Will the 4% Rule Lead to Financial Ruin?

Summary

In this Financial Freedom show, Rob Berger critiques a Wall Street Journal article warning of retirement risk with a 60/40 portfolio and the 4% withdrawal rule. He argues that while uncertainty in retirement planning is real, the article's doomsday scenarios are extreme and impractical. Berger suggests three common strategies to address uncertainty: conservative spending, insurance, and a more conservative portfolio. He emphasizes that each approach has a cost and shares his personal strategy of working in a lifestyle-friendly way to mitigate risks and enjoy financial freedom.

Takeaways

• 📰 The Wall Street Journal article discussed raises concerns about the traditional 60/40 retirement portfolio and the 4% withdrawal rule, suggesting they might lead to financial ruin.
• 💡 Retirement planning is inherently uncertain due to unknowns such as lifespan, inflation, taxes, and market performance.
• 🤔 The article posits that the next decade might see real returns on US stocks as low as 1.65% after inflation, which could impact retirement savings significantly.
• 🌍 An academic paper cited by the article suggests that a safe withdrawal rate, considering historical data from 38 developed countries, might be as low as 2.26%, not the traditional 4%.
• 📉 The article also discusses the potential risks from high national debt and the possibility of Social Security insolvency, adding to retirement uncertainty.
• 🔢 Historically, the 4% rule has withstood various market conditions, including periods of low or no returns, such as the first decade of the 2000s.
• 🧐 The academic study's methodology is criticized for being impractical for real-world investment, as it combines data from different countries and periods into a single simulation.
• 💼 The video suggests three main strategies to address retirement uncertainty: conservative spending, insurance (like annuities or delaying Social Security), and a more conservative investment portfolio.
• 💰 The 4% withdrawal rule is a conservative approach that has historically been safe but may limit lifestyle choices in retirement.
• 💡 The video emphasizes that any strategy to mitigate uncertainty comes with a cost, whether it's reduced spending, the cost of insurance, or lower expected returns from a more conservative portfolio.
• 👴 The 4% rule assumes a 30-year retirement period, which is an extreme case for most people, and the actual retirement length varies greatly among individuals.
• 👩‍💼 The presenter's personal approach to retirement uncertainty is to continue doing work they love in a lifestyle-friendly manner, which can provide additional income and purpose.

Q & A

What is the main topic of the Wall Street Journal article discussed in the video?

The main topic is the risk to retirement portfolios, specifically the potential issues with the traditional 60/40 portfolio combined with the 4% withdrawal rule.

What does the 60/40 portfolio typically consist of?

A 60/40 portfolio typically consists of 60% stocks and 40% bonds, aiming for a balance between growth and stability.

What is the 4% rule in retirement planning?

The 4% rule is a guideline suggesting that retirees can safely withdraw 4% of their portfolio each year without running out of money over a 30-year retirement period.

What is the main criticism of the article presented in the video?

The main criticism is that the article may be clickbait and presents a worst-case scenario without providing practical solutions for retirement planning.

What is the estimated real return for US stocks after inflation over the next decade according to the article?

The article suggests an estimated real return of 1.65% for US stocks over the next decade.

What does the video suggest as an alternative to the academic study's approach to retirement planning?

The video suggests considering a global equity portfolio, like Vanguard's VT, which is based on market cap and could provide a more practical approach to retirement planning.

What is the 'safe withdrawal rate' according to the academic paper mentioned in the video?

The academic paper suggests a safe withdrawal rate of 2.26% based on historical data from 38 developed countries.

What are the three general approaches to dealing with retirement uncertainties discussed in the video?

The three approaches are conservative spending, using insurance mechanisms, and making the investment portfolio more conservative.

What is the presenter's personal approach to dealing with retirement uncertainty?

The presenter's personal approach is to continue doing work they love in a lifestyle-friendly way, which provides extra income and purpose in retirement.

What are the potential downsides of using an annuity as a form of insurance against retirement uncertainties?

