Thursday, May 17, 2012

Bill Bengen’s “How Much is Enough?”

Bill Bengen has written another thought-provoking and important article. This one is “How Much is Enough?” appearing in the May 2012 issue of Financial Advisor.

With sequence of returns risk, what happens in the early part of retirement matters much more than what happens later. If there is any retiree in U.S. history most at risk of witnessing the failure of the 4% rule, it is those retiring at the start of 2000.

But now we have 12 years of data about the progress of 2000 retirees, and so we can begin to see more clearly about how things are working out.
Bill Bengen’s new article provides such a progress report. I explored similar themes in my article, "Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History? A Progress Report after 10 Years" from the Winter 2011 issue of Journal of Investing. A lot of my thoughts on this matter can be found in that article.

What I want to look at today, though, is the very nice idea Bill Bengen had for grafting the first part of the worst-case retirement scenario onto the end of the 2000-2011 period to see what might still be in store for the 2000 retiree. As it turns out, things may work out for the 2000 retiree after all. That is not to say that 2000 retirees using the 4% rule were doing something reasonably safe with market valuations so high at the time, but in hindsight things might just end up working out for them.

First a couple of preliminary points. In Bill Bengen’s initial work, he used the S&P 500 and intermediate-term government bonds. Later, he added small-capitalization stocks to the mix and this increased the historical SAFEMAX. Today he speaks about 4.5% as the safe withdrawal rate.

I have replicated his results and get the same findings as him. My only different assumption is that I think it is more realistic to have retirees withdraw from their accounts at the beginning of the year, whereas he has them wait until the end. I use the beginning of period assumption here, but I did double-check with end of period withdrawals and confirmed that I get the same result he describes in his article. When markets are dropping, the SAFEMAX actually is lower with end of period withdrawals. It is better to get your money out sooner! 

We have constant inflation-adjusted withdrawals, no account fees, and a 30 year retirement. I will show results for two different asset allocations. First, a simple allocation of 40% large-cap stocks and 60% intermediate-term government bonds, which I think is a pretty viable asset allocation for retirees. Second, I use the asset allocation from Bill Bengen’s article, which is 35% for large-cap stocks, 18% for small-cap stocks, and 47% for intermediate-term government bonds.

When small-cap stocks are left out, the worst retirement period began in 1966. A 40/60 allocation resulted in a maximum sustainable withdrawal rate of 4.04% with beginning of period withdrawals. Using an allocation of 35/18/47, a withdrawal rate of 4.68% could have been supported.
With small-cap stocks included, 1969 becomes the worst-case year to retire, supporting a 4.32% withdrawal rate.

Now comes the interesting insight from Bengen’s article. What happens if we consider the results for 2000-2011, and then to get a 30-year retirement we add to the end the data for 1969-1986. This is some bad news, as we are adding on the first 18 years of the worst-case scenario in history to the already somewhat miserable 2000-2011 period. Will the 4% rule survive?
With Bengen’s preferred allocation, the answer is yes. A 4.68% withdrawal rate could have been supported (as Bengen notes, this was 4.32% with end of period withdrawals, and coincidentally some of the same numbers re-appear in this table – I checked to make sure there are not mistakes). For the 40/60 allocation, essentially things will work out almost right on target. A 3.98% withdrawal rate can be supported.

And just one final note, for those out there predicting very serious doom and gloom and catastrophe still awaiting the U.S. economy. What happens if we make one more change to an already extremely bad luck case of 2000-2011 plus 1969-1986?  What will happen if economic catastrophe begins this summer (coming to a theater near you) resulting in a 65% stock market drop for both large-cap and small-cap stocks in the year 2012, and otherwise keeping the characteristics of this already quite gloomy scenario? Well, the 4% barrier will be broken, but things would not turn out nearly as bad as you might have expected in such circumstances. Depending on the asset allocation, the sustainable withdrawal rate will turn out to be 3.43% or 3.46%.

Maximum Sustainable Withdrawal Rates
For 30-Year Retirement Duration, Inflation Adjustments, No Fees
Using SBBI Data
Asset Allocation Defined as:
S&P 500 / Small-cap Stocks / Intermediate-Term Government Bonds
Retirement Period
Asset Allocation
40 / 0 / 60
35 / 18 / 47

1966 - 1995

1969 - 1998

2000 - 2011  plus  1969 - 1986

2000 - 2011  plus  1969 - 1986
with a 65% stock market drop in 2012

In conclusion, the 4% rule is not safe. It certainly hasn’t worked out well for a number of other developed market countries. I love the U.S.A., but I worry that the country won’t always enjoy the same fantastic financial market returns as it did in the 20th century. Nonetheless, in this particular case, 4% may end up working after all. We won’t know for sure until the end of 2029, but maybe we can relax a bit. Maybe I can make my blog less gloomy and more positive!

The thing about financial markets is that no one can predict the future. The best we can do is to constantly keep learning and test our assumptions and experiment and occasionally change conclusions as new information comes to light. It’s an ongoing process. No one has or will have all of the answers.


  1. This is wonderful to talk about, but most people laugh at the 4% withdrawal rate. To tell people that 4% isn't safe risks that some will just forego a savings goal of any kind.

    Ultimately, 4% is an anchoring point. Just because one is retired doesn't mean that we have to move forward blindly, and dispense with common sense.

    “Plans are useless, but planning is indispensable.” - DDE