Does the 4% Rule Work? [You’re Missing the Point]

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Have you ever wondered if there was a rule to follow when it comes to how much to save for retirement?

Here’s some good news: there is a highly-revered guideline that goes by the name of the 4% rule.

The 4% rule is quite popular, and a hotly debated topic for good reason; it’s a core tenet within the FIRE (Financial Independence, Early Retirement) community.

If you’re going to base an entire journey towards financial independence or early retirement on this one rule, you’d better be damn sure it works!

Despite your thoughts on that community, one thing is certain. Even if you’re not aiming for early retirement, it’s still a good rule to follow.

But there is still one question that lingers for some: does the 4% rule still work?

That being said, let’s get into the 4% rule for those of you that don’t know it yet. And if you do know it already, feel free to skip ahead.

What is the FIRE movement?

The FIRE movement, which stands for “Financial Independence, Retire Early,” is a lifestyle movement that advocates for saving a high percentage of one’s income in order to achieve financial independence at an early age, typically in one’s 30s or 40s.

The core tenets of the FIRE movement include living frugally, reducing expenses, and investing aggressively in order to build wealth quickly. By saving a high percentage of their income and investing in assets that generate passive income, such as real estate or dividend-paying stocks, followers of the FIRE movement aim to accumulate enough wealth to support their lifestyle without relying on traditional employment income.

Once financial independence is achieved, followers of the FIRE movement can choose to retire early or continue working, pursuing their passions or other interests without being dependent on a regular paycheck.

The FIRE movement has gained popularity in recent years, with numerous blogs, podcasts, and books dedicated to the topic. However, critics argue that the movement is not realistic for most people, and that it may encourage individuals to sacrifice too much in the present for an uncertain future.

What is the 4% retirement rule?

The 4% rule is a guideline used to determine the safe amount of funds that can be withdrawn from a retirement account every year.

This is based on the premise that you do not want to run out of money during retirement despite the fact that you still need to withdraw funds regularly to live off.

The rule states that you can withdraw 4% of your portfolio each year in retirement and have a high probability of never running out of money for the entirety of your life.

It doesn’t matter if you retire traditionally at 65 and expect 30 more years of life, or if you’re an early retiree and expecting 70 more years of life.

This withdrawal rate is considered to be a safe withdrawal rate (or SWR for short) by experts as it theoretically allows for an infinite number of 4% withdrawals once a year without exhausting your portfolio.

For example, if you had a $1 million portfolio, you could withdraw $40,000 each and every year of your remaining life and never run out of money, statistically.

How to calculate the 4% rule?

Suppose you’re able to keep your withdrawals at a steady 4% (or less) each year.

And suppose you have $1 million dollars in your portfolio at the time of your retirement.

For the first year, you take out $40,000 as allowed by the 4% rule. For those that like to see the math:

  • $1,000,000 x (4/100) = $40,000

You then use that to pay for the cost of living for the year.

You’re left with $960,000 in your account for the year.

Now suppose the stock and bond markets give you a combined 5% return by the end of the year, and that’s a pretty conservative assumption given present-day economic conditions.

  • $960,000 x (5/100) = $48,000

That $48,000 (in the form of capital gains, dividends, and yield) added to $960,000 gives you a grand total of $1,008,000 to start off the following year with.

Despite having spent money to live for the year, you are even better off the following year. How cool is that!

You can imagine by rinsing and repeating that for any number of years, you’d do quite well.

However, life doesn’t always go up, and neither do stocks or bonds. So the best assumption this rule can make is that on average, the stock market will return more than the 4% we’ve spent for each year.

As long as the stock market doesn’t tank significantly in the first few years of retirement, statistically, it’ll work out for you.

Is the 4% rule for early retirement?

Absolutely! The 4% rule is applicable to both early retirees and normal retirees.

Of course, the same caveat applies that the economy doesn’t significantly tank during your first few years when you’re starting out in retirement. Much of that is luck, unfortunately, and it can affect both early and normal retirees equally.

How long will my money last using the 4% rule?

Believe it or not, the 4% rule has an extremely high probability of lasting forever when done correctly. The probability of success is over 90%.

The 4% rule allows you an infinite number of 4% withdrawals that will never exhaust the entirety of your portfolio. But, if you happen to make a miscalculation somewhere along the line, it can most definitely derail the effectiveness of the strategy.

Does inflation affect the 4% retirement rule?

There are many factors that play into the viability of the 4% rule. But inflation is a great point of contention especially given the current economic conditions of 2022 (when this post was published).

When it comes to stock market performance, a certain amount of inflation inherently gets accounted for in your stock holdings.

Think about it. Say your grocery spending increased by 10% for the year. The money spent on those groceries, including the additional 10%, goes to the supermarket as well as the companies that produce the products.

That supermarket and that food company make up part of the stock market.

If they’re raking in an extra 10% due to inflation, that 10% gets reflected back onto their bottom-line, and by being a shareholder, it gets reflected onto your bottom-line as well.

Obviously, that’s an overly simplistic explanation, but you get the idea.

The FIRE community’s withdrawal rate debate

The question remains, does the 4% rule still work in this present day and age?

And I’d be lying if I said I knew.

Even the FIRE community doesn’t always agree on the correct withdrawal rate to use.

