I have always had an allergic reaction against dogmatic people. Rules have exceptions, and the 4% rule is no different. It is not personal, but I have rather kept away from institutions and their members who are preventing a critical examination of the status quo, as long as I can remember. It was often not a deliberate decision, but a subconscious feeling of discomfort that led me away from this environment.
But I can understand the behavior. It is probably comfortable to “believe” in a group of like-minded people about the same thing and to aggressively defend the “facts” once accepted as “truth” against outside and critical consumers. This creates cohesion.
Dogma is Everywhere
I used to think that certain activities are spared from this behavior, since the thing itself is something enjoyable or liberating. For example, athletes or people who prefer a similar diet.
It is now clear to me that this phenomenon, as a group against critical consumers or even new facts and to deny even proven errors of “own teaching”, although the valid data are opposite, almost everywhere occurs in varying degrees, where people come together.
An example in the sports field is for example the dogma that a person who likes to build up a lot of muscle should eat at least six meals a day. Clear research results and many people who are successful strength athletes with two or even only one large meal a day can not convince the followers of this old wrong teaching. And so, these “believers” continue to run around the area all day with their Tupperware, eating something every three hours. Social life suffers and joint activities with people outside this area are made more difficult.
The example of sport here was only a warm-up to the real shocker: And this is for me that even some people who are on the road to financial independence, this behavior shows. Yes, even in the field of hard-working savers and investors, some dogmas are defended, which on closer inspection do not have enough substance and adherence to it in the current market environment in my opinion, probably causes great pain with the dogma-riders.
I’m not talking about the sense of saving with the highest possible savings rate or investing that money in the stock market. These are all prerequisites and extremely meaningful and liberating things that every person should acquire. No, I’m talking about planning for the annual withdrawal rate of invested money during financial independence.
What is the 4% Rule?
As a background to the topic was about 20 years ago, a stock market study (Trinity), how much money a US pensioner can withdraw from his pension depot annually, without him running out of money until his death. As a result, came out at that time, with a 4% annual withdrawal rate from the deposit at retirement and then starting from this amount annually increasing by the rate of inflation, the cash flow with a security of about 90% during the remainder of the pensioner’s lifetime does not abate. The 4% rule was born.
The study also accounts so far for the standard US retiree. Only then, when the first people came up with the idea of early financial independence, because there was not more data at that time, you have taken this study to your own planning. Luckily for us all, the world continues to turn. New ideas are born and old ones are developed further. For example, Nobel laureate Robert Shiller taught us that the 10-year smoothed earnings ratio or “shiller CAPE” is much more meaningful than the normal price-earnings ratio to us and since then, the stock market valuations (and hence the level of future returns) have been much better appreciated.
If you take this Shiller Cape tool and look at the probability of safe deposit taking only years in which the US stock market was as recent, relatively high rated (f. ex. a CAPE over 20), then the probability of default, at a 4% annual removal, is significantly higher than in the Trinity study.
Moreover, most interested parties in early financial freedom do not intend to live on that money for only thirty years, as in the said study, but often much longer. A 45-year-old man who does not smoke and eats well today has a good chance of being 90 years old, maybe even a few years more. That’s 45 or 50 years in which case the money invested should provide a safe annual cash flow.
The study also estimated that the retiree may use his entire depot over the thirty years. “Passed” the thirty-year extraction period, the study even intended that, on the last day not a single cent would be found left in the depot of our sample pensioner.
I do not know about you, but personally, I will not plan, save, and invest for the coming decade just that I have to fight to survive with only pocket money. I also do not want to be forced, to have to work part-time jobs again in forty years’ time because of a strong recession. My goal is freedom and not a new self-imposed uncertainty and restriction. No 4% rule
Therefore, I have calculated around a lot myself with different tools and to come to the conclusion in this market environment with high US stock market valuation and a hopefully long withdrawal period of my depots on a three percent annual withdrawal rate. Over several decades, this one percent delta makes a huge difference compared to the 4% withdrawal rate repeated and defended everywhere like a mantra, deciding whether anyone is leaving the world as a relaxed millionaire or as a stressed and poor beggar due to the compounding rate effect. When people in US forums introduce similar considerations about financial independence, such as pointing out the current high US stock market valuation, or the longer withdrawal period, the “4% rule dogmatists” usually muzzle you. “Unnecessarily worked too long; failed even before the beginning; in the study is still … etc…”.
