method that seekers of FI/ER could easily apply to their own situations. I could make the case that the majority of subsequent retirement modeling has been influenced by his work. Certainly the Trinity Study was predicated on it.

But naturally these kinds of safe withdrawal rate methods have come under considerable criticism. The most common I run across is this: retirement spending shouldn’t depend on a blanket withdrawal rate, but rather on a percentage of pre-retirement spending that varies by individual. I’ve seen recommendations as high as 85%.

And I think that’s crazy. Recommendations that high completely ignore the “push down on your expenses” side of FI/ER; as if retirees have no self-discipline. I’m committing the logical error of attacking the argument by ridiculing it, of course, but I still think Bengen’s work convincingly demonstrates that given external marketplace realities, investment sustainability should be the main goal…especially to an early retiree. That suggests managing one’s expenses down as much as possible.

Another criticism I hear is that while a 4% withdrawal rate is “smooth,” the underlying markets are “choppy,” meaning retirees build up surpluses during high-return periods and run deficits during low-return periods. It’d be much more appropriate, these critics argue, for one’s withdrawal rate to vary with market returns.

But that doesn’t jive with the time-honored method of how commodity companies manage the price risk of their income streams. Say you’re a wholesale power company running coal generation. Since you stockpile weeks’ worth of coal but sell into a spot market for electricity, you’re engaging in a fixed-for-floating swap, or at least in the short term. Fixed expenses; variable revenue. So you hire futures traders and sell into the forward markets to lock in longer-term prices and smooth out your income stream. Investors like this because certainty’s always a good thing in the stock market.

Consumers and especially retirees are likewise caught in a fixed-for-floating swap. Their income remains constant but their bills fluctuate. That’s uncomfortable, and something that has to be carefully planned for…especially in times like Bengen’s Big Bang, when abysmal returns team up with high inflation to smack retirees all over the playing field.

Which is an argument for buying TIPS and annuities, maybe. As of this writing TIPS are paying as much as 3.875% depending on how far you go out. I’m a long way from 67, but I’m becoming more and more convinced that Social Security will be around for me…and if I were to buy a million bucks in TIPS at 3.875% and combine that with a couple of grand in combined monthly Social Security payments for my wife and me, I think we’d be able to maintain our current more-than-comfortable lifestyle, no problem. Antithetical, surely, to Bengen’s conclusions with respect to passing wealth on to one’s heirs, but an interesting question nonetheless, and certainly within the boundaries of a 4% safe withdrawal rate.

Well…I’m going to leave it there. I think I’ve shown that not only was Bengen’s work seminal to the FI/ER movement, and not only does it continue to be of high importance, but it also brings up all sorts of tangential questions that themselves are worthy of thought and study.

And that said, another tangential question is this: I had a six-pack of Stella Artois around here somewhere…where the hell did it get to? I’ve been working on this article for nine hours straight and I need to wet my throat. And Wikipedia tells me “Stella Artois” means “The Christmas Star” in French…surely a name that’d please a financial star-gazer like William Bengen.


By the way, these kinds of historical posts are common at my blog. Please click here to follow me on Twitter, and sign up for email updates using the widget in the sidebar. Thanks!

Author: ER Dude

Sick of your job? After a thirteen-year career, Early Retirement Dude fled corporate America for good. You can do it too! Visit http://EarlyRetirementDude.com or email EarlyRetirementDude@gmail.com.

34 thoughts

  1. This was an amazing post – one of the few completely new pieces of FI related content I’ve read in years – great work!

    I’d always heard of and read about the Trinity study, but hadn’t heard of Bengen at all. One thing I wondered was the mention of the “first year rate”, along with follow up years being calculated based on withdraw and inflation. I was wondering if you could give a basic example of what that looks like for year 2 under Bengen model?