Hell, even the inventor of the 4% rule, Bill Bengen, has recently stated that a 5% or even 7% withdrawal rate would probably suffice just fine.

In the FIRE community, some are advocating for a 3% and even 2% withdrawal rate, which indicates that they prefer to be on the more conservative side of things. As a whole, they do tend to sway on the more conservative side financially, and that probably has a lot to do with why they’re quite successful at maintaining financial independence.

The numbers 2% and 7%, applied in place of the 4% Rule, couldn’t be more different on a practical level.

Using a 2% withdrawal rate on a $1M portfolio gives you the freedom to spend $20,000 per year to live.

Using a 7% withdrawal rate on a $1M portfolio gives you the freedom to spend $70,000 to live.

Depending on which state you live in, one clearly allows you to live decently for the year while the other does not.

Is early retirement for you? See if one of the four types of FIRE could be for you.

Is the 4% rule accurate?

Historically speaking, the 4% rule is accurate and is a conservative estimate. However, there is no absolutes, and no one can predict the future, if there is a significant issue with the market such as right now, we would not be able to have a 4% return. The best that we can hope for is to be as prepared as possible.

Increase your chances of success with the 4% rule

Allocate your assets wisely

It generally assumes your portfolio is around 60% in stocks and 40% in bonds. It’s not a rule set in stone though.

If you’ve got more stocks, your total return probably does better but your volatility is much higher.

On the other hand, bonds tend to be much more stable in terms of volatility, but in terms of returns, they’ll very likely lag behind.

Keep in mind, bond interest rates were significantly higher previously than they are today.

You just might need a higher portfolio value to do a bond majority asset allocation. But as a plus, you won’t have to deal with all the stress of market swings as much.

Cut retirement spending now

The 4% rule also assumes that you will be able to maintain the same lifestyle throughout retirement (i.e., you do not increase or decrease your spending amount) and do not need to leave anything behind as an inheritance.

In other words, it requires you to stick to your retirement plan with little to no compromise.

However, if you happen to retire at a great time and your portfolio increases significantly at some point, then, of course, you could always adjust for more spending.

Whether the 4% rule works or not isn’t the point

There’s a saying from Malcolm X that goes:

“Tomorrow belongs to those to prepare for it today.”

Malcolm X

It’s crucial for your future self that you start planning your financial goals.

Part of that means setting a dollar amount as your goal, as well as a timeline for reaching that goal.

The 4% rule isn’t perfect in any way, but it helps you establish that dollar amount. It provides a simple yet absolute number to aim for.

I’d say that’s reason enough to use it.

If you know specifically what you’re aiming for based on the 4% rule, that means you’re already ahead of the majority of Americans.

Most Americans can’t even tell you how much they’d need in their portfolio for a successful retirement.

Also, your goal shouldn’t be to make as much money as infinitely possible. That’s a recipe for a mental health disaster as you’ll constantly be stressed.

The 4% Rule mitigates that mindset and orients your expectations into more achievable goals. Once you feel you’ve reached or surpassed your expectations, you can always modify your goals later on.

Pros and cons of the 4% rule: The pros


First and foremost is that it is easy to manage and follow. As the rule’s name clearly implies, all you have to do is withdraw the correct amount each year and trust that the market will do the rest.

As you wisely spend your expenses throughout the year, the rest of your portfolio potentially grows (depending on market conditions, of course) to prepare you for next year and all subsequent years.

Next is that it provides stable income and some peace knowing you have the resources to accommodate your lifestyle as a retiree.

The 4% rule was intended to ensure a retiree would be financially sound during a worst-case scenario based on somewhat recent historical data.

Hence, 4% may not actually even be the required rate these days.

Some financial advisers suggest that 5% might be the better approach to achieving a more sensible and comfortable life by increasing the withdrawal by 1%.

This added leeway can actually shave off a good amount of time off a person’s working years. It also allows you to avoid being on a level 99 budgeting mode for the rest of your life.

Lastly, it guides you in making wiser financial decisions to save you from running out of money in your days of retirement.

As humans, it’s fair to say we all have wants, and that’s okay. That’s our nature.

However, if left unattended, it may steer you away from the long-term goal of living a peaceful and worry-free life when making misinformed or impulsive decisions.

Pros and cons of the 4% rule: The cons


To balance the scale, the main drawback of the 4% rule is that it restricts you from making major lifestyle changes.

If you’re not the type of person who can stick to a general rule, then this may not work for you.

Making a change of even 1-2% per year can completely rearrange the puzzle, creating uncertainty that, needless to say, would not serve you well during retirement.

Furthermore, the rule may not work as well in the market today as bond interest rates have started to decline in the last few years.

So, to say that the 4% rule will have a 100% guaranteed successful outcome, especially in a bond-leaning portfolio, would be doing you a disservice.

In conclusion

Time and time again, the 4% rule has helped countless retirees plan out their retirement with a high probability of success.

Anyone using the 4% rule as part of their retirement strategy will likely live comfortably well into their later years.

Despite some of the uncertainties surrounding the specific percentage to use, whether it be 3, 4, 5, or even 7%, there is a lot of value to simply having an absolute goal to aim for, both financially and mentally.

We highly recommend considering it in planning out your long-term finances.

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