The downsides of using an annuity include the cost of the annuity itself, the lack of inflation adjustment, and the potential for it to be a poor investment depending on how long the retiree lives.

What is the presenter's view on the future of the 4% rule and retirement planning?

The presenter believes that while the future may be different, the current academic studies do not provide practical solutions, and that retirees should consider a combination of strategies to address uncertainties, including continuing to work in a lifestyle-friendly manner.

Outlines

00:00

📰 Critique of Wall Street Journal Article on Retirement Risks

In this paragraph, Rob Berger from the Financial Freedom show addresses an article from the Wall Street Journal that warns of the risks associated with a traditional 60/40 portfolio and the 4% withdrawal rule for retirement. Berger criticizes the article as clickbait and discusses the inherent uncertainties in retirement planning, such as lifespan, inflation, taxes, and market performance. He emphasizes the importance of context and proposes to explore the issue in more depth, promising to offer his personal approach to managing retirement uncertainty.

05:03

🤔 Analyzing the 4% Rule and Its Limitations

Rob delves deeper into the 4% rule, discussing its conservative nature and historical performance. He challenges the validity of an academic study that suggests a lower safe withdrawal rate based on global data, arguing that it lacks practical applicability for real-world retirement planning. Berger highlights the importance of considering historical context, such as post-World War periods, when evaluating the safety of withdrawal rates. He also introduces the concept of addressing retirement uncertainties through conservative spending, insurance options, and portfolio adjustments.

10:03

🛡 Strategies for Managing Retirement Uncertainty

This section outlines three general strategies for managing the uncertainties of retirement: conservative spending, insurance, and portfolio diversification. Berger explains that being conservative with spending can help manage market downturns and inflation, while insurance products like annuities or delaying Social Security can provide a safety net. He also discusses the trade-off of reducing portfolio volatility by shifting to more conservative investments, such as a 60/40 portfolio, and the importance of balancing these strategies based on individual circumstances and preferences.

15:03

💼 The Value of Loving Your Work in Retirement

In the final paragraph, Rob Berger shares his personal approach to dealing with retirement uncertainty, which is to continue doing work that he loves in a lifestyle-friendly manner. He suggests that this not only provides additional income to cushion against uncertainties but also brings personal fulfillment and purpose. Berger acknowledges that this approach may not be suitable for everyone but emphasizes the benefits of having control over one's schedule and the potential to defer spending from investments.

Keywords

💡Financial Freedom

Financial freedom refers to the state where one has enough savings or income to cover their expenses without being obligated to work actively for a living. In the video, it is the overarching theme and the ultimate goal that the host, Rob, aims to discuss and help achieve through retirement planning strategies.

💡6040 Portfolio

A 6040 portfolio is an investment strategy where 60% of the portfolio is allocated to equities (stocks) and 40% to fixed-income securities (bonds). It is mentioned in the script as a traditional retirement strategy that the Wall Street Journal article questions, suggesting it may not be safe for current times.

💡4% Rule

The 4% rule is a retirement strategy suggesting that retirees can withdraw 4% of their investment portfolio each year without running out of money over a 30-year retirement period. It is a central concept in the video, as the host discusses its validity and potential risks in the context of the article.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. In the video, inflation is highlighted as a factor that can impact retirement savings and the effectiveness of the 4% rule.

💡Safe Withdrawal Rate

Safe withdrawal rate refers to the percentage of a retiree's savings that they can withdraw annually without depleting their capital over a certain period. The video discusses how different studies have calculated this rate, with one suggesting a lower rate than the traditional 4% due to various economic factors.

💡Uncertainty

Uncertainty in the context of the video pertains to the unpredictability of factors such as lifespan, inflation, taxes, and market performance that can affect retirement planning. The host emphasizes the importance of addressing this uncertainty in retirement strategies.

💡Conservative Spending

Conservative spending is the approach of limiting expenditures during retirement to ensure that savings last. The video mentions this as one of the strategies to mitigate uncertainty, with the 4% rule being an example of a conservative spending approach.

