Ben Felix: This 'Ultra-Safe' Number Ensures Your Retirement Funds Last Forever
Is your retirement plan aiming too high?
The famed 4% withdrawal rule comes from Bill Bengen’s 1994 research paper that assumes a portfolio is perfectly split between U.S. stocks and bonds. However, PWL Capital chief investment officer Ben Felix pointed to more recent research in a podcast AMA that highlights a 3.5% withdrawal rate as an ultra-safe option.
People save and invest for many years, hoping they have enough to retire. If you’re focusing on the 4% withdrawal rule, Felix provided some reasons to reconsider.
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The Research Explained
While Bengen’s research focuses on a 50/50 portfolio between U.S. stocks and bonds, Felix draws data from a portfolio that is filled with global stocks. He said that adding global bonds to the portfolio makes things worse, but with his set-up, a 3.5% withdrawal rate is the safer approach.
Morningstar's annual State of Retirement study has altered the safe target percentage a few times since its 2021 inception, which highlights the risks (and therefore variability) of the 4% withdrawal rate. It also stipulates that the rate of failure goes up if you extend the time horizon. Felix conducted his own backtest to arrive at the 3.5% figure for a portfolio that only contains global equities.
Felix said that a 3.5% withdrawal rate only presents a 5% failure rate, compared to a 17.4% failure rate for the 4% rule. Failure rate refers to the likelihood of outliving your nest egg. When in doubt, the lowest rate is the safest one if you can hack it. After all, there's no obligation to spend more if you can get by on less.
When the 4% Withdrawal Rate Still Makes Sense
Felix’s projected 5% rate of failure for a 3.5% withdrawal rate for a global equities portfolio assumes a 30-year timeframe. The rate of failure for his proposed portfolio goes up if you extend the time horizon. He found an 8% failure rate with a 35-year horizon and a 14% failure rate for a 40-year time horizon.
While this research points to rising failure rates if you retire earlier, it also means your failure rate goes down if you delay retirement. People who retire in their 60s and 70s have a much better shot at pulling off 4% withdrawal rates than people who take the FIRE route and leave the workforce in their 40s or 50s.
Felix’s research only found a 5% failure rate with a 4.4% withdrawal rate for people with 20-year time horizons. Delaying retirement naturally gives you more options since you do not have to stretch the money across as many years.
Social Security will make it easier to preserve your portfolio or justify an elevated withdrawal rate if needed. People in their 70s are definitely receiving Social Security by that point, which offers an extra income source that goes beyond the nest egg. You can claim Social Security upon turning 62, but it is often better to delay your claim so you end up with higher monthly benefits.
The Sequence of Returns Risk Can Ruin the Math
If you spend $60,000 per year, you need a $1.5 million portfolio following the 4% withdrawal rule and a $1.71 million portfolio with a 3.5% withdrawal rate. Both of those setups let you spend $5,000 per month.
However, not every retiree prepares for the sequence of returns risk. If the stock market experiences a 20% correction the year that you retire, you will be forced to sell more shares to withdraw the same amount of money. The 3.5% withdrawal rate accounts for this risk to some degree, while setting up your portfolio based on the 4% withdrawal rate will leave you more exposed.
It’s a nice bonus if you have one year of savings stored in an emergency fund. That way, you won’t have to withdraw as much from your retirement plans during market corrections.
The 4% withdrawal rate is feasible for people with 20-year time horizons, but it’s extremely risky to use that same rate if you want to retire early.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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