    1. Thanks! I appreciate that very much. Yeah, I haven’t done much writing about the “money mechanics”–how to use your HSA as a retirement account, etc.–because I think those topics have adequately been covered. At the moment I think the FI/ER movement is to a great degree about philosophy and mutual support, so that’s what I try to stick to in my longer pieces.

      >a basic example of what that looks like for year 2 under Bengen model?

      To me that means forgetting about year one and resetting your assumptions to assume year two is the new year one, if that makes sense. Gets back to the idea that yesterday doesn’t matter; what’s important is whether your model tells you your retirement is sustainable from today onwards. Did that answer your question? If not, let me know.

      1. Mostly – would that mean you look at things on January 1st, and say, I have $2m, so I can spend 3%, so that’s $60k this year. Then next Jan 1, maybe there was 5% inflation during the year, and stocks went down, and they have $1.7m now. This next year, should they only take out $51k? With inflation, this would be a ~20% decline in effective spending (1/6 lower funds + 5% lower spending power due to inflation).

        Alternatively, to maintain the same spending power, they’d need to raise their spending by 5%, up to $63k, even though that’s closer to 3.7% withdraw rate.

        It’s sounding like this study is saying it’s OK to raise the rate based on inflation in this case? The lower scenerio is a lot less risky of course, but the effect of inflation is still something I’m wrapping my head around.

        1. Oh, I see.

          I might be covering ground you’re already familiar with, but to take a step back: perhaps the most common approach to post-ER budgeting is to set up budget for year one–say it’s 50K–and then to adjust it only for inflation at CPI or whatever other index you’re comfortable with. In this approach you’re not spending more or less just because your investments increased or decreased on paper.

          This is consistent with the idea that the broad stock market returns ~7% on average–the peaks smooth out the valleys. But that’s one reason why people tend to under-withdraw the 4% rate. Note that Bengen referred to the “maximum safe withdrawal rate,” and said that 3% was as “exciting as a crewcut” since it had a 100% success rate.

  2. I like the strategy of withdrawing a fixed 4% of the portfolio. In the good years, it means you have more budget, maybe you can reinvest part of it or spend it in that dream trip. In the bad years, it will show you that you´ll have to cut some expenses. Maybe you could comment on that. Congrats for the blog !

    1. Yeah, I touched on that…the “smooth/choppy” criticism of the withdrawal strategy. Seems like the method the critics describe and that you bring up might make big-picture budgeting difficult for early retirees since you only know what your returns were after you’ve already spent your budget money. Sort of a “time-the-market” exercise.

      I appreciate the congrats. This is a near and dear subject, as well as a great creative outlet.

      1. Another aspect on this could be that the critics assume that the early retiree should spend all the withdrawn money to the last buck every year. In my opinion life does not work like that, you can spend less than the withdrawn amount and start next year with a surplus and cover a potential overspending in the following year. So living with sanity can eliminate this factor too independently from market returns. However any FI/ER dude should close the year with a little left off if he really wants 🙂

        1. Absolutely, and in fact we do that through a couple of what we call “budgeting accounts” for accrual expenses like property taxes and vacations. We deduct $1145 from our $4100 budget, meaning we often have money at the end of the year that we haven’t yet spent. Eventually we do, of course, but until then it’s sitting there either earning interest or stock returns. See “Our financial situation as of June 3rd, 2017” for more info.

  3. Fantastic post that concentrates the essence of the FI foundation. What I really took away is that financial planners and wealth managers in the days, say before Windows 3.0, really did not understand the concept of FIRE. The FIRE blogger community created a new awareness level and subsequently an entire new market. Retirement goals and planning using FIRE principles has been completely redefined and more importantly personalized in the 21st Century. Lastly wisdom, experience and financial principals have been essentially carved in stone in the 20th century. It’s really up to us to recognize these principals and apply with to ourselves. The FI community provides a great service for deciphering the anicient code and keeping us motivated to apply it with modern tools.

