Capital Investment Advisors

#170- Why We Believe The 4 Percent Rule Is Here To Stay

Suze Orman recently called the 4 Percent Rule “very dangerous” and said, “It doesn’t work anymore.” In today’s episode, Wes joins forces with Connor Miller, Co-Chief Investment Officer for Capital Investment Advisors, to fight against those statements. Using market history, they defend the legitimacy of what they feel has been a solid retirement strategy since William Bengen discovered it in the mid-1990s. Giving specific examples, they lay out the case for this dynamic, flexible rule of thumb as a roadmap for a happy retirement.

Read The Full Transcript From This Episode

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  • Wes Moss [00:00:00]:I’m Wes Moss. The prevailing thought in America is that you’ll never have enough money and it’s almost impossible to retire early. Actually, I think the opposite is true. For more than 20 years, I’ve been researching, studying, and advising American families, including those who started late, on how to retire sooner and happier. So my mission with the Retire Sooner podcast is to help a million people retire earlier while enjoying the adventure along the way. I’d love for you to be one of them.Wes Moss [00:00:34]:Let’s get started.Wes Moss [00:00:36]:

    Your host, Wes Moss, along with Connor Miller. You’re in the studio. Welcome connor Miller.

    Connor Miller [00:00:42]:

    Good to be back on with you, Wes.

    Wes Moss [00:00:45]:

    I’m going to go right into this. Susie Orman slams the 4% rule. I think it doesn’t work anymore. I think it’s very dangerous. What? This is a headline while its creator, Bill Bangin now says it’s too conservative. What’s the new golden number for your golden years? This thing has made its way around the Internet, and Susie Orman, who is now famous for essentially saying, the way to not run out of money is to work until you die. Just keep working, keep collecting the paycheck, I don’t care how old you are. But she goes on to say Connor Miller. And the reason I’m bringing this up right out of the gate is that we here, our own team. You leading this effort when it comes to running these numbers. And this is a long historical study. This is not a small thing to run. What Bengan did, he did this back in the early 90s where he would choose a year every single year, all the way back to, I want to say, 1928. So he’s including the Depression and saying, what if you retired in January and February and March of 1928 and did it every single year to try to see what the optimal number is to pull out of your assets or be able to live on your assets without running out? The way I like to think about it is how do I max it out without running out? How do I use as much as I can without ever having the fear of running out of money? So arguably the greatest financial fear we all have. It’s the crux of retirement planning. It takes me a lifetime to save. Now I want to use it. And Susie Orman here is saying that you essentially shouldn’t. She says, quote, I would not be using the 4% Rule on any level. Why? Because there’s no way to predict what’s going to happen once you actually are living in retirement. Oh, wait, we don’t have crystal balls. That’s why we’re using history as a guide here. Susie and I know it’s Susie Orman, but just because she’s such a retirement planning wet blanket Debbie Downer, she’s saying that you can only withdraw up to 3% of your nest egg. And I’m not even sure she’s accounting for increasing that for inflation. So this is the crux of all retirement planning. Whether you have $500,000 that you’ve saved or two and a half million or five or $50 million, we’re all thinking about the same thing how do I use as much of as I can for as long as I can? And that’s what Bangin came up with. William Bangin, the aerospace engineer turned certified financial planner and really became the godfather of the 4% rule. And then a couple of years ago, Connor, he came out and said that 4% rule is too conservative. He said if you were to add small cap stocks to the allocation, he says you could really bump the rule up to four and a half percent. Now, this is a rule of thumb. There are very few in stone rules in the world of financial planning. This is just a really important rule of thumb. And I call it the 4% plus rule because Bengan is I side with Bengan on this because we’ve done it ourselves. We’ve run our own numbers, we’ve used our own assumptions. And the only assumptions that you really and let me maybe back up Connor. We’re going to talk about what the rule really says. So we save for 30 years or 40 years, and now we want to live, God willing, in retirement for 2030, maybe 40 years. If you retire early, super early at 50 and you’re going to make it to 100, you’ve got a half century. So it is a really long period of time. And inflation is a great nemesis to this because if as your costs get higher, your asset base has to grow or else it’s going to run down even more quickly. So the way that the original 4% rule works pretty simple. We’ll use a million dollars as an example. You start with 4% in the first year, and that gives you a dollar figure. It comes from a percentage, but the key here is the dollar figure of $40,000. And then the rule says that you’re going to every year in the future, adjust that $40,000 for whatever inflation is. So if inflation is 5%, then Connor, what’s the math on that 5%? You would up it by $2,000 per year, so it would go to $42,000 your next year. And that’s your new baseline?

