The Problems With The 4% Rule
Without a doubt, William Bengen´s research which culminated in the 4% Rule in the 1990s revolutionised retirement planning. Bengen proved that historically a US retiree could take an initial income of 4% from his portfolio and increase this by the rate of inflation for 30 years and not run out of money.
An Inflation-Linked Income May Not Be The Ideal
- Real levels of spending were maintained during the first decade followed by spending falling in real terms.
- “Smiley Face” spending – initial real spending levels reducing to a minimum then increasing due to medical and welfare costs.
- Select an initial withdrawal rate. For the UK 2.5% to 4% and US 3% to 4.5%.
- Withdraw the first income at the start of retirement
- At every annual anniversary:-
- If the portfolio value is greater than the initial portfolio value increase the income withdrawal by the rate of inflation. If not greater withdraw the same amount as the previous year
- If the actual portfolio value is 1.5 times the initial portfolio then take a bonus of 5% of the difference between the actual and initial portfolio value.
- The initial withdrawal rate has little effect on the total income received during retirement but the higher the rate the more income received during the first 15 years.
- The bonus is optional. If you don´t take the bonus the final legacy will be higher.
- The income will not reduce in nominal terms but may do so in real terms.
- The strategy has been tested on 35-year retirements from 1920 to 1985 for the UK and US-based on a 60/40 equity/bond portfolio with costs assumed at 0.3%.
- Increasing the equity proportion increases the income received and final portfolio balance.
A Higher Margin of Safety
Comments on US Data
- The US Bengen safe withdrawal rates are significantly higher than those for the UK (US Bengen 3.85% v 3.1%)
- The US MaxVar SWR is slightly higher than that of the UK (4.5% v 4.4%).
- Optimum SWRs for Bengen and Max-Var are 40% to 60% and the SWR for MaxVar declines with equity content over 50%.
- Income from MaxVar is on average 40% higher than from Bengen (70% higher in the UK).
- Provide greater safety from the sequence of return risk
- Produce more total income than the classic Bengen inflation-linked income
- Produce more income during the first years of retirement
- Offer a higher Safe Withdrawal Rate than Bengen
- Allow the retiree balance income against potential legacy
- Automatically adjusts income to portfolio performance