The 4% rule is a mind-killer

Sonnie Bailey

8 April 2022

I LOVE rules of thumb. In the right place at the right time, they’re invaluable.

There are, however, times and places where rules of thumb aren’t appropriate.

Working out how much you need in order to retire or feel comfortable or feel “financially independent” is NOT the time or place to rely on a rule of thumb.

In this spirit, let me make the following point abundantly clear.

I think the 4% rule is a dumb rule that a lot of smart people fall for.

What’s the 4% rule, anyway?

The next time you hear someone talk about the 4% rule, ask them what it actually means.

They’ll usually tell you something general. For example, it tells you how much you can spend based on a certain amount of capital.

If you accumulate a nest egg of, say, $1 million, 4% of this is $40,000 per year. The 4% rule suggests that if you want to sustain a lifestyle costing $40,000 per year, you’ll need to accumulate $1 million.

It’s sometimes known as the 25x rule. That is, if you want a certain level of annual expenditure, you need to accumulate 25 times that amount. $40,000 x 25 = $1 million; 4% of $1 million = $40,000.

Ask some more detailed questions and the answers get a bit shakier:

  • Is the 4% figure the same over time, or does it change? Ie, does it stay at $40,000 in inflation-adjusted terms, or is it 4% of the remaining capital at the start of each year?
  • Will the rule allow you to retain your capital (ie, does it imply that you’re living off the income/gains only) or does it allow for spending some of your capital, and if so, when will the lump sum run out?
  • What type of investment approach does it imply or require?

Whatever the 4% rule means to you or someone else, it involves quite a few assumptions.

The 4% rule originates from safe withdrawal rate research

The origins of the 4% rule come from the Trinity Study and a lot of research that follows.

Broadly speaking, these studies explore different retirement scenarios, and determine what level of probability, or confidence, that someone might have that their capital will stay above $0 over a certain period of time.

A study might assume, for instance, that someone has a portfolio of, say, $1 million, and that they want to withdraw a constant amount each year over 30 years. Whether that portfolio “succeeds” comes down to whether that portfolio stays above $0 over that 30 years.

Contrary to what a lot of people seem to think, the 4% rule is NOT about passive income. It’s NOT about maintaining your capital indefinitely. It’s about DECUMULATING: drawing down your capital over a period of time, and being confident that your capital won’t fall below $0.

In order to model this, the study will have to make a number of assumptions. For example, that expenditure will be constant over the 30 year period (perhaps adjusting for an assumed level of inflation) (admittedly, some studies might model different levels of expenditure over 30 years – for example, higher expenditure in the earlier years, with expenditure gradually reducing as time goes on).

The study will generally assume that the portfolio in question is invested in the same way over the entire period. (And that investments are taxed in a consistent way, and that fees also stay relatively the same.)

The study might then take different data sets (such as historical returns over different 30 year time periods, or might undertake a monte carlo analysis based on lots of scenarios assuming certain types of return distributions: for example, returns that are randomly generated, but assuming returns are normally distributed with a mean of X% and standard deviation of Y%).

Based on a study of this nature, they might find that all portfolios stay at $0 or above based on a level of expenditure of $35,947 per year. The study might find that 95% of scenarios “succeed” at a level of expenditure of $40,381. The study might find that 90% of scenarios “succeed” at expenditure of $43,423.

Tell me this: of these scenarios, what do you consider the “safe” withdrawal figure? The figure where all scenarios “succeed”, where 90% of scenarios succeed, or something different?

These studies will try different things. They might try different data sets (for example, historical data that’s not so US-centric, or monte carlo analyses that make different assumptions). They might analyse what type of investment portfolio will have a better “success” rate – for instance, a “60/40 portfolio” (one that is invested in 60% growth assets such as shares and 40% defensive assets such as bonds), or a 40/60 portfolio, or a 80/20 portfolio, etc.

They might also try to determine safe withdrawal rates for different time frames. 30 years might be appropriate for someone retiring at age 65, expecting to live until 95. But that’s probably not so relevant for someone who is wanting to retire in their 40s or 50s. What is the safe withdrawal rate over, say, 40 or 50 years?

It’s a dumb rule that tricks clever people.

What assumptions are you making? What assumptions are you prepared to make?

The 4% rule seems really straightforward. It provides a clear answer to a complex question.

The reason it’s straightforward is because it embeds – and disguises – lots of assumptions which are, quite frankly, silly for most Kiwis.

Consider, for example, the following questions.