    1. So true.

      >really did not understand the concept of FIRE

      Or for the most part hadn’t conceived that such a thing even existed. I’ve spoken with several financial advisors (free consultations) since I started planning my escape in 1993, and their reactions have almost all been incredulity.

  4. ERD….another excellent post…from a fella “who’s walked the walk”. You had me at chimps in suits and gate crashing car escapes. 🙂 Thanks for putting this content out on the interweb. 🙂

  5. This was an enlightening read! As someone who is in the process of learning about FIRE, getting the story behind the 4% will be incredibly helpful in my planning and future choices. Thank you! And thanks to Adam who asked the question which led you to clarifying the only area where I was unclear — how to apply the CPI changes.

    1. Glad to help, and thanks for the compliment! When I was first setting out to model my plan I used the Social Security market return and inflations assumptions that they used in their modeling. If I remember correctly, they used 3.5% for CPI, which has turned out to be a big overestimate. Not a problem for me, however, because it made my plan that much more conservative.

  6. ERD,
    I found your website this week… very inspiring! Thanks for putting this out there.
    I am one of those who is fortunate to love his job and make an excellent income. So, my drive is more towards the FI than the ER if that makes sense.
    I have been plugging my numbers into various ER calculators around the web. They are so different in their results. I am getting between 2.5M to 5M required. If I use the 25x rule, it is 2.5M (which is attainable) while the 5M is going to take a whole lot more effort.
    The “Ultimate Retirement Calculator” runs very high for my situation but it looks very detailed. Do you have a favorite calculator?

    1. I’m going to say up front that I’m an affiliate with this company, but I do in truth like Personal Capital because it includes it’s not only a live-updating financial management system–think Mint, only more suited to the needs of investors–but it includes a proprietary Monte Carlo analyzer. One-stop shopping as opposed to having to jump around the web. Check out my review.

      1. ER Dude,
        Thanks for the response… I did check that one out (using your link), but felt like I was not ready to link everything up, yet. I am using Mint (hence Quicken), so I understand that it is probably pretty safe. I need to do a little more homework first.
        I read your entire site a couple days ago… great stuff. I did not notice anywhere that you mention when you were married. Was that pre or post retirement?

  7. Great post and food for thought, given he did it in the era of basic spreadsheets, and lots of calculator power! It was interesting that he was discussing pre-60 retirement given the norm at that stage of 65, and a life expectancy post retirement of 20 years not 35 or 40!

    1. Yeah, definitely food for thought. I read your comment and it occurred to me: he doesn’t mention company pensions or Social Security AT ALL. They wouldn’t have been model-able, of course, but when subsidizing investment returns, a retiree could certainly have sustainably enjoyed higher than a 4% withdrawal rate.

  8. To provide a bit more nuance (I hope), Bengen’s work considered two asset classes (sans fees/expenses) of the S&P 500 and 5-year intermediate term government bonds. Cooley, Hubbard, and Walz (three professors at Trinity) used the S&P 500 and long-term high-grade corporate bond returns.

    Bengen’s SAFEMAX withdrawal rate was 4.15% — worse case scenario. Trinity Study, building/expanding on Bengen found a 4% withdrawal rate had a 95% success rate. This led to people to conclude that the “4% rule” has a 95% chance of success, a good level of statistical confidence, it’s sustainable. Not so fast.

    Long-term corporate bonds are very different (yield, volatility, and total return) than intermediate corporate bonds. And, Bengen/Trinity used historical data (and so included an historic bull 30 plus year bull market in bonds (given longer duration, an even stronger bull market for long term bonds)) to get their safe withdrawal rates.

    Globally, we continue to have historically low yields on bonds of all durations. No one knows if bond yields will increase (if they do, bonds prices will fall). Everyone should know there is no way we are on the edge of a bull market for bonds (which Bengen/Trinity historically based research captured).

