Will the 4% Rule Lead to Financial Ruin?
Summary
TLDRIn 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
- đ° 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.
- đĄ Retirement planning is inherently uncertain due to unknowns such as lifespan, inflation, taxes, and market performance.
- đ€ 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.
- đ 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%.
- đ The article also discusses the potential risks from high national debt and the possibility of Social Security insolvency, adding to retirement uncertainty.
- đą Historically, the 4% rule has withstood various market conditions, including periods of low or no returns, such as the first decade of the 2000s.
- đ§ 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.
- đŒ 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.
- đ° The 4% withdrawal rule is a conservative approach that has historically been safe but may limit lifestyle choices in retirement.
- đĄ 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.
- đŽ 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.
- đ©âđŒ 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
đ° 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.
đ€ 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.
đĄ 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.
đŒ 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.
Mindmap
Keywords
đĄFinancial Freedom
đĄ6040 Portfolio
đĄ4% Rule
đĄInflation
đĄSafe Withdrawal Rate
đĄUncertainty
đĄConservative Spending
đĄAnnuity
đĄPortfolio Volatility
đĄRetirement Planning
đĄPersonality and Risk Tolerance
đĄWork-Life Balance
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
Voir Plus de Vidéos Connexes
How This IIT Professor Got Financially Free in His 40s?
Retirement Gameplan: The Road to Financial Freedom
This Mumbai Man Is On The Road To FIRE With Equity SIPs | Mint Money
We RETIRED EARLY. Revealing our INCOME STREAMS for Early Retirement
No Retirement in Sight?
Risk Management for Individuals â Part III (2024 Level III CFAÂź Program â Reading 22)
5.0 / 5 (0 votes)