Periodically, we read articles from William Bengen, the inventor of the safe withdrawal rate (otherwise known as the 4% Rule), from various esteemed retirement academics, from the retirement researchers at Morningstar or from other retirement experts about this year’s version of the 4% Rule. For example, in 2021, Morningstar experts told us that the initial safe withdrawal rate was 3.3%. Then in 2022, they told us that it was 3.8%, and this year, it is back up to 4% as long as equity investments don’t exceed 40% of the retiree’s portfolio. And while the basic safe withdrawal rate may vary somewhat from year to year based on current economic conditions and whether or not it is followed blindly without adjustment (increasing the initial withdrawal amount by inflation each year), researchers generally have determined that historical investment experience supports a conclusion that an annual withdrawal in the neighborhood of 3-5% of a retiree’s portfolio at retirement, increased annually by inflation, has a high probability of lasting at least 30 years without depleting portfolio assets, assuming about 50% of the portfolio assets is invested in equities.
Therefore, the retirement researcher community was rather surprised when Dave Ramsey, nationally syndicated financial radio personality and host of The Ramsey Show, recently indicated in his YouTube November 2, 2023 podcast (starting at about 1:13) that retirees who invest 100% of their portfolio in equities can safely withdraw 8% of their portfolio in the first year of retirement and increase that amount by inflation each year indefinitely without depleting their portfolio. In his podcast, Mr. Ramsey warned his listeners to “stay away from the 4% morons” and “goobers [stupid nerds] who put 4% out on the market.”
In response to Mr. Ramsey’s podcast, esteemed retirement academics David Blanchett, Michael Finke and Wade Pfau wrote an article for Think Advisor entitled, “Supernerds Unite Against Dave Ramsey’s 8% Safe Withdrawal Rate Guidance.” They do a good job of defending themselves and the rationale behind the 4% Rule rather than Mr. Ramsey’s 8% Rule, and we will not repeat their arguments here.
Notwithstanding the recent brouhaha between Mr. Ramsey and the Supernerds (and the majority of the retirement expert community), we are not big fans of the 4% Rule. In fact, we are not big fans of any static fixed percentage [X%] rule. In this post, we will once again briefly remind our readers why we believe the Actuarial Approach is superior to static withdrawal rules for planning near or during retirement, and we encourage you to utilize the Actuarial Approach either on a standalone basis or as an independent check of the approach you are currently using.
Advantages of the Actuarial Approach
The Actuarial Approach employs a model (Actuarial Financial Planner) and a process that involves systematic comparison of household assets and liabilities and tracking of the resulting household Funded Status over time for the purpose of making better financial decisions in retirement, including decisions relating to spending and investment. This is the same general process used by actuaries to help ensure the financial sustainability of many other financial systems, such as Social Security and defined benefit pension plans.
The advantages of using the Actuarial Approach over a fixed percentage static withdrawal rule include:
- The Actuarial Approach is based future expectations, not on historical experience that may or may not be repeated in the future
- It develops a robust spending plan that reflects all user assets and user-specific spending goals, not a simple withdrawal plan that ignores non-portfolio assets and outputs only constant real- dollar annual portfolio withdrawals.
- It produces a dynamic spending plan, not a static head-in-the-sand withdrawal plan designed to last for at least 30 years, but with no recourse if portfolio assets are depleted or become larger than desired.
- It automatically adjusts the expected longevity planning period based on user age(s). The default longevity planning periods may be overridden by the user if desired.
- It permits entry of alternative future assumptions for investment returns on non-risky investments, investment returns on risky investments, longevity planning periods and expected increases in future expenses. This feature can be used to stress-test the user’s plan for alternative future experience or to make the users plan more or less conservative.
- It produces a simple metric (funded status) that helps users decide when their spending plan may be increased or should be decreased. This metric is automatically adjusted from year to year to reflect variations in investment returns, inflation, longevity, spending, sources of income and assumptions about the future. By comparison, it is not clear how the 4% Rule is adjusted for these variations. As a simple example, how is the 4% Rule adjusted for excess withdrawals in prior years or for changes in the 4% Rule from year to year?
- It permits users to distinguish between user-selected-essential expenses and discretionary expenses to facilitate risky vs. non-risky asset investment allocation decisions
- It permits users to distinguish between recurring and non-recurring expenses, to select a reduction in spending upon the first death within a couple and to assume different rates of future increases in expenses to facilitate more accurate costing of expected future spending.
Recommendation/Take Away
As with many other things these days, there does not appear to be complete agreement among individuals with respect to a given topic. In this case, the topic is the real-dollar amount that may be safely withdrawn from a portfolio each year for the next 30 years (or more) without depleting the portfolio. Retirement academics generally argue that the amount to be safely withdrawn in the first year of a 30-year retirement is about 4% of a portfolio invested about 50% in equities and 50% in bonds. Dave Ramsey argues that 4% is way too conservative (stupid) and he believes the amount should be closer to 8% of the individual’s portfolio and the portfolio should be 100% invested in equities.
While we tend to side with the Supernerds on most retirement-related issues, we don’t necessarily have a problem if more aggressive retirees want to push the spending envelope and use a higher withdrawal rate (but probably closer to 4% than 8%). For those that do (or for those who don’t), however, we recommend that they annually compare their plan with the plan produced by the Actuarial Approach (inputting override assumptions consistent with their plan) so that they can make necessary spending adjustments in the future if warranted.
