Retirement Investor

Don’t Believe in the “Safe Withdrawal Rate”


You’ve been a good saver. Now, as you get ready for retirement, you begin to consider how you will use your retirement savings to generate monthly retirement income. Will you need the advice of a financial advisor? Sensibly, you conclude that you do. You have questions:

  • How much can I safely spend each month?
  • How much risk should I take?
  • How can I protect my financial security if my investments don’t perform well?

To answer these questions, you decide to contact several local financial advisors. You find that when it comes to generating retirement income from your investment portfolio, each advisor’s advice is the same: use the 4% Rule. After conversations with these advisors, you’ve come to believe that the 4% Rule is the best approach, or even the only approach to implement. 

What is the 4% Rule? It’s a popular methodology for producing income that states you will be able to “safely” draw down annual income beginning at 4% of your portfolio’s value, and then in each subsequent year, you’ll withdraw an amount adjusted for inflation based upon the Consumer Price Index (CPI). The Rule assumes that your portfolio is composed of stocks and bonds. 

The 4% Rule is like dollar-cost-averaging, in reverse. This is but one of its numerous flaws. When you are accumulating money, dollar-cost-averaging is an exceptionally good and well proven strategy for investing in stocks.  But reversing the process can be fatal to your retirement income. This is because selling stocks when prices are depressed removes your ability to enjoy gains once stock prices recover. In a prolonged downturn, it’s all too easy to ignite a downward spiral in your investment portfolio’s values that ultimately leads to having no income at all.  

Why do many financial advisors recommend the 4% Rule? In part, the past eleven years of unprecedented appreciation in stock prices has caused some to underweight risk. This recency bias makes for a dangerous mindset. 

It’s important to understand other weaknesses of the 4% Rule. For one, it was developed using “back-testing,” a process that creates projections of future financial results based upon historical investment performance. The  justification for the 4% Rule was based upon historical investment performance during the period between 1925 to 1995. But what is the value of relying upon  historical investment results when today’s economy looks so different than in the past? For example, in 1994, the 5-year Treasury paid an interest rate of 6.69%. Today’s 5-year Treasury pays a little more than 1%. 

In recent years, especially since 2008, we’ve seen major structural changes to the U.S. economy. Today, it’s credit growth that drives economic growth. In the Pandemic year of 2020, for example, to generate economic growth and to  keep pushing stock prices skyward, The Federal Reserve,  through the process of quantitative easing, pumped $3 Trillion into the U.S. money supply. The Fed’s balance sheet assets now stand at an unbelievable $8.6 Trillion. That’s a one-thousand-percent increase since 2008! Is it a coincidence that asset prices have climbed consistently during this period? It’s important to realize that we are living in a very, very different world, one with radically transformed drivers of growth. Ask yourself: how long do you believe the Fed can continue to print money in order to keep stock prices high?

In terms of advice for retirees, some in the financial services industry are beginning to focus on these changes. Morningstar recently completed an analysis that recommended lowering the allegedly “safe withdrawal rate” from 4% to 3.3%.  I credit Morningstar because it shows that people are rethinking the wisdom of relying upon outdated investment assumptions as justification for assumed levels of income that retirees can “safely” withdraw from their investment portfolios. 

However, I would go much, much further. In my view, there simply is no “safe withdrawal rate.” Why do I assert this? Because of a fatal shortcoming that lies beneath all of the many academic papers which have been written over the years and that have relied upon “back-testing” to promote the 4% Rule: They assume that the investor never sells any of his or her investments. Consider your own investing experience. During a scary period of market losses or volatility, has fear ever driven you to sell some of your investments? Selling throws the entire premise of the 4% Rule right out the window. 

Fortunately, there are alternative approaches to the 4% Rule. Depending upon your investing profile, other strategies may offer you big advantages. Next month I’ll describe an alternative to the 4% Rule that provides superior protection, and more.

David Macchia

David Macchia is Founder of Wealth2k, Inc. He is an author and entrepreneur focused on retirement security. David is the developer of the widely used retirement income solution The Income for Life Model® as well as the recently introduced Women And Income™, the first retirement income solution developed for women investors.

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