The 4% Rule
It only seems right for 1 Engineer On Fire to start with the 4% rule. Why you ask? Because an engineer developed the rule! In 1994 Bill Bengen, a former aeronautics engineer turned financial planner, published an article describing his 4% rule. He used historical stock market data to estimate a “worst case safe withdrawal rate”. Safe meaning a high probability of success of not exhausting a portfolio over 30 years.
The Trinity Study
If you really want to dive into the numbers, I suggest looking into the Trinity University study. In this study they used historical 30 year rolling stock market data, various rates of return and various asset allocations to calculate a percentage of success! If you are nearing your FI number and considering retirement, take a good look at the data found in the Trinity study.
In my reading I find many financial advisors and bloggers tend to oversimplify the 4% rule. Like so many numerical simulations the assumptions are critical. Variables like length of retirement, your asset allocation, rebalance frequency all play a huge role in the result. Data analysis is an awesome tool but must be understood completely to avoid misleading conclusions. Bengen used a 50/50 allocation rebalanced annually but again look at the Trinity study for wider variation on the subject.
The 4% Rule Modified
In 2006 Bengen raised the 4% rule to 4.5% and spoke of even higher average rates. In an Oct 2020 interview, he updated the rule to 5% but also considered an updated portfolio allocation (30% S&P 500, 20% US small cap and 50% intermediate treasury bonds). He warned the rule is not a law of nature it is empirical. Meaning it is only based on the data we have available.
What does all this mean?
I believe the work done to determine the safe withdrawal rate was some of the most important for modern day investors and people seeking FIRE! It’s really a rule of thumb giving people a data-based benchmark to start planning. So many variables to consider for every individual case. If you are new to your FI journey, just use 4% and keep investing. As you get closer (5 years) to your FI number, dig into the data and realign your goals to your comfort level.
What did I do?
In my twenties I just put away every penny I could spare (401-k and mutual funds) and didn’t worry about it. I tracked my progress monthly and targeted double-digit growth.
In my thirties I maximized my 401-k and bought more mutual funds in IRAs. As life turned more complicated with family and work my monthly tracking turned to quarterly.
In my forties I could see the light at the end of the tunnel and began making serious projections. I used 3% inflation, 4% withdrawal rate and no Social Security. I ran projections with growth percentages from 5-11%. I realized my personal and professional responsibilities took more and more of my time. I had amassed a pile of different mutual funds and began to lose focus in my portfolio. I decided to seek the help of a professional advisor. When I had little money and plenty of time, I managed everything myself (no load mutual funds were the index fund of the era). When I no longer had the time, I searched out the best help available. I selected Merrill Lynch and their analysis confirmed my plan was sound.
At age fifty I realized I liked my job and the people but the commute and politics were wearing on me. I decided to work until 55 and made a shift in my planning. I had reached a Lean FI number but wanted to target a lower withdrawal rate. My wife and I started expanding our leisure activities in preparation for retirement. I realized my focus was always on accumulation and I knew practically nothing about withdrawals!
My brother-in-law, also an engineer, introduced me to “Can I Retire Yet” by Kirkpatrick (another engineer!) and I found “You Can Retire Sooner Than You Think” by Moss. Both books confirmed I was in good shape financially. I decided I never wanted to go back to full time work so I added a buffer to my FI number. I calculated 25 times my annual budget (4% withdrawal) and added 40%. Why 40% you ask? Over my investing life my worst year was -32%. If I suffered a 40% drop in the market the day I retired, I would still have my full FI number. 😊
1 Engineer On Fire
What rule do you use for planning?