    Given today’s bond market, retirees age 65 (forget 40-year old FI/RE acolytes) are tragically naive if they follow Bengen’s SAFEMAX of 4.15% withdrawal or Trinity’s 4.00% withdrawal and believe them to be sustainable. If sequence of return risk doesn’t get them, longevity risk and inflation will. Past performance (aka Bengen and Trinity outcomes) are not predictive of future results. That goes for the S&P 500 and even more so with “bonds”.

    Prof. Moshe Milevsky recently tweeted the following:

    Moshe A. Milevsky‏ @RetirementQuant Jun 2, 2017
    I have come to the conclusion that only 4% of the people who quote or reference the 4% rule, truly understand how it works (or doesn’t)

    I agree with the good professor.

    1. Thanks for the input. Nicely nuanced. 🙂

      At some point these models all reduce to “it depends.” I don’t say that to be flip; I say it in agreement with your statement about past performance and your quote from Milevsky. It’s a MUST for both traditional retirees and anyone choosing the FI/ER path to do their own modeling based on variables/factors/assumptions/mechanisms/etc. they fully understand and that match their own situations most closely, rather than working from rules of thumb (which is not to denigrate the value of broad studies, by the way.)

      I’m seeing in your fourth paragraph a proposition where elaboration might be helpful to those who are just now learning about SAFEMAX and the TS and so forth:

      >there is no way we are on the edge of a bull market for bonds

      and also in your entire fifth paragraph, but especially:

      >If sequence of return risk doesn’t get them, longevity risk and inflation will

      Care to discuss? It’d be helpful, I think, to those who are just beginning to formulate their retirement plans. And hell, I’d like to pick your brain for my own edification too.

      1. Sure.

        With regard to bonds, bond prices/values are inversely related to bond yields. When bond yields decline, bond prices/values increase and vice versa. And the longer the duration of a given bond, the more severe the inverse relationship is.

        For a bond mutual fund, the one metric that captures this “interest rate risk” is duration. A bond fund with a duration of 5 years (about right for an intermediate bond fund) generally means that if interest rates go up 1%, the value of the bond fund will decline by about…5%. A bond fund with a duration of 15 (typical of a long term bond fund) would decline by about 15%.

        A “bull market” in bonds are periods of time when bond yields decline. We’ve had a 30 to 35 year bond bull market as yields on bonds have fallen fairly steadily over the past 30 or so years (and they’ve been historically low for several years now). Mortgage rates in the 1980s were 15% or so; today they’re 3-4%. Same is true (trend-wise) with 10-year Treasuries, 30-year Treasuries, and corporate bonds as well.

        We can’t possibly be on the edge of a bull market for bonds because there is NO WAY bond yields will drop from plus 3-5% today to minus 10-12% in the future.

        No. Way.

        Bengen/Trinity bond allocations picked up higher yielding bonds which helped provide a “safe” withdrawal rate (a bond yielding 8% is nice when you want to sustain a 4% withdrawal rate). And…as the yields dropped, bonds increased in value. That helped Bengen/Trinity too.

        What are retirees/FI-RE people using for their bond allocation today? What is the duration of their bond portfolio? What is their bond portfolio yielding? Beats me. I wonder if they know or if they are thinking it’s OK to be 100% in stocks?

        Bottom line with bonds, going forward they are not going to perform like the intermediate or long bonds Bengen/Trinity models captured.

        Sequence of return risk is what happens when early in my “retirement” when portfolio suffers a bear market (a drop of 20% or more). (See this for historic returns: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

        Notice that S&P500 did the following

        2000 = -9.03%; 2001 = -11.89%; 2002 =-21.97% —Had enough?

        Wait, 2008 = -36.55%.

        Retiring with $1,000,000 on January 1, 2000, and taking out $40,000 a year would be pretty tough to do.

        So, let’s say I’ve got $1,000,000 and I take out $40,000 on day one of retirement (so I’ve got $960,00 invested (75% in stocks ($720k an 25% in bonds $240k).