💡Annuity

An annuity is a financial product that provides a stream of payments to an individual, typically for the rest of their life, in exchange for an upfront payment. In the video, the host discusses annuities as a form of insurance against the uncertainties of retirement.

💡Portfolio Volatility

Portfolio volatility refers to the degree of variation of returns on an investment portfolio over time. The video script mentions that a 6040 portfolio reduces volatility compared to an 8020 portfolio, which is a strategy that could be used to manage risk in retirement.

💡Retirement Planning

Retirement planning is the process of considering one's financial goals, needs, and circumstances to determine how much money they will need to retire and how to invest to meet those needs. The entire video is centered around discussing various aspects and strategies of retirement planning.

💡Personality and Risk Tolerance

Personality and risk tolerance refer to an individual's unique preferences and comfort levels with taking risks, especially in financial decisions. The video suggests that these factors play a significant role in determining the best approach to retirement planning and dealing with uncertainty.

💡Work-Life Balance

Work-life balance is the equilibrium between time spent on work (including career and ambition) and leisure time spent on personal activities. The host suggests that continuing to do work one loves in a lifestyle-friendly way can help address retirement uncertainty without incurring additional costs.

Highlights

Rob Berger discusses a Wall Street Journal article on the risks of a traditional 60/40 retirement portfolio and the 4% withdrawal rule.

The article suggests that a 60/40 portfolio combined with the 4% rule could lead to financial ruin due to uncertainties in retirement planning.

Critique of the article as clickbait, which is unusual for The Wall Street Journal, but important due to public interest.

Retirement planning is fraught with uncertainties such as life expectancy, inflation, taxes, and market performance.

The article's historical perspective on the 60/40 portfolio performance, highlighting the worst and best years.

Projections of low real returns for stocks in the next decade, estimated at 1.65% after inflation.

Academic paper cited in the article suggesting a safe withdrawal rate of 2.26% based on a global analysis of 38 developed countries.

Concerns about U.S. debt and Social Security's sustainability adding to retirement uncertainty.

Contextualization of the article's claims, including historical instances of low stock returns and the resilience of the 4% rule.

Critique of the academic paper's methodology, which combines data from different periods and countries into a single dataset for simulations.

An alternative study by Wade Pfau that examines safe withdrawal rates on an individual country basis, highlighting the impact of world wars.

Three general approaches to dealing with retirement uncertainty: conservative spending, insurance, and a more conservative portfolio.

The 4% rule as a conservative spending approach and its historical context.

The cost and limitations of using insurance like annuities to mitigate retirement risks.

The trade-off between a more conservative portfolio and expected returns, with the 60/40 portfolio as an example.

Personal approach to retirement uncertainty by continuing to do work that one loves in a lifestyle-friendly manner.

The importance of recognizing that addressing uncertainty always comes at a cost, whether through conservative spending or other methods.

Final thoughts on the WSJ article, different ways to address uncertainty in retirement, and personal reflections on the topic.

