Despite being a giant in retirement planning, Bill Bengen is a humble chap.
He was a financial advisor in the US in the early 1990s trying to figure out how his clients, mostly Baby Boomers like him, needed to save for retirement to ensure they wouldn’t run out of money.
It was becoming a pressing question at that time because his generation was the first to have a long life expectancy in retirement.
Bengen sifted through the academic literature for answers on the topic but couldn’t find anything of use.
So, he investigated the data himself. He wanted to find how much retirees could safely spend each year without the well running dry.
He looked at what would happen if someone retired every year since 1926, and what the outcome would be based on different withdrawal rates - the percentage of your retirement savings that you can safely withdraw each year to ensure your money lasts throughout your retirement.
Bengen was aware that the US had seen some torrid stock market downturns, such as the 89% peak to trough fall during the Great Depression, and the 34% decline in 1973-1974. And he knew that these kinds of bear markets could be harmful to retirees, especially if they happened early in retirement (so-called sequence of returns risk).
Bengen wanted a fixed withdrawal rate that could outlast any 30 year period, even the worst ones.
Using a portfolio of 50% US stocks, 50% US bonds, he found that a starting withdrawal rate of 4.15%, with the initial dollar amount adjusted thereafter for inflation, would ensure a retiree wouldn’t run out of money over a 30-year period.
That 4.15% became the ‘4% rule’, and it ended up revolutionizing retirement planning. It became a simple rule that advisors and their clients could use.
It meant retirees could easily calculate how much they needed to save for retirement - by simply dividing the amount of money they would like to spend each year by the withdrawal rate. So if they wanted $50k each year from their portfolio at a 4% withdrawal rate, they could divide $50k by 4%, equalling $1.25 million.
How 4.15% became 4.7%
Critics of Bengen thought his 4% withdrawal rate was too low. But Bengen himself admitted it was very conservative, based on surviving worst-case scenarios.
Like other advisers, Bengen subsequently found that many retirees didn’t spend enough. They’d take their dividends and interest and try not to tap their principal. That ran counter to the 4% rule though Bengen copped some of the heat anyhow.
In his new book, A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More, Bengen, now retired, has refined his research and come up with fresh strategies to ensure people get the most out of their retirement.
He’s tinkered with the data, and instead of using a 50% equities/50% bonds portfolio as he initially did, he increased the number of assets and created a more diversified portfolio – adding micro, small and midcap stocks in the US as well as international stocks.
Each one of the additions increases the withdrawal rate that retirees can use. Consequently, Bengen has changed his estimate of a safe withdrawal rate from 4.15% to 4.7%.
Again, that’s a conservative number, and Bengen suggests that he’d probably recommend 5.25-5.5% for today’s retirees.
The biggest enemies for retirees
Bengen says inflation is the biggest enemy for retirees. In the 1970s, US inflation averaged 8-9% per annum. It destroyed many retiree portfolios. That period had significant input into his 4% rule.
The other enemy is a bear market, especially a prolonged one. In America, there were two severe bear markets in the first half of the 1970s. Combined with high inflation, retirees were impacted not only by nominal portfolio declines, but it was worse when adjusted for inflation.
Bengen says if you can avoid periods of high inflation or a bear market at the start of retirement, then things should turn out fine (much easier said than done).
The ‘free lunches’ for retirees
Bengen says there are four ‘free lunches’ that can add to your withdrawal rate without adding additional risk:
- Diversifying your portfolio
- Rebalancing once a year
- Slightly tilting your equity allocations to microcap and small cap stocks
- A rising equity glide path
The last point needs elaboration. Bengen suggests starting with a lower stock allocation of 30-40%, before increasing it each year.
Bengen says the data indicates that this results in a higher withdrawal rate.
He admits he was surprised by the results, though they make some sense. If you encounter a bear market early in retirement, having low stock exposure will protect you, and when markets rebound, you’ll be buying into that through your rising equity glide strategy.
His other piece of advice is that everyone is different and your retirement portfolio and spending should be customised to suit you.
James Gruber is Editor of Firstlinks.