In my opinion, here again the ” Tupperware enthusiasts with their six meals a day” are on their way. They entrench themselves behind an idea that is basically good and then no longer allow for optimizations.
Drawing Your Own Conclusions
Anyway, to all those who like to think and calculate for themselves I can show a very good elaboration on the topic of Early-Retirement-Now next to the already presented “cfiresim” calculator. The preparation has become incredibly good and I recommend anyone who is interested in the topic just to read it.
The main results from this study are:
– Calculated over a longer period than 30 years, the dependability of a depot at a 4% annual withdrawal rate at the beginning and then rising with the inflation rate the assumed residual value of the depot of at least half of the initial value at the current high US equity market valuation of only at approx. 50-70%!
– The solution to avoid depot failure is to reduce the annual withdrawal rate.
– At an annual withdrawal of 3.25% even after 60 years, with an approximate 97% certainty, a US based index still has at least half of the starting value adjusted for inflation in the custody account even after 60 years.
– At my personal calculation at a 3% annual removal we are at 100% security that the depot can not fail, even with a current Shiller CAPE 28 value.
Now some people will yell that it takes years to work from the 4% to 3% annual withdrawal rate. As a pure example of calculation, when a planned a withdrawal of for example $30,000 a year so now $1.0 million is necessary instead of “only” $0.75 million previously. The difference sounds incredibly big for someone who has not yet saved and invested six-digit assets. In other words, that useless 4% rule is costing you potentially years of work.
What is easily overlooked is that at these monetary amounts, the compounding effect of already invested money throws many tens of thousands of dollars in addition to the savings rate on the already existing money pile. Based on our assumed 5.5% annual interest after inflation and the optimized taxation of dividends structure from a diversified stock (ETF) portfolio, the 0.75 million dollars invested in our example adds up to an annual average of $41,250 in taxed dividends and price increases. In addition, the income for many people at this point in their career is usually much higher than at the beginning and thus the opportunity to save a lot more money each month, if you manage to keep the cost of living in line.
For example, if you save $2,000 per month and can invest in the stock market, you will get the sum of approx. 0.75 million dollars after almost 19 years. Congratulations, wonderful! If you then only save a little over three years and continue to grow your invested assets through compound interest in the largest affluent machine of all time, you have now reached a whole million dollars, and thus a 3% withdrawal rate! The interest on the deposit has thus become more important than saving itself even before this date. The money invested has become a huge snowball that brings more and more prosperity and thus freedom without the 4% rule.
Maybe I’m just conservative in monetary matters but for me personally it would be worth a good three years to be financially free for 100 years rather than having to worry about the current high US market valuation for decades, whether in the near future the money is enough. For someone who is already 60 years old at the beginning of retirement and who will receive a state pension in a few years’ time, that is another matter and it can be planned at 4%, but for people below the 50, I would not risk in the current market environment to go down.
Depending on the type, you should alternatively plan at least one side job, if just at the beginning of the withdrawal period, a strong bear market comes, which pushes the valuations and thus significantly reduces the value of the depot.
Since I am still planning a long period together with a family with children, I do not feel like such uncertainties and therefore the 3% collection rule applies to me. With a mix of some stock market ETFs and a few strong single stocks, the three percent will come through dividends. This also gives you the good feeling that you will never have to sell an investment again. Historically, even in times of strong recession, dividends are significantly less reduced than many people assume. Even in the crash period 2008-09, the dividend cut of the S&P500 was only about 20% and rose again in 2010.
So, if you are planning with your financial freedom already in the third decade of life, you should install some additional collateral. Either by reducing the annual depot withdrawal to 3% or by other measures such as an optional additional income stream. This will let you sleep much better at night and achieve financial freedom which is why many supporters run the entire effort at all. To be free, but also to stay free for life. Don’t stick an arbitrary rule like the 4% rule.
Cheers on a future in freedom!