        And the stock market, where if have 75% of my assets allocated ($720,000) drops by the end of the year by 20% down to $576,000. We’ll assume bonds yielded 2% for the year so the $240,000 in bonds grew to $244,800 — so no bear market in bonds too.

        Now I’m starting year two with not $1,000,000 but $820,800.

        Forget inflation. I want/need $40,000 to cover my expenses. I need to draw down 4.873% ($40,000/$820,800). I take out $40,000 and start year two with $780,800 (with $585,600 in stocks and $195,200 in bonds).

        This year stocks drop 25% and bonds drop 3%. At the end of year two, my stock portfolio is worth $439,200 and my bonds are worth $189,344.

        I start year three of retirement with $628,544 ($471,408 in stock, $157,136 in bonds).

        Forget inflation, I need $40,000 (which is 6.36%) and now my nest egg is $588,544.

        A couple bad years at the beginning of “retirement” (that is “when” during the draw down period you get returns, the “sequence” of returns) will wipe you out. Forget most humans can’t handle those kinds of losses. What would you or I do if we need $40,000 a year but three years into retirement, our nest egg is less than 60% of where it was when we started? Probably panic.

        If we bailed out of stocks then, we’re human but we’re out of the game. The next five years the S&P 500 gains 25%, 18%, 3%, 12% and 10%. The “average annual return” for stocks is pretty decent (I’m not going to do the math here with -20, -25, 25, 18, 3, 12, and 10, but there is a sequence of return that over 10 years is 8%). But if all the good years are late in the sequence and we’ve bailed out of stock, we’re done. And if we withdraw an increasing amount, we’re at best pretty darned panicked.. If the good returns come early, no problem.

        Average portfolio returns (stocks average 8% a year for the past 80 years) are of absolutely no value to retirees and FI-RE when you are trying for sustainable withdrawals. It’s the sequence (the order) of returns that make all the difference.

        Sequence of return for a 65-year old (with a 30 year window (see Bengen and Trinity) is one thing. For a 35-year old who is in FI-RE, it’s an entirely different kettle of fish.

        This is essentially longevity risk…the risk of living too long.

        Bengen/Trinity were assuming a 30-year period for retirement. That’s probably too short for 65-year olds today. Bengen and Trinity didn’t not study 40 or 50 years of sustainable withdrawal rates.

        As for inflation, if one needs 2, 3, or 4% increase compounded annual in their withdrawal, the $40,000 becomes:

        year 2 = $40,800
        year 3 = $41,616
        year 4 = $42,448
        year 5 = $43,297
        year 6 = $44,163
        year 7 = $45,046
        year 8 = $45,947
        year 9 = $46,865
        year 10 = $47,803.

        In 20 years at 2%, the initial $40,000 withdrawal would be $59,437; 30 years it’s $72,454; in 30 years and 40 years on it’s $88,321.

        Today’s 40-year old person on FI-RE needs to think about 30 years on at their age 70. Anyone think a million dollar portfolio will sustain a 2% inflation withdrawal starting with $40,000 (4%) withdrawal?

        I do not..

        We’ve had 8 years of a bull stock market with very, very little price inflation. These conditions will not last forever. Stocks (and bonds) have bear markets. Inflation will likely return, at some point.

        Make sense?

        Helpful?

        Questions?

        1. That’s an excellent explanation of a couple of very real issues lurking behind the formulaic approach common in the FI/ER movement. I’m gonna throw some things out that I imagine you know but that some readers may not be aware of.

          People new to FI/ER often don’t understand bond yield/price inversion, leading to a question you ask:

          >What are retirees/FI-RE people using for their bond allocation today? What is the duration of their bond portfolio? What is their bond portfolio yielding? Beats me. I wonder if they know or if they are thinking it’s OK to be 100% in stocks?

          Many retirees slash FI/ER people aren’t 100% in stocks, and either have or intend to have a bond allocation, but frequently they want that allocation simply because they’re following the conventional wisdom rather than proceeding from an understanding of the mechanics that underly that CW.

