The 4% safe withdrawal rate (SWR) rule is like the quest for the Holy Grail. Us FIRE acolytes put the 4% rule on a sun-dappled pedestal and worship it like a golden idol . . . but I know of few in the FIRE community who actually follow its core tenets.
We tweak, sneak, and dance in and around the 4% rule to eke out an even better outcome, all while proclaiming in blogs, podcasts, or at dinner conversations that we actually really do sincerely actually believe in the 4% rule. Maybe. But there are caveats! But you can offset those. But, but but.
What gives? Why is FIRE so fickle about retirement math? Is the 4% rule real or not?
Core tenets of the 4% SWR rule
FIRE personalities reference the 4% rule like its one of the Ten Commandments. But most quote some bastardized version of it that meets their personal ethos, but may not meet yours.
So what actually are the core tenets of the 4% rule, as originally conceptualized by Bill Bengen’s Trinity Study in the 90s? Let’s take a peek under the hood.
4% SWR Core Tenets
- Assets needed to retire: 24.09X annual expenses (popularly rounded up to 25X)
- Safe Withdrawal Rate: 4.15% (popularly rounded down to a 4% soundbite)
- Portfolio: 40% Bonds / 60% stocks
- Inflation adjustments: Yes, yearly without fail
- Length of time money lasts: 30 Years
Pretty simple stuff, right? In short, if your annual expenses are ~$40K, you can retire with $1M, and then adjust annually for inflation no matter what.
So lets say the market crashes, sending your $1M nest egg down to $0.75M, and inflation is up 10% after year 1 . . . the 4% rule says you can increase your baseline withdrawal from $40K to $44K in year 2 (even though this is now ~6% of your new nest egg $0.75M amount).
This process repeats yearly where your spending increases and your portfolio gets whipped around by the market like a canoe in a vast ocean. It’s a wild ride some years but the data says your portfolio will hold up and last at least 30 years, even under the worst market conditions like the Great Depression.
FIRE’s take on the 4% rule
The FIRE movement is not a monolith, but the movement’s voice on the safe withdrawal rates is much more dynamic and adapts to a variety of factors that are ignored in the golden 4% SWR rule. The result is FIRE provides more a range than a target.
Laid out as core tenets, FIRE SWR looks like something like this:
FIRE SWR Core Tenets
- Assets Needed to Retire: 15X – 35X living expenses
- Safe Withdrawal rate: : ~3% – 5% portfolio. So Maybe 4% or . . . I’m Rob Burgundy? FIRE is as fickle about the SWR as a Beverly Hills Trophy Wife trying to choose a pair of leather stilettos.
- The Fire Portfolio:
- Stocks. 70 -100%
- Bonds. 0 – 30%
- Social security: Factor expected payout into future cash flow
- X-factor: side hustle, rental income, real estate crowdfunding, REITS, etc.
- Inflation adjustments: Resist, resist, resist. Okay sometimes take it, but overtime beat inflation
- Length of time money lasts: 30-60 years
At a 10,000 ft view, the FIRE movement and the 4% rule look sort of alike, but compared side by side, they differ on every core tenet.
Probably the biggest difference is in spending habits. The 4% rule is impractical theory where you spend the same inflation-adjusted dollars every year like a robot; in FIRE you flex your spending down when markets tank, which is what most people actually do in real life.
The FIRE movement’s identity then is not just to latch on to a wooden fail-proof 4% rule. The FIRE movement identifies itself as an improvement over the 4% rule, that will allow earlier retirement, a longer retirement, and a smoother retirement.
All fine and good, but FIRE’s modification of the 4% rule is not terribly instructive. FIRE retirement withdrawal teachings are all over the map, often contradictory, and can even be harmful if misapplied. The result is FIRE bends the 4% rule into an awkward pretzel that lacks a clear identifiable shape. FIRE may offer meaningful improvements to the 4% rule, but trying to replicate its scattershot teachings is like trying to catch moving water.
The updated 3.5% rule no one talks about
Secret Life of FI is full of opinions, but pulling the plug on employment and retiring early may be the most important decision you will make in your life. Such a decision should be based on data, not opinions.
So what does the data say if your retirement money needs to last 60 years? Modern financial authorities have run these simulations, and fortunately, a retirement that lasts 2X as long does not require 2X the assets.
Following the same wooden rules of the Trinity Study, an early retiree’s SWR drops just 0.5%. Using the traditional model, then, your SWR moves from 4% to 3.5%. This would mean you would need to save 28X your living expenses as opposed to 25X to be able to retire on a 3.5% SWR.
To put that in perspective, growing your savings from 25X in living expenses to 28X likely means working just one more year. With an average historical stock market return of 10%, one year of not touching your assets alone can grow your nest egg near the 28X mark, and a FIRE acolyte working one more year with a high savings rate can easily save/invest any gap leftover.
So is this the end? For traditional retirees, the Holy Grail is 4% SWR, and for FIRE, the Holy Grail is 3.5%? Is it that simple?
The answer: it can be. If you want to retire early with limited knowledge, research, or tools to adapt, then a 3.5% SWR can be your Holy Grail. Stop reading and get saving!
But help, my SWR changes daily with the market!
Yeah, you knew it wasn’t that simple, right? Life never is. Chances are if you consume FIRE blogs, you already know that personal finance math is not exact like algebra.