Transcripts

hey everybody welcome back to the

Financial Freedom show my name is Rob

Berger today we're going to be taking a

look at a Wall Street Journal article

let me show it to you uh the headline a

time honored strategy puts your

retirement at risk and not just any kind

of Risk by the way of financial ruin

that doesn't sound good uh I guess for

effect we we we get the tombstone with

our 6040 portfolio which I guess means

it's dead and a zombie is apparently

taking our retirement portfolio to um I

guess some deep dark place Underground

and uh specifically the article is

saying look the whole tried andrue

retirement portfolio of a 6040 portfolio

combined with the 4% rule uh could lead

to catastrophic outcomes that doesn't

sound uh good I really dislike articles

like this I think they're clickbait and

I don't normally see that kind of thing

from The Wall Street Journal but uh a

lot of people emailed me about it so

we're going to walk through it because

at a high level it does raise a really

important issue and that is is

retirement planning is fraught with

uncertainty we don't know how long we're

going to live what inflation will do

taxes the market and so we all know

there's a lot of uncertainty involved so

what we're going to do is take a look at

this article put it in some context

which think I think it desperately

desperately needs and then we're going

to look at sort of at a high level the

three ways we might think about

addressing uncertainty and then three

things that might help us think about

the best approach for us including my

personal approach to dealing with with a

retirement uncertainty so we'll get to

that in just a minute so let's start

with the article I'll leave a link to

everything below the video although I

will say for the Wall Street Journal

article you may need a

subscription uh to access the article

but I'm going to walk through it

briefly with the 6040 portfolio the

article just sort of went you know it's

had good years and bad as the article

points out uh 2022 was a bad year it

shows the Worst Years here and the best

years uh over here frankly that's true

of any portfolio or or any asset so this

is not all that I mean maybe interesting

from an historical perspective but

that's about it but what the article

then goes on to say is is basically two

two things the first is that many

believe over the next decade real

returns that is after inflation in the

US for stocks will be quite low I think

he put it at

1.65% I think that's what he said

maybe if I can find it

quickly right here yeah 1.65% was was

was one sort of estimate that's the

first thing and the second thing he

points to an academic paper uh that says

hey if we look outside the United States

you know yes us has had a great run for

the last 100 years but if we look at uh

38 developed countries so we're not you

know we're still talking about developed

economies and we sort of factor in all

of their returns and inflation we get a

safe withdrawal rate not a 4% but of

just

2.26 uh per. and then if that weren't

enough he adds into the article how much

debt our country has and the interest

payments and that Social Security could

go belly up so it's a real feel-good

article now you know In fairness you

could say well Rob we need to think

about these things and absolutely we do

but we have to think about them in the

right context let me try to give a

little context to what this article is

saying first off this idea of an after

inflation return over the next decade of

1. 65% uh is in and of itself we've

experienced that before I mean you US

Stocks were basically flat the first

decade of this Century uh and and

certainly from a retirement perspective

uh if you retired in 2000 you saw your

assets you know go down significantly

over that decade of course if you stayed

the course they've recovered nicely uh

since 2009 of course we don't know what

the future will hold but the point is

you we've had decades before that were

really bad and of course you know the

70s were terrible in large part because

of high inflation and so it it you know

even with those bad time periods at

least so far the 4% rule uh has has held

we're going to talk a little bit more

about that in a second but as for the

academic paper uh here it is I read it

when it came out I'll link to it below I

think it's an interesting paper from an

academic perspective but but from a

practical uh sort of retirement planning

perspective and even if we want to sort

of dive into the 4% rule uh I think this

has very little uh applic ability and

and the reason is this it constructs its

its data on return stocks bonds and

inflation by looking at these developed

countries over different periods of time

but then it takes all of this monthly

data kind of throws it into one big pot

and then runs simulations against that

so it might pick you know for certain

periods data from Germany and then lvia

and then the United States and then a

different country and in that sense it's

just not practical it's it's not

constructing a portfolio that you or I

could ever actually invest in it would

be I think useful If instead it just

said let's look at a global portfolio

you could think of a mutual fund like

vanguard's VT that's a ticker VT that's

a global uh Equity portfolio I think

it's about 60% US Stocks 40%

International and it's just based on

market cap and so that that those