          “You’re this far out from retirement, so you need a corresponding percent of your money in bonds.”

          The FI/ER crowd tends towards Vanguard ETFs, meaning that for a bond allocation, while they definitely have the opportunity to know what issues their allocation specifically consists of, they’re likely subbing out to the Target Retirement Funds and going on autopilot. Hence the need for conversations like this one.

          >What would you or I do if we need $40,000 a year but three years into retirement, our nest egg is less than 60% of where it was when we started? Probably panic.

          This is exactly what happened to me–retired in 2005, went 40% down in 2008–and if I hadn’t been a buy-and-hold guy, I’d have panic-sold like so many others. Strategy and discipline were paramount, but equally so were tactics.

          Judicious loss-harvesting, pushing down on expenses, getting more involved in the barter economy, etc. And fortunately by then I’d owned several stocks for the better part of a decade, two of which were ten-baggers and all of which were deeply in the black.

          So: assuming another 40% drop, loss-harvesting, atypical returns, and large amounts of free time to develop income-replacement methods aren’t, I think, tactics that’ll be available to the average fully-committed index ETF investor who’s still working. So again, understanding is paramount.

          >Sequence of return risk

          I mostly hang out in Reddit’s financial independence sub, where sequence of return risk is a frequent source of debate. The solution most commonly offered (besides the unpalatable finding of a job), is to shoot for a lower withdrawal rate across the long term by living that way in general; by cutting expenses; and/or by diversifying the income stream across real estate, some sort of agreeable side gig, etc.

          Again, this is all stuff I imagine you know but may be unfamiliar to others. So let me ask you this:

          You came in from Bogleheads, right? With your permission I’d like to split our discussion out into a new post in order to give it the visibility it deserves elsewhere. It’s a highly valuable and thought-provoking topic, but it’s buried here where few are going to see it.

          And I get a good many vicarious readers on this blog–meaning them no disrespect, it’s just that early retirement can be a tantalizing lifestyle–and I think they could benefit from…well, call it “FI/ER investing 201” for lack of a better phrase. That cool with you?

          Thanks again for participating.

          1. I came into your blog via Rockstar Finance. I’m pretty sure I’ve never been to Reddit. I have poked around Bogleheads quite a bit. And I admire Jack Bogle. A lot.

            Target retirement funds are, I think, very sophisticated, elegantly designed, easy to use, and incredibly dangerous investments. But that’s another topic for another day.

            The “math” in the last post with sequence of return risk was not precise, it was off the top of my head. And that sort of imprecision can be an issue for some of the helpfully skeptical Bogleheads there.

            That aside, I’m OK with you posting this material where you see fit. Thanks for asking me. Please,let me know when you do that.

  9. Some thoughts regarding the S&P 500, sequence of return risk, and inflation.

    The last five years on the 1990s generated historic returns:

    1995: 37.20%
    1996: 22.60%
    1997: 33.10%
    1998: 28.34%
    1999: 20.89%.

    $300,000 on January 1, 1995 invested in the S&P 500 with no additional investments, would end 1999being worth $1,042,069.

    Someone hoping to “retire” on January 1, 2000 with $1,000,000 withdrawing $40,000 on that date and thinking they could increase their withdrawal on subsequent January 1st by 2% were in for a surprise.

    The first three years of the ’00s were negative returns of -9.03%, -11.85%, and -21.97%.

    By the end of 2002, the million dollar nest egg (after withdrawals of $40,000; $40,800; and $41,616) was stood at $540,157. It would take super human efforts to continue taking ever-increasing (by 2%) withdrawals from a nest egg that was just about cut in half in three years.

    The next five years were all positive for the S&P 500 and by the end of 2007, even taking 2% inflation-adjusted withdrawals) the nest egg was up to $683,253. Not great but perhaps encouraging.

