For those of you without cushy pensions, I’m sorry folks. The 4 percent rule is outdated. It is now unwise to follow the 4 percent rule as a proper safe withdrawal rate in retirement. Instead, I highly recommend lowering your safe withdrawal rate closer to 0.5 percent to 1 percent for the first year or two after you retire.
The Federal Reserve and the Central Government have made reaching financial independence and living off only retirement income more difficult. Interest rates have come way down, which means it requires a lot more capital to generate the same amount of risk-adjusted returns.
As a retiree or soon-to-be retiree, taking on more risk is exactly the opposite of what you should do. Once you have won the financial game, your goal is to never go in reverse again.
This is a long article. Therefore, if there’s one thing to remember, it’s this equation:
Proper Safe Withdrawal Rate = 10-year bond yield X 80%. If you follow this safe withdrawal rate formula, you are going to do just fine in retirement.
The Evil Fed And Government
After sending out my weekly newsletter saying we should all be thankful to the Federal Reserve for bailing us out, a number of readers sent angry responses. Here is one of the more lengthy ones.
The Fed is terrible.
They create debt, they print money, they weaken the dollar, and they create socialism. They also ensure there is an unhealthy power grab at the central government. We now accept that the central government is the babysitter, mother, and protector of us when we stub our toes financially, physically, or by other means such as a national disaster.
The Fed has NEVER been audited. I’m sure you know that. It’s also a private business made up of private bankers that control our money supply.
Need some QE? Here comes the Fed with their massive printing press and voila! We have more money in the system. Need to artificially support the stock market? Voila! Here comes the Fed with massive money pumping and now we have industries that are protected by US tax dollars.
So to me, this isn’t positive news because the elephant in the room needs to be fed. We are simply kicking that can down the road so we can continue buying all our toys, big homes, and make believe that everything the US government and the Fed are doing is good for us.
It’s only good for bankers. We are the sorry fools who have to pay the tax bill on 27 trillion in debt….and it’s still growing.
The Government May Want Us To Work Forever
The commenter has a point here. So let us bottle up his rage and share what it really means for people who want to achieve financial independence.
We will eventually have to pay back our debt in the form of higher taxes. Or we will have to eventually implement austerity measures to control our budget. Both are likely to happen. We just don’t know when. Perhaps our children and our grandchildren will foot the bill.
Let’s say we all agree that the Federal Reserve and the Central Government are terrible for Americans.
They shouldn’t have unleashed trillions in stimulus money to save us from another great depression. Maybe they should have let the stock market collapse and tens of millions of unemployed people go into financial ruin.
After all, a free market is a fundamental point of capitalism. Let’s just make sure that anybody complaining about the Fed and the central government give back their stimulus checks and enhanced unemployment benefits.
At the same time, all of us deserve to eventually retire and live a life with less financial stress. Nobody wants to work at a job they dislike until they die.
For those who haven’t been regularly investing, the Federal Reserve and the Central Government have turned the game of life on extreme hard mode.
The proper safe withdrawal rate has plummeted because interest rates have plummeted. You now need to invest a lot more capital to generate the same amount of risk-adjusted returns.
Maybe our government wants us to work forever to fund their massive spending! See image below.
The Proper Safe Withdrawal Rate Has Changed
Due to a record amount of stimulus created in a record short amount of time, interest rates have dropped faster than a cement block tied to a dead body thrown off a boat in the middle of Lake Tahoe by one of Capone’s capos.
The 10-year bond yield is at ~1.1%. It will likely stay at depressed levels for a long time.
At a 1.1% risk-free rate of return, $1 million will only generate $11,000 a year in risk-free, pre-tax income. Below is a chart that illustrates the sad drop in risk-free income from $1 million over the years. At least the 10-year bond yield has rebounded from a low of 0.51% in August 2020.
If you’ve got your home paid off, your health insurance covered, and your kids all grown up and independent, $11,000 + Social Security will provide for a very simple retirement lifestyle.