    Connor Miller [00:05:18]:

    Yeah. So that you’re not adjusting your standard of living that you’re able to afford next year what you afforded last year.

    Wes Moss [00:05:25]:

    Ultimately it’s protecting your purchasing power. My purchasing power is protected if I can ratchet up what I pull out from my investments or I live on along with inflation. So then what Bengan said and looked at this at every iteration, every month from 1928 until he published this in the early ninety s. And then he’s redone this. We redid this in 2017. We started hearing, well, interest rates were low. There’s lots of chatter around retirement planning communities and Wall Street. That because interest rates are so low, the 4% rule doesn’t stand anymore. Well, here’s the good news. The good news is interest rates are back to more normal levels, more historically normal levels. Ten year treasury this week it was over 4.1%. So we’re not dealing with a 1% ten year treasury anymore. So bonds are paying something. Money markets are paying something. So if you’re able to look and see what Bangin said is that he gives us a probability. He says, well, if you’re only taking 4% and you’re ratcheting that number for inflation for a long retirement, then you’ve got an 80% to 90% chance, depending on when you retire, that you’re not going to run out of money by the time you have a 30, 40, or 50 year retirement. That was Bangin’s original thesis and what he proved out, or at least his evidence proved out. We’ve redone this. We’ve done it over and over again. And the most recent version, we did it as of what year?

    Connor Miller [00:06:54]:

    Connor our last starting year was 2013. So going all the way back to 1928, all the way through a starting retirement year of 2013. And then you got to make some assumptions thereafter to continue it out into the future.

    Wes Moss [00:07:08]:

    Explain that part of it.

    Connor Miller [00:07:10]:

    Yeah, like I said. So 2013, that’s ten years ago. We don’t want a retirement just to last ten years. We want to make sure that it’s going to be durable, it’s extend for the long term. And so you have to make some assumptions moving on past this year. Obviously, we don’t know what the stock market is going to do on a year to year basis. But generally speaking, using history as a guide, you can make some broad assumptions on what the stock market will do, looking at what the S and P 500 has done, what bonds will return you, and then ultimately what inflation could and should be as well.

    Wes Moss [00:07:44]:

    Okay, so for the assumptions moving forward, for the years that we haven’t experienced, we utilized 5% for stocks as at just an average annual rate of return.

    Connor Miller [00:07:54]:

    Which, by the way, is below the historical average of the market. So being a little conservative there, it’s.

    Wes Moss [00:07:59]:

    Below by a lot. It really is. Right? Depending on what tranche you’re looking at, stocks have really been double digit returns over 10, 20, 30 years, 10%, 11%, depending. So we’re using five in these assumptions. For bonds, we’re using a 3% rate of return. Again, the ten year treasury today is yielding over 4%. I would say that’s being relatively conservative. And the other way we make this even more conservative is because, remember, the nemesis of the running out of money is the ratcheting up of how much you’re pulling out because inflation goes up. So we’re assuming 3% inflation into the future every single year, year over year after year. I think I’d be remiss to not jump back to, say, another critical component of making the 4% rule work. Connor is that you have some sort of balance between stocks and bonds. And what Bengan also discovered in all of this analysis, and we’ve redone the study in the same way, is that if you’re only using, let’s say, 20% in stocks over that period of time, the longevity of your assets doesn’t look all that good if you’re using too much in equities, if you have a 100% stock portfolio. Because we have a couple of really big drawdown periods throughout the course of market history, of course, and we’ve lived through many of them just in the last 20 years. The damage to the portfolio is so big that it also cuts the lifespan short of being able to max out without running out. So interestingly, he found this optimal range of having a portfolio that had anywhere from 50% to 70% in equities. No more than 70, no less than 50. Then you start getting into either not enough growth to keep up or too much volatility with an all equity portfolio that digs you too big of a hole a couple of times in history. It’s really the balance that Bangin studied that I very much believe in around this rule of thumb that is our friend because for the most part, and this didn’t happen last year, but for the most part, when we have a bad year in equities, we’re going to have a decent year in bonds. And that is that ballast in an overall portfolio. Sure, you may have a bad year on the stock side, but if bonds are holding up or even accelerating, then you’re getting a steadier overall amount that you’re working with that can then provide income for you. So I think it’s a really important piece of the equation here. You’re taking 4% in year one. You’re taking that dollar amount you’re ratcheting up for whatever inflation is over time. These are all historical numbers since 1928, starting in every given month. And then we’re assuming we have a balanced portfolio. And for the years that still haven’t happened, because we’re trying to plan for 30, 40, 50 years out. We’ve got to use some assumptions. Connor we went back and said, let’s just be really conservative with those assumptions. So we’re saying stocks do five, bonds do three, and inflation ratchets every single year at a solid 3%. Now, remember, we had a lot of years where inflation was way under 3%. We had a decade and a half of one and a half to 2% inflation. Now we just had a one year period or two year period where it was much more than that. And now, as we know, CPI is back to the three range. So today we’re at 3.2%.

