One of the most widely discussed retirement topics among personal finance enthusiasts and financial planners is the 4% rule of thumb (“4% rule” for short). The 4% rule refers to a concept regarding the sustainable withdrawal rate from portfolios in retirement (i.e. the amount of money that can be safely withdrawn from a portfolio without the portfolio running out of money).
Relying on historical data, three professors in the seminal Trinity Study found that withdrawals of 4% from a portfolio of stocks and bonds, adjusted annually for inflation, were unlikely to exhaust the portfolio over a 30-year period. In other words, if you’re planning for retirement, the 4% rule, as interpreted by many, tells you that you can safely withdraw approximately 4% of your portfolio each year.
Many, particularly in the FIRE community (Financial Independence Retire Early) have taken the 4% rule as gospel – in most circumstances (at least historically), the 4% rule will be successful for a 30-year retirement and even longer. Plenty of others argue that the 4% rule is just a starting point and less a law of nature. I’m in this camp.
One of the problems with the 4% rule is that it is only based on historical data, which may or may not reflect what will happen in the future. Also, for those contemplating a retirement longer than 30 years and/or are retiring at the top of a bull market, 4% could be too risky. Frustrated proponents of the 4% rule would then argue back that naysayers are worried about corner cases when the focus should be on the most probable. And, so on and so forth.
I enjoy reading the analyses and debates over safe withdrawal rates (“SWR”) and whether 4% is the right number, too high or too low. Selecting an SWR is important because that number guides you to how much money you need to save for retirement (in combination with a pension and/or Social Security, if you’re lucky), and what you ultimately determine as your SWR reflects how risk-averse you are when it comes to personal finances.
The consequences of picking a too conservative or too risky SWR are potentially quite big. Pick an SWR that’s too high, and you run the risk of running out of money too soon and having to try and find work in your retirement and/or decreasing your living standards dramatically. On the flip side, pick too low of an SWR and you’ll have more left over than anticipated, which likely means you’ve forgone spending that could have enhanced the quality of your life and experiences.
Up until now, thinking about SWR and the 4% rule has largely been a theoretical exercise for me. I’m not retired and was not planning to in the immediate future. However, while I could run back-testing and simulations as many others have done, I’m interested in seeing how the 4% rule plays out in real life for myself.
My plan is to use my Donor-Advised Fund at Schwab Charitable as the test subject for my 4% rule experiment.
Here’s how it will work. The experiment started in December 2018 with an initial portfolio size of $16,000, which I will segregate from the rest of my DAF funds. $650 of donations from my DAF to charities in December 2018 represents an initial 4.06% withdrawal. The portfolio is invested into a traditional 60/40 stock and bond portfolio, with the 60% in Schwab’s Total US Stock Market fund and 40% in Schwab’s Total US Bond Market index fund.
Come December 2019, we’ll take a look at where the portfolio stands and then withdraw (i.e. donate) another 4% adjusted for inflation based on CPI.
So, yes, this will be one long, slow experiment, but it’ll be meaningful to me because it’s a real-money account will have real world consequences on the amount I can distribute (admittedly modest in this experiment).
And, if the markets do start to tank as some expect with a possible recession around the corner, there will be a psychological effect in seeing a reduced value portfolio and having to answer the question of what to do next (e.g. withdraw less money next year to preserve principal, which would be the equivalent of a retiree tightening the belt and spending less money). Stay tuned!