Even if you got the maximum Social Security monthly payment of about $2,900 a month or $34,800 a year, you’ve only got $45,800 a year in income. You’re not popping Cristal off your yacht with only a $1 million net worth.
Unfortunately, the average Social Security payment is closer to $1,500 a month instead. Therefore, we’re really talking about an average annual Social Security benefit of $18,000.
Once you’ve reached financial independence or retirement, your risk profile goes way down. This is why using a safe withdrawal rate closer to a risk-free rate of return makes sense.
Assets Returns Are Intertwined With The 10-Year Yield
Returns in the stock market, bond market, and real estate market are all relative to the risk-free rate of return. If the risk-free rate of return declines, so do overall returns for risk assets ceteris paribus.
No matter how you want to construct your retirement portfolio (60/40, 50/50, 30/70, etc), returns are likely going to be structurally lower. Let me share some explanations.
Example #1: A company looking to raise money to fund operations isn’t going to issue a corporate bond that pays 8%, unless it’s in dire straits. Instead, a company will probably discover that adding a 2% – 3% interest rate premium to the 10-year bond yield will garner enough demand. A company’s goal is to raise capital as inexpensively as possible.
Example #2: A company has historically paid a 60% dividend payout ratio. During the ups and downs, the company’s dividend yield has range between 3% – 4%. The company has always wanted its shareholders to earn at least a 1% premium to the 10-year bond yield. With the 10-year bond yield down below 1%, the company can now cut its dividend payout ratio and provide closer to a 2% yield. The company can then keep more retained earnings for growth and operations.
Example #3: Let’s say you want to take advantage of potential distressed asset opportunities in commercial real estate. One common way commercial real estate professionals measure is the spread between cap rates versus the 10-year bond yield. The wider the spread compared to the historical average, the more profit potential there is.
With the coronavirus, the current office cap rate vs. 10-year treasury yield spread is at its highest in history. As a result, you sign up for CrowdStreet for free, one of the top real estate marketplaces to get alerts on any upcoming deals to take advantage. CrowdStreet and sponsors are actively looking for distressed deals for you before they are profit-seeking like you.
Plan Financially Beyond Yourself
Using the 10-year bond yield as a barometer for retirement income generation is conservative. However, I also believe the ideal withdrawal rate in retirement doesn’t touch principal so long as your estate is below the estate tax threshold.
One of the big reasons why Americans are in so much financial trouble is because most only plan for themselves. When you start planning for your children, you are forced to at least put on your oxygen mask before helping others.
If your estate is above $11.58 million per person, feel free to increase your withdrawal rate to whatever you want. Paying a 40% death tax rate on every dollar above the estate tax threshold is a crying shame. With Joe Biden as president, he will likely try to cut the estate tax threshold in half.
Why The 4 Percent Rule Is Outdated
The 4 percent rule was first published in the Journal Of Financial Planning in 1994 by William P Bengen. It was subsequently made popular by three Trinity University professors in 1998 called the Trinity Study. Inflation and interest rates were much higher and pensions were common. The 4 percent rule is the most common safe retirement withdrawal rate cited.
Some like to naively claim that they are financially independent once they achieve a net worth equal to 25X their annual expenses. But if you think logically, there’s a big problem with the 4 percent rule.
Let’s look at where the 10-year bond yield was back when the Trinity Study was published in 1998.
In 1998, the 10-year bond yield was between 4.41% to 5.6%. Let’s say the average 10-year yield rate was 5% in 1998.
Therefore, of course you’d likely never run out of money in retirement following the 4 percent rule. Back then, you could earn 1 percent more on average risk-free! And if you looked at the 10-year bond yield in 1994, it was even higher.
If you had a classic 60/40 stock/bond portfolio, the historical return was about 8%. You were golden. Going forward, I’m not so sure with both bonds and stocks at all-time highs. Valuations for both asset classes are expensive.
See the historical chart of the 10-year bond yield below.