percentages are going to change as

capital moves around the globe it would

be great to see a study on that uh and

to see how the 4% rule would fare using

that type of investment approach because

that's something we could actually

replicate if we wanted to now there may

be issues getting data far enough back

with that but the point is this study

the way it constructs its data may be

perfectly fine from an academic

perspective just not very useful uh uh

for you and I and in fact there's

another study that Wade fou published

about a decade earlier and this is a

chart from that study he kind of in a he

didn't do the same simulation but as you

can see he looked at individual

countries and he calculated what he

calls their safe Max that's just their

safe withdrawal rate that term was

actually coined by Bill bengan who wrote

the 4% rule paper in 1994 and you know

this is interesting what I find most

notable about this apart from the fact

that Canada apparently at least as of

this paper was

winning uh is that when you get to the

really bad you know bad withdrawal rates

we could probably handle threes

particularly three and a half or higher

but when you get under two including 047

what do you notice about these countries

Italy Belgium France Germany Japan and

look at the years for their saf Maxs

World War II World War I World War II

World War I World War II these are

countries that were devastated by uh a

World War now of course you may say well

Rob that could happen to the United

States sure World War III I guess could

be fought in the US and and we could

lose and we could end up you know after

history is done with us we could have a

safe withdrawal rate although I'm

guessing that would be the least of our

concerns at that point but we could have

a safe withdrawal rate of 1% but as a

practical matter I know of no way to

address that possibility and certainly

starting with a 2.26% withdrawal rate

like the academic study suggested is not

going to save us and and so I you know

again I think it's it's absolutely right

that the future uh will not unlikely to

look like the past and maybe a period

will come where the 4% rule uh doesn't

doesn't pan out but these academic

studies don't really help us solve any

real world retirement planning issues so

with that then let's get to sort of part

two of this video how do we deal with

all of the uncertainties that we face in

retirement and I think by and large we

we take one of of of three uh approaches

the first is we get very conservative

with our spending right we we spend we

don't spend as much as we think we might

be able to we we cut back in some way

and in in fact that really is the 4%

rule let me show you what I'm talking

about this same paper by Wade foul uh if

we go up one slide this shows us the

safe withdrawal rate by Year from 1900

he ends it Based on data that he had uh

I think 19 I guess 78 or 79 and here's

our 4% rule this was from the mid to

late 1960s that was the worst time to

retire from a safe withdrawal

perspective but you can see that you

know there's a couple other in that same

time period that were

close but most of the time the safe

withdrawal rate was was much much higher

right and so uh in fact sometimes it was

well above 10% even the average was

probably I would guess somewhere in the

six to 7% range so a a 4% initial

withdrawal rate from a spending

perspective is extremely uh uh

conservative so but that's one way we

could deal with all the uncertainties is

to be conservative in our spending and I

think as a practical matter what that

often means in retirement is when the

Market's down maybe inflation's High we

saw that just a couple of years ago uh

retirees tend to tighten the belt they

they they spend less that's what they do

so that's one way to deal with all of

the uncertainties another way is with

insurance right so we could buy an

annuity that would be one way to use

Insurance to deal with the uncertainties

I suppose we could look at delaying

Social Security as a form of insurance

either delaying to full retirement age

or perhaps all the way uh uh to 70 so

that would be another way to think about

insuring uncertainties and maybe a third

example would be if you relied on

Medicaid to deal with Assisted Living

towards the end of your life if you

needed to of course that would mean your

assets were for the most part depleted

but Medicaid would be a form of of of

insurance we could think of it that way

so that's the second way right so

there's conservative spending there's

some form of insurance and then I think

a lot of ways uh retirees think about

dealing with uncertainty is to make uh

their portfolio more conservative you

might have been 8020 or 9010 when you

were working you retire you go down to

7030 or maybe the vaunted 6040

retirement Port portfolio and that

doesn't take away all uncertainty but it

certainly reduces the volatility of your

portfolio because bonds uh have a lower

volatility uh than stocks and so that's

a third way we might deal with

uncertainty and I think in many cases

what we do is some combination of those

three three things right we may delay

Social Security uh we may cut back on

spending when the when the inflation

Rises or or the the markets uh down

right and and then maybe we we we make

our portfolio a little less uh volatile

with more bonds so we could use a

combination of those three things but

