What is the 4% rule?
The 4% rule gained popularity in 1994, when financial adviser and MIT graduate William Bengen attempted to answer a question brought to him by a number of clients: “How much can I spend in retirement without running out of money?”1.
Bengen looked at U.S. historical data going back to 1926 in order to answer this question. Bengen’s analysis looked at a 65 year old couple, with a 60% stock and 40% bond portfolio, who would need their savings to last 30 years. Based on this work, Bengen concluded that even in 1966 (the worst case scenario) a 65 year old couple could draw-down 4% of their retirement savings each year for 30 years without depleting their nest egg.2
These findings were published in the October 1994 edition of the Journal of Financial Planning and have stuck with investors and advisers ever since.
International Success of the 4% Rule
Bengen’s research relied on U.S. stock and bond market returns between 1926 and 1994 – a time when the United States became the world’s leading superpower. The table above details how successful the 4% rule would have been for retirees in other developed countries for which there is sufficient financial market data.
As the table details, success rates for the 4% rule would have been below 50% for a number of European countries. That is to say – more than half of retirees with a 60% stock, 40% bond, portfolio using the 4% rule in Italy, France, and Germany would have outlived their nest egg. This compares to a 95% success rate in the United States over the same time period.
What will be the success rate of the 4% rule for American retirees in the 21st century? While it seems reasonable to focus on U.S. historical data, who is to say whether the future experience of retirees will be similar to our past, or whether it will be more reflective of situations experienced in other countries? Based on current market conditions, it is very possible that a 4% draw-down of savings will not be sustainable for American investors in the 21st century. Now is the time to speak with a financial professional who can help address the risks, and opportunities, facing your retirement years.
2 Bengen, W.P. 1994, “Determining Withdrawal Rates Using Historical Data.” Journal of Financial Planning 7, 4 (October): 171-180