I really hope people who blindly follow the 4 percent rule or the 25X expenses rule realize this very important point. Everything is relative when it comes to finance. To use a rule today that was created when the 10-year bond yield was much higher is irresponsible.
20X Gross Income Net Worth Target
If you want to follow a more reasonable net worth target goal, then try to amass a net worth equal to 20X gross income. Only then, do I believe you might be able to declare yourself financially independent.
With my 20X gross income rule, you can’t cheat by simply lowering your annual expense budget. The 20X gross income rule forces you to accumulate more wealth as your income grows. It also makes you better decide whether you want to continue your way of life.
That said, even the 20X gross income rule may still not be high enough if you want to ensure that you don’t run out of money in retirement.
The New Safe Withdrawal Rate To Follow
If you provide a similar 9% to 28% discount to the 10-year bond yield to come up with a safe withdrawal rate back in 1998, then the safe withdrawal rate in 2021+ is equal to 10-year bond yield X 72% – 90%.
In other words, the new safe withdrawal rate in 2021+ is even lower than just withdrawing based on the 10-year bond yield rate. And you thought my withdrawal rate was too conservative.
When the 10-year bond yield was at ~0.7, a safe withdrawal rate was actually closer to 0.5% – 0.63%. When the 10-year bond yield was at its low of 0.51%, the safe withdrawal rate was equivalent to 0.36% – 0.46%.
To make things simple, the new safe withdrawal rate equals the 10-year bond yield X 80%.
We can call this the Financial Samurai Safe Withdrawal Rate (FSSWR) if you’d like. This is my proprietary methodology of estimating a proper safe withdrawal rate.
We’ll use an average 20% discount to the 10-year bond yield to come up with the safe withdrawal rate. The 20% can be viewed as a buffer in case of financial emergencies, bear markets, poor spending habits, and a further decline in interest rates.
Thanks to a steady decline in interest rates, the 4 percent rule from the 1990s has declined by over 85%. In other words, we should change the name of the 4 percent rule to the 0.5 percent rule.
As a rational believer in the new safe withdrawal rate percent rule, you have a desire to not run out of money in retirement and leave some of your wealth to your kids and various charitable institutions.
If you’re OK with spending all your money and leaving nothing, then the 20X gross income rule as a net worth target before retiring is probably good enough. If not, carry on reading.
Proper Safe Withdrawal Rates
To make things easy, I’ve put together the proper safe withdrawal rates in retirement. Given the 4 percent rule was popularized when the 10-year bond yield averaged 5 percent in 1998, we can multiply various 10-year bond yield rates by 80% to come up with an appropriate safe withdrawal rate.
Realistically, we are likely never going to see a 10-year bond yield above 5% in our lifetimes.
The New Safe Withdrawal Rate Rule Is The Reality
Although the new safe withdrawal rate rule may sound extreme, it is based on financial reality today. 2021+ is a very different time than 1998. Inflation is much lower and risk asset returns will likely be structurally lower for a while as well.
Further, you’ve got to account for a potential bear market after such tremendous growth. Believe it or not, stocks do go down or nowhere for years e.g. the 1970s and 2000s. Have we all already forgotten what happened in March 2020?
We can certainly take more risk by investing in riskier assets with higher potential yields. However, once again, if you are close to financially independent or financially independent, you should invest more conservatively. Going financially backwards is terrible because time is so precious.
Thankfully, none of us are zombies. We don’t aimlessly follow a safe withdrawal rate rule until we die. Instead, we adjust based on economic conditions.
If we feel more risk-averse, we will lower our withdrawal rate below the 0.5 percent rule, save more money, or figure out ways to make more money. If we feel like sticking our heads in the sand and ignoring logic, we can stick to a 4 percent or higher withdrawal rate. We can also choose to work for life.
There is not a better chart that shows we can change if we want to change than the chart below. All it took was a global pandemic for the typical American to finally save over 30%! We are adaptable.
