Thoughts on the 4% Withdrawal Solution

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Q: What percentage of my account can I withdrawal annually and not run out of money during my retirement?

A: A common answer is the 4% solution?

The 4% solution is a rule of thumb coined by financial advisor Bill Bengen in a 1994 study that attempted to identify the maximum safe percentage a retiree could withdrawal annually from their accounts. He showed, using historical returns, that if retirees withdrew 4% of their nest egg’s value in the first year and then increased the dollar amount by inflation rate every year, their savings would easily last 30 years. This was based on a portfolio that was evenly split between large company stocks and U.S. Treasury bonds.

As with most rules of thumb, it is easy to understand but not necessarily right for every situation.

Here are my main problems with this theory:

  • It treats all income as the same
    • Some sources of income such as CDs or pensions are much more secure and dependable than other sources of income such as stock market returns.
  • It requires you to confine your annual budget to 4% of your account’s value.
    • Some areas of your budget can be eliminated easily such as vacations while others are much more difficult to live without such as food, housing and medicine.
  • If your budget was a constant 4%, some years would find you spending much less than your portfolio could provide for.

Instead of using the 4% solution as your safe withdrawal number, I suggest you break down your portfolio and match your different types of income with your different types of spending.

Here are a few basic groupings:

On the income side:

  • Steady income
    • social security
    • pensions
    • annuities
    • individual bonds
    • bond mutual funds
    • CDs
  • As the name implies, these investments tend to generate income steadily every single month regardless how the economy and/or stock market performed.
  • Fluctuating income
    • individual stocks
    • stock mutual funds
    • real estate
    • commodities
    • hedge funds
    • private equity
  • As the name implies, these investments tend to generate income some months while other months you would end with little or no income (or worse yet a loss) based upon on how the economy and/or stock market performed.
  • One is neither better nor worse than the other, but it is important to realize they are different.

On the spending side:

  • Essential
    • medical
    • property tax
    • utilities
    • food
    • housing
  • Discretionary
    • eating out at restaurants
    • entertainment
    • new clothes
    • cars
  • Luxury
    • vacations
    • home remodeling
    • charitable giving
    • helping others
    • Items that fall in the luxury category are usually the ones that are eliminated first when times are tough and added back last as investment returns recover.

I believe having a comfortable retirement is best achieved by matching your essential spending with your steady income and your discretionary spending and luxury spending with your fluctuating income.

This way when the stock market cooperates you do not have to maintain your 4% spending diet and when the stock market doesn’t cooperate you do not have to worry about not being able to meet your day to day basic living expenses.

The next table shows historic returns and average gains and losses across various indexes. I encourage you to review these numbers and determine if the investment should be classified under steady income or fluctuating income.

Historic risk and returns as measured by changes in prices year-over-year. 2012 data as of 8-31-12

Source: Morningstar. Returns do not include effects of dividends, capital gains, taxes or management fees. Past performance is no guarantee of future results.


  • The U.S. Large Cap Stock Index is represented by the S&P 500 Stock Index.

  • The U.S. Small Cap Stock Index is represented by the Russell 2000 Index. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. The Russell 2000 includes the smallest 2000 securities in the Russell 3000 Index.

  • The Real Estate Index is represented by the Dow Jones Wilshire REIT Index. This index measures publicly traded Real Estate Investment Trusts.

  • The International Stock Index is represented by the MSCI EAFE Index. This index is designed to measure the market performance of the developed markets, excluding the U.S. and Canada. The index includes stocks from 22 countries.

  • The U.S. Total Bond Index is represented by Barclays U.S. Aggregate Index. This index is comprised of approximately 6,000 publicly traded bonds including U.S. government, mortgage backed, and corporate bonds and has an average maturity of approximately 10 years.

  • The U.S. Mortgage Bond Index is represented by Barclays Mortgage Backed Index. This index covers the bonds of mortgage giants Ginnie Mae, Fannie Mae and Freddie Mac.

  • The U.S. Government Bond Index is represented by Barclays U.S. Government Index. This index is composed of 5,400 publicly traded bonds with at least one year to maturity and $25 million outstanding.

  • It is not possible to invest directly in an index.

  • All information was provided by Morningstar and although believed to be reliable, Wells Fargo Advisors does not guarantee the completeness or accuracy.

  • This historical information represents past performance and should not be considered indicative of future results.

  • Returns do not include effects of taxes, capital gains or transaction costs.

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