Who hasn’t pondered the possibility of running out of money in retirement?
It’s a pervasive undercurrent in retirement planning for millions of Americans. The fear is particularly palpable for many of those nearing and living in retirement.
Bengen is the guy who proffered the celebrated “4% rule” for withdrawing money from retirement accounts decades ago, explaining how much retirees can safely spend each year without the well running dry.
He’s been refining that strategy ever since.
Here are edited excerpts of our conversation:
Kerry Hannon: How did you get fascinated with this question of whether people will outlive their money more than three decades ago?
Bill Bengen: I was a financial advisor then, a relatively new one. I was an early baby boomer, as were many of my clients. They were just starting to ask questions in the early ‘90s about retirement, which was some 20 years off for them, and how much they could spend and how much they needed to save.
When I tried to find answers to those questions in literature, from other advisors, from textbooks, there was nothing available. That’s really not surprising because at that time it was just starting to become a big issue because my generation was the first really to have such a long life expectancy in retirement.
If you retired in the ‘50s or ‘60s you might have looked forward to about 10 years of retirement, and that’s about it. But the rest of us now are looking at 20, 30, even longer periods of time.
Read more: How much should I have saved by 50?
Can you explain in the simplest way possible, what the 4%, now 4.7%, rule is?
I basically reconstructed the investment experience of hundreds of retirees from 1926 to date and tested them with various withdrawal rates from retirement accounts, primarily IRA accounts, over a 30-year period. And back in ‘94, I came out with a number, 4.15% as the lowest safe withdrawal rate for any person. So if you use that number, you would’ve always been successful with 30 years of withdrawals. It’s actually not something I recommend to everybody — it’s a very conservative number.
Did you ever expect when you came up with a 4% rule that this was going to become the gold standard?
Not a clue. I was doing it for my clients at that time. It’s an amazing thing.
One big problem I have found is that retirees don’t spend enough. Most people are so conservative. They’ll take only their dividends and their interest and try not to tap the principal.
That runs counter to the approach that I use. In most cases, people will be able to take considerably more than that safe withdrawal rate. You worked your whole life to accumulate all this wealth. Why not get the most out of it while you’re retired?
What does this mean in terms of how much you have saved in your retirement accounts?
If the withdrawal rate you choose is 5%, that means the first year you’d be taking out 5%. So you need 20 times your draw in the first year to start. So if you take out $50,000, you need to have a $1 million portfolio.
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What’s changed since your initial number to the new number today?
My research is more sophisticated. In ‘94, I was looking at a portfolio with two investments — US bonds and large US company stocks. That hardly qualifies as a diversified portfolio.
I’ve increased the number of assets and created a more diversified portfolio. I added small company stocks and micro-company stocks in the US, international stocks, mid-company-sized stocks. Each one of them has their own cycle of investing, and each contributes to the diversification of the portfolio and increases the withdrawal rate.
So diversification works?
Yes, as you increase the number of assets, you increase the withdrawal rates. I suspect it’ll probably peak out somewhere around 5% when you add in all the other assets.
I haven’t looked at gold, precious metals, commodities, real estate investments, and other alternative investments. There are a lot of other things folks can invest in and do invest in: bitcoin, for example. I think there’s a pretty good chance adding some of those to your portfolio will further enhance your withdrawal rate — assuming you get the performance out of the investments.
Author Bengen with a model of the Saturn 5 moon rocket. “Aerospace was my first love,” Bengen said. (Photo courtesy of William Bengen)
Can you talk a little bit about someone who’s retiring into an uncertain economic environment, whether it’s high inflation or a bear market?
My research shows that if early in retirement you encounter a bear market or sustained high inflation, your withdrawal rates are going to drop quite significantly. So if there’s anything you could do to avoid that in terms of timing your retirement, it’d be a good idea.
Inflation, in my opinion, is the greatest enemy of retirees, especially those who try to maintain a lifestyle with inflation. During the 1970s inflation was 8% or 9% a year for 10 years, and it devastated portfolios. That’s where we got the 4.7% rule from. The worst-case scenario was right there in the ‘60s.
What are the four free lunches that add to your withdrawal rate without adding an additional risk?
Diversification, rebalancing once a year — if you do those properly, you’ll give yourself an increase in withdrawal rates — tilting your equity allocations slightly toward small-company and micro-company stocks. Fourth, a rising equity glide path — starting with a much lower allocation of stock. Let’s say 30% to 40%, rather than the normal 60% that we might begin with, and increasing it each year.
When I tested that glide against my database, it resulted in an increase in withdrawal rate. Very curiously, it’s hard to explain why. We think it has to do with the fact that if you encounter a bad bear market early in retirement and you’re using this method, you’re going to have a low exposure to stocks. So you won’t be damaged that much.
After the bear market is over, the market always recovers and usually pretty strongly, and you’ll be buying into that.
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Parting thought?
The 4.7% rule is the worst-case scenario, and retirees should be looking for more. For today’s retirees, I’d probably recommend something around 5.25% to 5.5%.
Everyone is different. Personalize it for your situation.