The New Safe Withdrawal Rate Rule Provides A Net Worth Stretch Target
With the 4 percent rule, you multiply your annual expenses by 25 to get a target net worth. With the new safe withdrawal rate rule, you adjust. Let’s say the 10-year bond yield is at 0.7%. Then the nw safe withdrawal rate is 0.5%. You would then multiply your annual expenses by 200 to get a target net worth.
Following the new safe withdrawal rate rule to obtain financial independence is difficult. For example, I’ve challenged myself to generate $300,000 a year in passive income. The goal of $300,000 has been carefully calculated to pay for between $150,000 – $200,000 a year in after-tax expenses.
Therefore, in order to proclaim true financial independence using 0.5 percent as a safe withdrawal rate, I would need to amass a net worth of between $30 – $40 million ($150,000 – $200,000 in annual expenses X 200).
As two unemployed parents, amassing a $30 – $40 million net worth appears next to mission impossible. We’ve only got Financial Samurai to help us generate active income at the moment. However, at least the 0.5 percent rule has provided a new net worth target to shoot for.
Now we’ve got to figure out whether it’s worth both of us trying to find day jobs again and forsake our kids all day for more wealth. It might be worthwhile given there should be more work from home opportunities. But it’s hard to go back to the salt mines after being away from work since 2012.
I suggest calculating your financial independence number using the 0.5 percent rule as well. Divide your annual expenses by 0.5% percent to come up with your net worth stretch goal. Or multiply your desired annual expenses in retirement by 200 to get to the same amount.
Now that you have your net worth stretch goal, you will be more proactive in figuring out ways to accumulate more wealth.
The #1 Way Around The New Safe Withdrawal Rate Rule: Supplementary Retirement Income
If you find a 0.5 percent withdrawal rate to be an impossible or ludicrous net worth goal, then all you’ve got to do is earn supplemental retirement income. Your supplemental retirement income fills in your income shortfall.
For example, let’s say you want to live off $100,000 a year in retirement income. This would equate to having a $20 million net worth using the 0.5 percent rule. Unfortunately, you’ve been blindly following the 4 percent safe withdrawal rule. Therefore, you thought accumulating $2.5 million was enough.
You now realize the 4 percent rule was developed in the 1990s when the 10-year bond yield averaged 5%+. After cursing out the Federal Reserve and the Central Government, you calm down and figure out the gap.
Your $2.5 million can only safely generate $12,500 a year in passive income using the 0.5 percent rule. Therefore, your retirement income shortfall is $87,500 ($100,000 desired retirement income – $12,500 your true retirement income).
Since you don’t think you’ll ever get to a $20 million net worth, you need to find a way to make $87,500 a year in supplemental retirement income. Thankfully, there are multiple ways to make money from home nowadays.
Even William Bengen, the man who first published about the 4 Percent Rule has admitted in the comments section below that he is earning supplemental income as a writer and consultant post-retirement.
Depending on how much supplemental income you’re earning, your withdrawal rate could increase by a tremendous amount and your nest egg would still be fine.
Another Way To Use The New Safe Withdrawal Rate Rule
A less onerous way to calculate your retirement net worth goal is to add up how much retirement income you already have and subtract it from your desired retirement income. Just know there is always a risk your existing retirement income may decline.
For example, my current retirement income is about $250,000 a year. My goal is to have retirement income of $300,000 a year. Therefore, I’m $50,000 short.
Using a 0.5 percent safe withdrawal rate, I would need to amass another $10 million in net worth. $10 million comes from dividing $50,000 by 0.5 percent or multiplying $50,000 by 200.
Or, I can simply find a way to make an additional $50,000 a year in active income to live the life that I want. Ideally, you want to create active income after your career in an enjoyable way.
If it wasn’t for Financial Samurai, I would try to make at least $50,000 a year teaching tennis. If for some reason I couldn’t teach tennis, I’d self-publish another book or try and get a book deal with a traditional publisher. Tennis and writing are my two favorite hobbies.
Thanks to the dramatic decline in interest rates, the days of retiring and doing nothing all day are over. And this is not a bad thing. It’s great to stay active in retirement.
