Hey everyone, we have good news. FIRE just got a lot easier. Bill Bengen, the creator of the 4% rule, said 5% is a good withdrawal rate in the current environment (2020). That’s great news for the FIRE crowd. Many of us use the 4% safe withdrawal rate as a guideline. We save and invest until our net worth is 25 times our annual expenses. That’s one definition of financial independence. Once you achieve that goal, you can retire early, change jobs, become a stay-at-home parent, or live a nomadic lifestyle for a while. FIRE gives you a lot of options. If we change the safe withdrawal rate to 5%, we only need to save 20x instead of 25x. That’s a huge difference.
Safe Withdrawal Rate (SWR)
First, let’s quickly go over the 4% safe withdrawal rate. This is what Mr. Bengen came up with, in 1994.
- At the time of retirement, set the withdrawal rate to 4% of your portfolio. So if you retire with $5 million dollars, then you can safely spend $200,000 the first year.
- Adjust for inflation every year. If inflation is 2%, then you can withdraw $204,000 next year.
- The timeline of the study is 30 years. I retired from my engineering career when I was 38 and hope to live to a ripe old age. My timeline was closer to 50 years so I saved up 30x to be safe.
- The 4% rule is the worst-case scenario. Most retirees would end up with plenty of money after 30 years. Only a few would exhaust their entire retirement portfolio after that time period.
What made Bengen change the withdrawal rate from 4% to 5%? The key is this: 5% is a good withdrawal rate “in the current environment”. The 4% SWR was the worst-case scenario and it’s proven to be too conservative for most retirees. Retirees can safely withdraw more than 4% if the stock market is undervalued and/or the inflation is very low. Take a look at Bengen’s article in Financial Advisor magazine – Choosing The Highest Withdrawal Rate at Retirement. It is very good. We’ll summarize it here, but the article is worth a read. I’ll use some images from there.
Stock Market Valuation
The stock market valuation is a big factor for figuring out SWR. It makes sense. If the stock market is inflated when you retire, then your portfolio would be inflated as well. Here is a chart from Bengen. It’s based on Michael Kitces’ idea to incorporate the Shiller CAPE into the calculation.
- The Shiller CAPE tells us the stock market’s value. If the stock market is overvalued, your portfolio will be bigger. The risk of crashing is higher and the Sequence of Returns Risk could be a problem.
- The SAFEMAX is Bengen’s update to the SWR. It shows how much you can withdraw and still succeed in retirement. We can see that the worst-case scenario over the last 100 years is higher than 4.5%. So 4% SWR is very conservative.
- This chart only goes up to 1990 because the study period is 30 years. The Shiller CAPE was very high over the last 25 years so I expect the SAFEMAX will drop closer to 4% as the study progresses. Shiller CAPE is 31.69 in 2020. You can check the Shiller CAPE here.
Another critical factor in the SWR calculation is inflation. High inflation can erode the retirement portfolio. The US has controlled inflation very well over the last 100 years so it isn’t a big problem for us. Recently, the Federal Reserve Board (the Fed) is pushing inflation down even further by cutting the interest rate. This low inflation environment is very good for soon-to-be retirees. If inflation stays low to moderate, retirees should be able to set a higher SWR.
Here are Bengen’s tables.
When you’re ready to retire, check this table and see what your SWR should be. Currently, we have low-inflation and high Shiller CAPE. Hence, Mr. Bengen is recommending 5% SWR for soon to be retirees.
FIRE with 20x?
Alright! I find this research fascinating. I knew inflation can erode our savings, but I didn’t know it was this important. This is good news for the FIRE crowd. The Fed is planning to keep inflation low for a long time and we’ll all benefit from this policy.
Does this mean we can lower our FIRE goal to 20x instead of 25x? I think 20x would work for regular retirement, but not for FIRE. From what I understand, the higher SAFEMAX withdrawal means your portfolio will be close to zero after 30 years. My retirement will be closer to 50 years. Life won’t be so rosy if we run out of money when I’m 68. For early retirement, 25x is a safer goal. It’ll give us some margin.
Lastly, early retirement doesn’t mean you have to stop working completely. I plan to earn a bit of income via part-time work (10-15 hours/week) until I’m 65. This way we don’t have to draw down our retirement fund until much later. You can check out our withdrawal strategy here.
In summary, here is what I’d do.
- Accumulate 25x your annual expense.
- Earn a bit of income so you don’t have to draw down your portfolio.
- Wait until 65 to start withdrawal.
Actually, 20x should be fine for step 1 if you put off withdrawal until later. If you plan to withdraw in your 40s, then you probably need to use a smaller SWR.
What do you think of the revised SWR from Bill Bergen? 5% might not seem like a big difference from 4%, but it could mean 3-4 years of working. Personally, I think 20x is perfectly fine if you plan to retire after 60. For FIRE, we probably should save at least 25x or work part-time after early retirement to be safer.
SWR is fine and all, but you really should plan your retirement yourself. Every situation is different. You can’t depend on anyone to tell you how much you need. A great tool for individual investors is the Retirement Planner at Personal Capital. It is the best retirement calculator out there. It’s even flexible enough for early retirement. Sign up with Personal Capital and check it out.
You can read my review of the Retirement Planner here.
Image credit: Benjamin DeYoung
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.