Minimizing the odds of actuarial ruin (outliving your retirement savings)

Retirement Drawdown: Tips to Make the 4-Percent Rule Work


The four-percent rule was introduced in a landmark paper published by William Bengen in 1994. Earlier this year, Chris O'Flinn and Felix Schirripa published a significant update to Bengen's paper. The duo used Bengen's historical methodology but looked at all retirement periods beginning each month since 1926, substantially increasing the number of data points. They were able to reflect the investment experience up through June 2009, including the most recent meltdown. Here are a few key points and conclusions:

For Retirement at Age 70 or Later

For all 20- and 25-year retirement periods, the four-percent rule reflected no instances of actuarial ruin with a portfolio invested 75 percent in stocks and 25 percent in bonds (a 75/25 portfolio). For a portfolio invested 50 percent in stocks and 50 percent in bonds (a 50/50 portfolio), there were no failures for 20-year retirements, and only a 2 percent failure rate for 25-year retirements.

Conclusion: The four-percent rule appears to be safe if you're retiring at age 70 or later, since a portfolio with a 25-year retirement goal would have very high odds of lasting until age 95 and later. I think targeting a retirement that lasts until age 95 is a reasonable goal.

For Retirement at Age 65

For all 30-year retirement periods, the four-percent rule failed only 4 percent of the time for a 75/25 portfolio, and 8 percent of the time for a 50/50 portfolio.

Conclusion: You could use the four-percent rule if you retire at age 65, but be ready to make mid-course adjustments under certain circumstances, as discussed below.

For Retirement Before Age 65

For 35-year retirements, the four-percent rule failed 8 percent of the time for a 75/25 portfolio, and 15 percent of the time for a 50/50 portfolio. For me, these failure rates are too high to guarantee peace of mind for retirements well before age 65.

Conclusion: I believe that 35 years is just too long to be withdrawing principal from your retirement accounts. Too much can go wrong during that long of a period. Instead, if you're retiring before age 65, I'd recommend living on just the interest and dividends of a portfolio balanced between stocks and bonds, at least until age 65 — and until age 70 would be even better. That strategy produces withdrawals of about 3 percent of your portfolio. I'd also suggest you work part time if you need additional income to meet your living expenses.

The O'Flinn/Schirripa paper also showed that the four-percent rule failed when there was high inflation and/or poor stock market returns early in a retirement period. Examples are retirements that started in the mid 1960s to the mid 1970s, and retirements that started before the significant stock market crashes during the Great Depression. Monday morning quarterbacks would give you this advice: Don't retire before the market crashes or before there's high inflation!

Comment: Confusing stuff. In all of our models, retiring before 66 does not work for us. One has to laugh about the last sentence: "Don't retire before the market crashes or before there's high inflation!". Who's going to know that!? My own model suggests that living in a high state income tax state (think Minnesota) won't work in the long run. Of course one could always die young but one never knows. Kathee's parents lived to 73 and 78. Mine 81 and 90+ (Mom is still alive).

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