    Connor Miller [00:11:21]:

    And remember, the Fed’s long term target for inflation is 2%. So 3% 50% above the Fed’s long term target.

    Wes Moss [00:11:31]:

    So if we run these numbers, we’re looking at probabilities of not running out of money. And if you utilize the 4% rule and you use our assumptions here that are similar to Bengan’s assumptions. Again, real data. We use the S and P 500 and for the bond index, did we use the aggregate bond index or what was the exact index we used?

    Connor Miller [00:11:54]:

    Yeah, using the aggregate bond index as far back as we could go, and then using a blend of treasury bonds, essentially going back beyond the data that.

    Wes Moss [00:12:03]:

    We had when you’re in the 1930s and correct, the S and P 500 fell nearly 20% in 2022. Inflation jumped to double digits, and the Fed has continued to relentlessly raise interest rates. It feels like chaos, but at Capital Investment Advisors, we take a disciplined approach to investing to help our clients find happiness in retirement, regardless of the scary headlines. We can’t control the chaos, but we can control what we do about it. If you’d, like, help with your disciplined retiree strategy, reach out to our that’s your wealth. Susie Orman this last couple of weeks has been making its way around every single, almost any financial planning website that I’ve been on, or financial website I’ve seen. It keeps popping up. Susie Orman says the 4% Rule is dangerous. She would have, quote, no part of the 4% Rule. And that because you don’t know what’s going to happen in retirement, then that’s utilizing too much of your money. Essentially what she’s saying. So she’s saying you don’t have a crystal ball from what I have read, and she’s had some iterations, but she’s really getting aggressive now in the last couple of weeks around this, from what I can tell. She’s essentially saying the only way to not run out of money over time in retirement is to, one, continue to work and work and work until you die, and never touch anything in your nest egg. And that way you won’t run out. Is that essentially what she’s saying?

    Connor Miller [00:13:47]:

    That’s what it sounds like. I mean, she specifically says she wants you to work until at least 70 now. At least? At least 70? Yeah. It doesn’t sound like she really wants us to spend any of our money, which really could be a self fulfilling prophecy at that point, because if nobody’s spending money, then economy is not going to do too well.

    Wes Moss [00:14:07]:

    It doesn’t sound very good for the economy either. Right. No. Spending working forever would be good. So that’s productivity.

    Connor Miller [00:14:15]:

    But if no one’s spending their money, then no one needs to work.

    Wes Moss [00:14:20]:

    That’s true. So again, it’s not only is this a wet blanket when it comes to retirement planning, it’s also terrible for the economy. And I just think psychologically it shuts people down. Wall street is always well, Wall Street for many years, to me, sends the messages, it’s never enough. If you have a million dollars, you should really have two if you really want to retire. If you have $2 million, you really should have five if you really want to retire and inflation makes it so that your cost of living goes up so dramatically, you need more than you ever thought. But at some point, you have to sit down and get realistic about what we can achieve. What can we do? We’re working for 30 or 40 years. We can’t work forever. Moss humans can’t do that. So there’s got to be some sort of planning balance. There’s got to be some sort of goal in the future that we can try to hit, so then we can utilize the hard earned savings and investments that we’ve worked so hard to save over the years. We try to take a step back and say, well, what is realistic here? William Bangon, the famous aeronautic engineer who turned certified financial planner back in 19 90 91, published his 4% rule. We call it a rule of thumb. And it works not perfectly because it’s a rule of thumb. It’s not etched in stone. It essentially says you can pull out 4% a year from your initial dollar value. So 40,000 on a million, and then ratchet that up every year for whatever inflation is. And yes, when we go through 10% inflation a year, you’re ratcheting up 40,000 by $4,000, and that’s your new high watermark. And then the next year, if it’s another 10%, it’s 10% on 44,000. We’re accounting for inflation. But if you’re looking at the numbers, what’s really interesting here is that as long as you have 50% in stocks and again, when banging into the study and when we redid the study, we used at least 50% of a portfolio in the S and P 500 actual retirees going back to the late 1920s and then the aggregate bond index. So that’s the other part of the overall investment equation.