    Then came the Great Recession and the S&P 500 declined by 36.55%, Withdrawing $46,866 at the beginning of that year, the bear market resulted in the nest egg shrinking to $403,788 by the end of the year.

    The next year’s withdrawal would have been $47,804 on a nest egg worth a bit more than $400k.

    Fast forward to 2016.

    The 2% inflation-adjusted withdrawal on January 1, 2016 was $54,911 and by December 2016, the nest egg was $444,457. Eight years of positive returns did wonders.

    Two bear markets — the first protracted over three years, the other rather more quickly — coupled with increasing the withdrawal rate by 2% would have been problematic for “retirees”. Withdrawing $55k on a nest egg of $450k is about a 12% withdrawal. Is a 12% withdrawal rate sustainable?

    Withdrawing a level $40k (instead of taking a 2% inflation adjusted withdrawal) helps quite a bit even with this extremely adverse stock market environment as the ending balance would be slightly more than $665k at the end of 2016.

    Experiencing awful returns early in “retirement” is the sequence of return risk.

    Here is another “rear-view mirror” look at sequence of return risk withdrawing a level $40k from a million dollar nest egg starting ten years ago on January 1, 2007.

    The second year of this “retirement” has the nest egg getting hit by a bear market (down 36.55%). The eight subsequent years have ALL been positive and the next egg is valued at $1,217,188 at the end of 2016.

    Flipping the returns around (so the bear hits in the ninth year of the ten-year period instead of the second)…so this lucky retiree has 8 years of positive stock market gains…ends better with the nest egg valued at $1,442,583. Of course, and the end of the eighth year it had ballooned to $2,258,497.

    Bengen and Trinity were important academic works that were insightful GENERALLY, but very, very dangerous for individuals to implement PERSONALLY.

    The safe/sustainable withdrawal concept is reasonable in theory but by now, everyone should know that they used historical data that no longer applicable. Said another way, they don’t work today. At all.

    A flexible approach in terms of income needed as well as time segmentation and other strategies help. But it is sheer fantasy to belive that a 4% withdrawal rate (forget a 4% withdrawal that increases x% a year) is sustainable.

    It is extremely difficult to “keep calm and carry on” when bear markets hit. Which they always have and always will. No one, knows when, why, how big, or how long.

    ER Dude, I looked a Reddit FIRE for about 5 minutes today. It seems rational and experienced financial, economic, and investment thinking is abhorrent to the denizens there. That’s five minutes of my life I won’t get back.

  10. Actually, the 4% rule was tested using data when annual dividend yields on stocks were closer to 4%. If you dig into the sources of returns ( dividends + capital gains), it is really obvious. In effect, the 4% rule makes the argument for living off dividends in retirement.

    Dividends are more stable and more predictable than stock prices, which makes them a very reliable source of income for retirees. Plus, dividends have increased at a rate that is slightly higher than the rate of inflation.

    Mr Bogle also wants retired investors to look not at the value of their portfolio, but at the income stream they get.

    1. Speaking personally, our annual budget is roughly $50K a year. Usually about $21K of that comes from dividend income. There’s probably a study in that as well, or maybe one’s already been done. Thanks for the comment!

  11. Thanks for summarizing the data. I’m a skeptic so I usually go to the source to confirm what I read especially on the internet. It’s nice to know the 4% rule is based on good data. Also good to know that FIREcalc is accurate.

    I recently reviewed the $75,000 income happiness paper by Daniel Kahneman myself and found that as with your review, the devil is in the details. Ignore them for simplicity’s sake to your peril!

    It’s reassuring to know that an MIT graduate financial professional gives us a great success rate at typical stock bond allocations over very long periods.

    I especially like that having between 50 and 75% stocks is the sweet spot because I’m comfortable there. I think Professor Joel Seigel comes to a similar conclusion regarding bonds and returns over long time horizons, although maybe not in the context of safe withdrawal rate.

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