The 4% rule is designed to protect from apocalyptic events like retiring on the eve of the 1929 stock market crash/Great Depression and never collecting another dollar of earned income, never receiving Social Security/Medicare, and never altering spending habits but giving yourself a pay-raise every year, even while your neighbors are standing in breadlines. The 4% rule is designed around one extreme market high snapshot.
But as noted retirement finance wizard Michael Kitces points out, if you change nothing other than the time you take a snapshot of the value of your assets, your retirement math gets screwed up.
Your assets and thus your SWR can swing dramatically depending on whether your snapshot is the market peak, the market bottom, or somewhere in between. This creates the so called “timing paradox,” where your SWR can be 10% in some time periods and as low as 3.5% on the other extreme.
Here is an illustrative example. Lets say at the top of the 2007 bull market, you finally reach $1M and can retire and begin withdrawing $35K dollars a year adjusted for inflation (3.5% SWR). Oh shit, you waited too long and the market tanked so you kept working.
Fast forward to early 2009. Your initial $1M is down to $0.65M, making a $35K living expenses withdrawal ~5.5% of your portfolio instead of the 3.5%. You’re f*cked aren’t you? Guess you can’t retire until you are back at $1M, and that is going to take several years, right?
Wrong says the data. The same SWR market simulations that said you could retire in 2007 with a 3.5% SWR on $1M is still operative in 2009 in the middle of a stock crash, even though the math at that specific point in time works out to a much higher 5.5% asset drawdown. So you can retire at 3.5% SWR at the top of the market, and somewhere north of that depending on timing and severity of the market during a crash like we famously had in 2008/2009.
As we all know now, the market went on a historic 10 year bull run after that 2009 low point, recovering Great Recession sunk portfolios and then some. In short, Kitces argues that the same historical market data that says you can safely retire with a 4% withdrawal rate at any point in time also means you can retire with a higher SWR at any other point in time.
In other words, there is no SWR Holy Grail – trying to find it in an always volatile market is like trying to catch moving water. In reality, since market math is always changing, your SWR is always changing. Its not a single, fixed number target, but actually more of a range based on numerous factors. Here is a graphic that captures it:
Wait, so I can retire even earlier?
Actually, yes, you can! Extensive research done by Kitces, Bengen, and others show that the 4% rule is too conservative for all but a few apocalyptic points in time (i.e. the eve of the Great Depression). 90% of the time, the 4% rule leaves retirees with more money than they started with 30 years later, and a full 2/3rds end up with double or more.
In short, you can safely retire with a SWR higher than 4% (or with less assets), but the math gets lets precise. There is no crystal ball that predicts the market for the next 60 years, and thus, there is no exact science that tells you how much to raise your starting 4% SWR
With that said, stress tested data does give us some usable guidelines around which we can determine how much to raise the 4% SWR for our personal situations.
For the sake of brevity, I’m not going to dive into the technical: CAPE and P/E stock market ratios, shifting asset allocation specifics, variable withdrawal rules, etc. If you are a finance nerd, feel free to read up here, here, and here.
For the rest of us sane people, I’ll just provide a simplified version of Kitces’ “layer cake” SWR table, which will put this in non-finance nerd English. Basically, you started at a 4% baseline, and then you add or subtract to that number depending on a few factors.
This more personally tailored approach can yield outcomes as conservative as 3.5% or as high as 7%. This approach is more instructive than the standard 4% rule and it helps to solve the “timing paradox” where your assets (and thus SWR) gets whipped around by the market.
So for one extreme example, if an early retiree wants to pull the plug while the market is at a peak, then the SWR is 3.5% (think the October 2007 peak, before the Great Recession crash). On the other extreme, a 67 year old retiree may have a SWR as high as 7%, if they retire in a down market and are willing to aggressively cut spending when their assets are down. Think of a January 2009 retiree at the bottom of the Great Recession as an example.
Most FIRE acolytes are likely somewhere in the middle. Myself, I plan to retire at neither the market peak nor trough, so I can add 0.5% to my SWR. I also intend to aggressively dial down spending in down markets in retirement just like I have done in my work life, so I can add another 1.0%. After subtracting the 0.5% for early retirement, this table outputs an SWR of 5%.
The adjustable safety harness
Here’s the point: the 4% rule is nothing more than bumper guards on a bowling lane. It allows you to roll the retirement ball blindfolded to the market and still reach the pins without winding up in the gutter. Its less a rule and more of a safety harness.
But this safety harness is a little too safe 90% of the time, because the market is rarely that far in the toilet, and retirees rarely spend this robotically 30 years straight without adjusting as needed (or being backed up by social security).
The adjustable SWR approach allows this safety harness to be more tailored to the individual, opening even earlier retirement possibilities or higher spending opportunities for a more relaxed retirement.
So is the flexible SWR approach the new Holy Grail? It or some derivative of it probably should be. Shoot, for FIRE in particular, even just replacing the 4% rule with 3.5% would be more useful. Some FIRE bloggers have even suggested it. But it hasn’t caught on. Nothing else seems to roll off the tongue as easily as the 4% rule.
Everybody wants easy answers to complex questions. Retirement math is no different. For theoretical fail-proof retirement simulations, its certainly valid to keep using the 4% rule to arrive at a general retirement target. But it’s not the Holy Grail. You won’t follow it to a T, nor should you.
In practicality, those nearing the 4% threshold (25x living expenses saved) will be better served by arriving at an individualized target between 3.5% and 7% that is more appropriate to their unique circumstances.