pretty much what we do to to deal with

uncertainty I think for the most part

falls into one of those three buckets

and that still raises the question okay

what's right for me a lot of it's going

to be driven by personality there is no

one right answer to deal with

uncertainty but let me give you three

things uh to think about as we close out

uh this video the first thing is that we

often worry about things that are at the

extreme and and let me give you an

example I want to go back to this chart

you know we we worry about whether 4% is

is safe enough but 4% is at at and an at

the extreme every other time going back

to 1900 we can actually go back to 1871

if you want to the safe withdrawal rate

was higher now yes I know the future

could could be worse for us however

invest right we can invest

internationally uh we don't have to put

all our money in US Stocks but however

we decide to invest the the future could

be worse but we're talking already we're

starting at an extreme case that's only

happened once in the last 100 years and

so as we think about how we're going to

deal with uh the possibility that the 4%

rule will not not work going forward we

need to we need to at least recognize

that we're already starting at a very

extreme case and by the way it's more

than just the 4% rule because remember

the 4% rule assumes a 30-year retirement

that in and of itself is an extreme case

most of the people watching this video

will not be retired for 30 years the

average retirement age in the US is in

the ear your early 60s most people don't

live in the early 90s yeah I I know you

might for all I know you retired at 37

you'll live to be 114 if that's you yeah

you're already living in an extreme case

but we need to recognize that the four

percent rule is based on a 30-year

retirement by the way that may be

perfectly reasonable from a retirement

planning perspective but as we think

about how to address these uncertainties

we should at least recognize that we're

already uh talking about in extreme

cases the 4% rule a a 30e uh retirement

so we're talking about extreme cases

right from the beginning that's that's

the first thing the second thing is that

however you choose to address

uncertainty it always comes at a price

there's no free way to address

uncertainty right if you're going to buy

an annuity of course annuities cost

money and depending on how long you live

that they may be a good buy or a bad buy

and uh they're not adjusted for

inflation so they they expose you to the

risk of inflation you may choose to

delay Social Security that's something

that I'm going to do but that's not

without risk I mean you know we talk

about the fact that the Social Security

fund uh could could could run out of

money and then we could just be paid a

smaller percentage based on on income

from Social Security taxes in about a

decade so no matter what we do there's

risk we could talk about a conservative

spending approach like the 4% rule which

is a very conservative approach but of

course that then costs us in the form of

not spending money doing things we might

have enjoyed doing like maybe travel or

whatever is important uh to you so as we

think about uncertainty we almost always

deal with it in the extreme cases and

whatever we choose to do to address it

it comes at a cost by the way the 60/40

portfolio comes at a cost as well its

expected return is going to be lower

than say an 8020 uh portfolio so there's

always a cost the third thing and final

thing and this has been my Approach and

this won't apply to everyone but I think

the absolute best way to not only deal

with uncertainty this is probably the

only I'll call it costree way to deal

with uncertainty and it's to do work

that you love

uh as long as you can in a lifestyle

friendly way so for me I don't want to

be in a cubicle 9 to5 those days for me

are are past I don't want to even be in

a fancy office 9 to5 those days are past

as well but I'm working right now as I

record this video my family's upstairs

they're they're talking they're visiting

with some friends and I'm down here for

about a half hour uh recording this

video and then I'm done and I control my

own schedule makes some income which

absolutely helps me address the

uncertainties of retirement now I get it

this sort of thing isn't for Everyone by

the way I'm not suggesting you all start

YouTube channels but if you can find

work that you love that can be done in a

a lifestyle friendly way whatever that

means to you uh I think it can give you

great purpose in retirement it can

reduce all of the risks of of

uncertainty that we've talked about by

giving you extra income it may be enough

that you even actually defer spending

any of your Investments

or it may just reduce the amount of

money you have to take out of uh your in

investments in retirement either way it

helps reduce uh the uncertainty of you

know life of retirement while also

giving you something that you enjoy

doing with a purpose and hopefully maybe

something that can help other people so

there you go that's my take on the Wall

Street Journal article not a fan how I

think about uncertainty and retirement

uh different ways to address it and just

my thoughts on those if you have any

questions or comments leave them in in

the comments below this video and until

next time remember the best thing money

can buy is Financial Freedom