Your goal is to try and make income from things you enjoy doing. One of the key reasons why I’ve consistently published three new articles a week since 2009 is because it’s fun to help people see what’s financially possible.
Find something you’d be willing to do for free to have a wonderful post-career life. If not, you run the risk of running out of money and feeling empty.
Reach Your Target Net Worth, Then Choose Whatever Withdrawal Rate You Like
Let’s say you still think a 0.5 percent withdrawal rate or my new safe withdrawal rate rule of 80% X 10-year bond yield is absolutely unreasonable. You have the right to do nothing in retirement! Not only do you want to spend all your money before you die, you don’t want to leave any money to your children or to charity.
Therefore, don’t use my new safe withdrawal rate rule as a withdrawal rate. Use the rule only as a net worth target. Once you’ve reached your net worth target based on the new safe withdrawal rate rule, then you can change your safe withdrawal rate as you see fit.
For example, let’s say you are happy living off $50,000 a year in retirement. You don’t have a pension or any passive income. You’re also not including Social Security in your calculations. A 0.5 percent withdrawal rate says that you will need to amass a $10 million net worth. Let’s say you succeed in getting to $10 million by age 70 and expect to live until age 90.
With an expected 20 years left to live, you could divide your $10 million by 20 and safely withdraw $500,000 a year. Withdrawing $500,000 a year is equivalent to a 5 percent withdrawal rate. If there is a bear market or big unexpected expense during this time, you can adjust your withdrawal rate accordingly.
Reaching For Yield Can Be Dangerous
What lower interest rates have done is “force” investors to reach for yield. Since it’s too hard for most retirees to live only off my new safe withdrawal rate rule, most retirees don’t. To be able to sustain a higher withdrawal rate, the retirement portfolio must either generate higher yields, higher returns, or both.
Investors have been fortunate to make solid returns in the stock market, bond market, and real estate market since 2009. Will we be as lucky going forward? I have my doubts.
Ideally, if you don’t make supplemental retirement income, you want to have a portfolio that yields your desired withdrawal rate or higher.
Therefore, reaching for yield may consist of:
- Investing in a REIT ETF like VNQ, which has a yield of ~3%
- Investing in individual REITs like O, which has a yield of ~4.5%
- Investing in private eREITs (what I’ve been investing in recently) that have historically provided a ~9% return, even when the stock market is down
- Investing in individual dividend-paying stocks like AT&T with a forward yield of ~6.95%
- Investing in a dividend ETF like VYM with a ~3.75% yield
- Buying rental property
- Lending out hard money
- Buying an annuity
More Risk Means Greater Potential For Loss
However, when you reach for yield, your risk of losing money increases. If you were born in 1980 or later, please try not to confuse brains with a bull market or artificial support from the Fed. Risk assets do go down sometimes, which is what many opponents of the 0.5 Percent Rule seem to forget.
And to be clear, my new safe withdrawal rate rule encapsulates owning risk assets like stocks and real estate, and not just treasury bonds. It includes various retirement portfolio permutations such as a 60/40 or 50/50 stock/bond portfolio.
Remember, the 10-year bond yield is intertwined with all assets. It is the opportunity cost used to calculate the required premium necessary to own other assets. Only you can decide how much more risk you would like to take.
Retirement Life Will Be Different Than What You Imagine
As someone who left his day job in 2012 at 34, I’m providing you some firsthand retirement perspective. It is very easy to pontificate about the proper safe withdrawal rate in retirement while working.
But I assure you, only when you and your partner no longer have a steady paycheck will you genuinely experience all the emotions that comes with being unemployed. There’s a lot of attention on the positives. However, there are also some negatives as well.
Until this day, I have yet to meet an early retiree who isn’t generating some sort of supplemental income. Some will end up generating a massive amount of supplemental retirement income. While some may just earn an extra few bucks here and there.
Going from aggressively saving and investing for years to suddenly withdrawing is an anathema. Therefore, the tendency is to not do so. There is a reason why William P Bengen admitted in my comments section, “I’m on my 4th career as a novelist/4% researcher.” Not even the creator of the 4% Rule is following his own rule.