    Connor Miller [00:16:37]:

    I do want to say I think that inflation piece is really important too, because you could be saying, well, hey, we’ve had last year, we had 9% inflation. Does this rule still apply? But going back to 1928 encompasses all of those periods of high inflation before it’s got the 70s in there. And so even in periods of elevated inflation, this rule of thumb has proven to have a high probability of success.

    Wes Moss [00:17:04]:

    And really the success measure, and that’s such a good point, Connor, is that this is a probability of not running out. That is what is, quote, success when it comes to the way we’ve run this and the way the numbers work out here. 90% of the time, utilizing this rule, 90% of the time money lasts 40 plus years. That’s a pretty good rule of thumb to go on. 94% of the time money lasts 35 plus years. And then 98% of the time money lasts 30 plus years.

    Connor Miller [00:17:38]:

    And the two years where it didn’t last 30 years, you know, how many.

    Wes Moss [00:17:42]:

    Years, how long did it last, those two fateful percents?

    Connor Miller [00:17:45]:

    29 years.

    Wes Moss [00:17:46]:

    29 years. So as long as you’re investing in a balanced, diversified way at least that’s what this study has done. Your money really should last 30 years. Now you could make the case that if you retire at 60, that only gets you to 90. And that’s true. But here’s where the reality of planning really comes in, because this is a rule of thumb. How do you then take off that 2% chance that you might run out or the 10% chance in one out of ten cases it doesn’t quite work? Well, that’s not all that difficult to solve for either. And that goes back to being sensible around your retirement planning and thinking of this in a couple of different ways. One, of course, retirement planning is not a straight line. So it’s never been, it never will be, going back to what Susie says, which is there’s going to be unforeseen things that happen in retirement. Of course that’s life. But these rules are really just guidelines and they’re not etched in stone. So flexibility is a key. It’s not a straight line. Which brings me to use a range in the 4% range dynamically. Maybe there’s some years when you can get away with only needing three and a half percent from your retirement portfolio and that’s going to be enough. Maybe you’re going to have some years when it has to go to 5% or maybe even a little bit more than that. And that’s the reality. Connor as we work with families, I’ve seen this over and over and over again. Very rarely does anybody stick to their exact 4% rule. They may have years where they don’t need as much and they have years and they say, look, I’m going to build a new barn and it’s going to cost me $50,000 or $80,000. I’m going to need a little bit more than my 4%. Okay, noted. That means that in the future we may want to be looking at scaling back a little bit, at least for a year or two. So this is a continuum. It’s a continuum, I think anywhere from three and a half percent to 5% in some years. But we want to try to get back to that average of around four, maybe slightly higher than that. So that’s what I’ve seen in 20 plus years of doing this. And then number three on, I would say, my caveat list, or let’s put this to work in the real world list, is that the real world supports a four and a half percent withdrawal rate. So Bengan came back, william Bangin, the grandfather of this rule, originally came back and said this a few years ago. Barron’s published this and said when he originally did the study, he looked at large cap equities with the S and P 500 and the aggregate bond index going back, call it 80 some years. But what he redid, he said, well, small cap companies, even though they’re more volatile, they do have overall higher returns over the course of time. So let’s say as an example, large cap stocks have been around ten. They’ve been a little more than that, but let’s just say ten and small caps have been more like twelve. So he said, what if I utilize instead of only having large cap stocks, what if he introduces to his model 10% of the overall investment? Pie to small caps have a slightly better rate of return and in doing so he gets similar probabilities of money not running out over these 30 plus year periods of time, even using a four and a half percent withdrawal rate. So Bang in here is saying, look, you could even model out four and a half percent. Susie orman is recently saying you can’t do anything more than three. That’s a huge difference. And I want to just put that in context here. So using four and a half percent versus using 3% connor is, let’s call that 50%. That’s a 50% difference.

    Connor Miller [00:21:42]:

    Yeah. On a million dollars you can take $45,000 versus someone else telling you to take $15,000, less $30,000 a year.

