Why Withdraw 4% in Retirement When the Market Averages More?

Don’t down in this!

“Then there is the man who drowned crossing a stream with an average depth of six inches.”
–W.I.E. Gates

The standard financial planner advice when it comes to how much you can spend in retirement is 4% of your nest egg when you retire, adjusted annually for inflation. Actually, the more accurate safe withdrawal rate is 3.88%. Click on that link to find out how we came up with that number.

However, if your grandparents saved and scrimped, and when they retired, lived off of the interest off of their money, then you might wonder why you can’t do something similar with your investments – just take what you earn each year and live off of that.

Furthermore, the compound average growth rate of the stock market from 1963 through 2013 was 10.22%. That’s a lot higher than 3.88%.

Are You Leaving Money on the Table by Only Withdrawing 3.88% in Retirement?

In a word, yes.

However, there’s a tradeoff that you’re making, which hinges on two words:

  • Volatility
  • Inflation

Why volatility impacts your withdrawal strategies

Volatility is the fancy financial term for the market going up and down. Some years, it’s up. Some years, it’s down.

So far, so good.

If the market always gained at least 3.88%, then you would be in good shape.

The problem is that a little more than one year in three, the market returns less than 3.88%.

When it does that, you’re eating into your principal.

Retirement planners like for your money to last at least 30 years in retirement. I looked at the historical annual returns from 1871 through 2013 and then determined if a retiree between 1871 and 1973 could last 30 years by either withdrawing the gains, or, when gains were less than 3.88%, withdrawing 3.88%. This strategy only worked 61.2% of the time. When I make plans, I will only approve them if they work 90% of the time in my projections.

Therefore, volatility kills off this idea.

Why inflation impacts your withdrawal strategies

The other issue that retirees face with managing their money is that they need to keep up with inflation. If you can remember when gasoline was under a dollar a gallon (or a quarter a gallon) or Cokes out of the vending machine were only a quarter (or a nickel), then you are thinking of the ravages of inflation.

Inflation isn’t always bad. If you have a mortgage, then inflation is your friend. If you’re working, then inflation will usually mean pay raises in line with inflation, although not in recent history.

However, you shouldn’t have debt when you retire, and you probably aren’t earning a paycheck, but the price of milk, eggs, and bread goes up each year. To keep up, you need your investments to beat inflation for you. Plus, healthcare and long term care expenses, a greater portion of a retiree’s spending, have a higher inflation rate than the standard number cited – which is usually for consumer goods and services.

As we can see here, 3% inflation – roughly the average inflation rate – means that $1 at the beginning of retirement buys only 41.3 cents worth of the same goods and services 30 years later. Put another way, after 30 years, you need $2.36 to buy what it took $1 to buy 30 years before.

That’s why you cannot put your money into CDs and money market accounts in retirement and expect to have enough to last, unless you have about three times the standard amount required.

Published by

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

5 thoughts on “Why Withdraw 4% in Retirement When the Market Averages More?

  1. Help me understand something. Let’s take a best-case scenario, where a couple retires with a an entire million dollars in invested assets. Oh AND let’s assume that they’ve also paid off their house. Wow, fantastic, right? They are very wealthy and did incredibly well.

    But wait: a 3.8% withdrawal rate only gives them $38k / year income, and that’s before taxes! And, correct me if I’m wrong, but this income will not be tax-sheltered in any way, either.

    In much of the country, this may only barely qualify as a living wage. Now, granted, social security does contribute a little, but it’s so small, it’s almost not worth talking about.

    And, keep in mind that my example gives the best case scenario. Am I missing something here?

    1. You have the gist of it. The average Social Security payment is about $1,250/month, so a couple will get $2,500 a month. Taxes won’t be that bad (ahem…Lesson 14 of the Winning With Money course), and if the Roth accounts are big enough, may be close to $0. But, let’s assume for the sake of easy numbers, 10%. That gives our standard couple $5,670/month in after-tax income.

      That puts this hypothetical family somewhere between the 50th and 75th percentile of family income (granted, a little dated info, but real wages are pretty stagnant).


      If you’re 40, while Social Security is nominally adjusted for inflation, that $1 million target isn’t. You need to have $1 million in today’s dollars when you retire to reach that same standard of living (ahem…Lessons 12 and 13 of the Winning With Money course).

      So, it all depends on your definition of a living wage.

      1. Ok, I figured I had it right, but wanted to make sure. I can see why so many retirees are so poor in their later years. Securities are simply an unsuitable vehicle to generate retirement income.

        I’m glad I’m investing in real estate.

  2. I have a vague idea of your personal PIRE plan. So are you ignoring the standard withdrawal rates for yourself because you’ll just cashflow and preserve all capital.

    So how about a blog post on why a bit of leverage is so bad once retired? Personally the pros outlive the cons, as long as I keep LTV lower side of things, and plenty of cashflow margin..

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