Listen to anyone espousing the 4 percent rule with a grain of salt. Ask them these questions: Are they making a significant amount of supplemental retirement income? Are they telling you the truth about how much they are actually spending a year? Ask are they actually withdrawing 4 percent a year?
0 Percent Withdrawal Rate
Once I left work, I challenged myself to not withdraw any money from my retirement accounts e.g. a 0 percent withdrawal rate. Instead, my goal was to allow my retirement accounts to compound as much as possible during a bull market. To survive, I would live off my severance package and supplemental active income.
I wasn’t comfortable withdrawing principal when I was already giving up a healthy salary. Many retirees feel the same way. Old habits die hard.
Today, I’m trying to consumption smooth and spend more money on a better life. As a result, I’m now OK with withdrawing up to 0.5 percent from my retirement funds to supplement my passive retirement income. However, once a bear market returns, I will have to reevaluate.
It is easy to come up with financial models to govern your future retirement. However, as an emotional human being, I promise you that your actions in retirement will be different from what you imagined.
Use The New Safe Withdrawal Rate Rule As A Guide
Don’t be mad at my new safe withdrawal rate rule. The 10-year bond yield has ticked up in 2021. Therefore, you can increase the 0.5 percent withdrawal rate up to 0.88 percent if you like. Instead of amassing 200X your expenses, you only need to amass closer to 114X your expenses to retire.
If anything, be mad at the Federal Reserve and the government for saving us in the present and making investors rich. We’ll eventually have to pay back our debt sooner or later.
The new safe withdrawal rate rule (80% X the 10-year bond yield) is just a net worth and safe withdrawal rate guide in this low-interest rate environment. Depending on how much of your wealth you want to pass on and how much risk you want to take, my new safe withdrawal rate formula may be too aggressive or too conservative. Only you can decide.
The best way I’ve found to follow my new safe withdrawal rate formula is to build enough passive income. As soon as you can build enough passive income to cover your desired living expenses, you won’t even need to touch principal if you don’t want to.
At the minimum, I hope most of you will at least agree that the 4 percent rule is obsolete.
Coming up with the 4 percent rule when you could earn 4.4% – 7.8% risk-free from 1994-1998 is as profound as saying the sun is hotter than the moon. It is as risky as saying Elon Musk’s children won’t starve to death. It is as deep as saying all organization charts look alike.
We don’t live in the 1990s any more. Lower your safe withdrawal rate percentage or shoot for a higher net worth target before retiring or declaring yourself financially independent. Alternatively, learn to live happily on less or find ways to make supplemental retirement income.
If interest rates dramatically increase or decrease, we can reconsider the 0.5 percent rule. But for now, the 0.5 percent rule is a more appropriate safe withdrawal rule to follow than the 4 percent rule.
Recommendations To Build Wealth
Track your net worth. If you now plan to boost your net worth further using the 0.5 percent rule, then I suggest tracking your finances for free with Personal Capital’s award-winning financial app. The more you can stay on top of your finances, the more you can optimize your wealth.
I’ve used Personal Capital’s free app since 2012 and have seen my net worth skyrocket since. The more you can track your finances, the better you can optimize your finances.
Take advantage of lower rates. Although lower rates have robbed retirees of their income-generating abilities, at the very least, take advantage of rock-bottom interest rates by refinancing your mortgage. Get free real quotes on Credible. Mortgage rates are at all-time lows. When lenders compete for your business you win.
How To Feel Rich If You Can’t Get Rich (a follow to address and help folks who are upset about the new FS SWR)
Readers, do you think the 4 percent rule is outdated? What do you think about my 0.5 percent rule as a safe withdrawal rate or as a way to calculate your target net worth? What do you think is the proper safe withdrawal rate in retirement? Why do we accept a safe withdrawal rate from working professors in the past who have never retired? Why do some get so angry that I suggest people be more conservative with their financial plans?