    Wes Moss [00:21:51]:

    So it’s a 50% difference between these two. It’s really a great divide and there is no perfect answer and there is no one that is perfectly right in this. So Bangin is not perfectly right. Susie’s certainly not perfectly right. And we’re trying to be the arbiter here and just look at this practically speaking, which brings us to the timing of this. So you’re probably thinking what’s the worst period of time? In my mind, I would think right out of the gate, if you retired right at the beginning of the Great Depression, I would have guessed that’s probably the worst period of time to retire. The stock market went down, the economy was terrible, we had kind of a yoyo inflation to me, without looking at the numbers before we did this, I thought that’d be the ultimate worst time. Ironically, the worst time, and we call this getting into the danger zone, was not during the Depression. And then if I would have guessed so we’re going to get to what’s the kind of the worst time when money does run out and ready for the gasp, 29 years. But we do have these two different zones, so we call the danger zone and we have what’s called the buffett zone. The buffett zone, I would say, is a little more fun to talk about. And you get into a buffet zone anytime your annual withdrawal rates drop below a 2% level. So imagine you start out year one, it’s 4%, but you had the great fortune that inflation was low for a while right as you retired and the stock market, so at least half of the overall portfolio did really well. So you had a lot of growth and you didn’t have to ratchet up your spending all that much because you had fortunate timing. And now if you chose to stay disciplined and not go beyond the rule now your withdrawal rate drops because you’ve got this larger portfolio and you haven’t increased your spending. So you end up where in some cases, you get a withdrawal rate that goes below 2% per year. And I think one of the best examples of that is if you were retired in 1950, the numbers get really pretty almost. They get very buffett like. That’s why we named it the buffett zone, meaning that if you stick to your guns and you never spend more than your 4% year, one even ratcheted for inflation. If you retire 1950 because markets did so well and inflation was so low for so long, then you ended up with a really low withdrawal rate about 1213 years in. By 1963, the withdrawal rate had dropped to 1.9% because the portfolio had grown so much. By 2009, this original million dollar investment that we’ve run this with grew to over $50 million. And then by 2013, it was 75. And by the year 2020, Connor, it was over what, way over $100 million? Yeah.

    Connor Miller [00:24:46]:

    This is really like the generational zone, right? This is when you stop thinking about yourself and just thinking about the next generation, who you’re going to pass this to.

    Wes Moss [00:24:54]:

    But that’s the other way to think about this dynamically. If you end up retiring at a really good time, you’re probably not sticking to your 4% number because the markets have done so well, you’re probably going to spend a lot more. So you’re not going to just sit there and have the discipline if 50 years later, your million dollar has turned into 50 million. So I think it works both ways. Now, in the danger zone, this is anytime your withdrawal rate gets over 6%. And one of the worst times wes retire would have been mid 1960s when we ended up with bad markets, particularly in the early seventy s and super high inflation. So your $40,000 very quickly was 50, 55, or $60,000. And again, if you run that linearly and never change it, your withdrawal rate ends up over 6%. And then you go into this, what we call this danger zone spiral. And as an example, this is the very small 2% scenario. Only 2% of the time over the course of this whole study when money ran out in less than 30 years, in this case, 29 years. So it still lasts almost three decades. And I think we’ll wrap up on that note. Connor Miller, man, thank you so much for being here. Awesome input today. Thank you for bringing so much of this together.

    Mallory Boggs [00:26:12]:

    Hey, y’all, this is Mallory with the Retire Sooner team. Please be sure to rate and subscribe to this podcast and share it with a friend. If you have any questions, you can find that’s You can also follow us on Instagram and YouTube. You’ll find us under the handle Retire Sooner podcast. And now for our show’s disclosure. This information is provided to you as a resource for informational purposes only and is not to be viewed as investment advice or recommendations. Investing involves risk, including the possible loss of principal. There is no guaranteed offer that investment return, yield or performance will be achieved. Stock prices fluctuate, sometimes rapidly and dramatically due to factors affecting individual companies, particular industries or sectors, or general market conditions. For stocks paying dividends, dividends are not guaranteed and can increase, decrease or be eliminated without notice. Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Past performance is not indicative of future results. When considering any investment vehicle, this information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Investment decisions should not be based solely on information contained here. This information is not intended to and should not form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment tax, estate or financial planning considerations or decisions. The information contained here is strictly an opinion and it is not known whether the strategies will be successful. The views and opinions expressed are for educational purposes only as of the date of production and may change without notice at any time based on numerous factors such as market and other conditions.

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