Is your expenditure going to stay constant (inflation-adjusted or otherwise) year after year?

My guess is that your expenditure won’t stay constant from year to year.

Some years will be more expensive than others, with car replacements, home maintenance and repairs, and more or less travel from one year to the next.

As you get older, it’s likely you’ll have less energy and inclination to spend money compared to the earlier years of your retirement.

Is your income going to stay the same, year on year?

In particular, what credence do you give to receiving NZ Super? If you’re single and living alone, and just about to turn 65; you plan on retiring on your 65th birthday; and you think you’ll keep getting roughly the same level of NZ Super over the course of your retirement, you might be able to work out what you “need” using the 4% rule. If you want to spend $50,000 per year, you’ll need to supplement $23,000 of NZ Super to the tune of $27,000 per year. $27,000 x 25 = $675,000.

This is quite a big difference compared to someone who doesn’t want to assume they’ll receive NZ Super. $50,000 x 25 = $1.25 million.

If you plan on retiring at 60, and are comfortable with assuming you’ll receive NZ Super, how do you work out what you need, based on the 4% rule? Is it at simple as multiplying $50,000 x 25 or $27,000 x 25? (Spoiler: no.)

What level of confidence do you want to have?

There’s a difference between wanting something close to a 100% level of confidence versus a 90% level of confidence or below.

For most people, a 100% level of confidence is too high (and doesn’t really exist; whatever model you use, it’s not necessarily going to tell you what your experience will be). For most people, a slightly lower level of confidence may be necessary, with the understanding that you might need to recalibrate your expectations over time. The level of confidence you might want or need is personal to you.

How long will your capital need to last?

For someone in the situation I listed above – ie, someone retiring at age – it might be well and good to pin their retirement figure to a safe withdrawal rate based on modeling 30 year time periods.

But even then, there’s a big difference between someone who gets to 65 with a lot of health issues versus someone who is in enviably good health and has lots of family members who have lived into their late 90s.

If you’re wanting to retire earlier, do you really want to rely on research that relates to 30 year periods?

Are you comfortable with taking advantage of some of your home equity eventually?

As you hit your mid-80s, you might end up going into a retirement village. After selling your home and paying the occupancy advance, you might end up with, some additional capital to support your retirement expenditure. How do you fit this into the 4% rule?

Alternatively, reverse mortgages might not be super popular, but they can be appropriate for some people. If you’re 95 and running low on capital but have $1 million in equity locked up in your home, then an arrangement of this sort (or a loan from family, secured against the home) might be suitable.

MIght you want or need to help out family members, or might you receive windfalls?

Do you anticipate helping one or more children with their education or helping them get on the property ladder? Do you have a child or grandchild who might become vulnerable at some point and need your help?

Are you from a family that has a lot of wealth? Are you a beneficiary of a trust with a lot of assets? To what extent do you wish to incorporate these factors into your planning?

Might there be changes in your relationship status?

People die. People separate. People merge.

If you’re in a couple, it’s likely that one of you will pass away before the other. In traditional marriages, it’s usually the wife who survives her husband – often by many years. This will impact household expenditure (only one mouth to feed) but will also impact NZ Super (soon to be $35,000 or thereabouts for a couple, or $23,000 for a single person living alone).

What buffer do you want or need in case of a separation? What credence would you give to entering into an encore relationship with someone who also has assets?

Don’t put your life in hard mode

I’m the first to admit that I don’t speak to a representative portion of the NZ population, so I can’t say this is true for everyone.

But for a disproportionate number of people I speak with, focusing on the 4% rule puts their lives in hard mode.

For a lot of people, this rule of thumb massively overestimates how much they need to accumulate in order to retire comfortably, or before they give themselves permission to feel financially comfortable.

It means that people end up letting money dictate their lives in a way that they don’t need to.

If you want to accumulate lots of financial wealth, that’s great! It’s especially great if you accumulate lots of financial wealth because you’ve added lots of value to the world! You do you.

If, however, you’ve used the 4% rule to determine how much you need, without interrogating the assumptions behind it, I want you to step back and think about whether the 4% rule is right for you. My guess is that it’s not.

If you’re making sacrifices and compromises, or taking unnecessary risks, because you think you need an inflated figure, then you might be putting your life in hard mode.

If that’s the case, you’re breaking my heart.


And if you’re telling people how much they need by pointing to the 4% rule, without noting the assumptions that are involved, then take this as notice. I’m losing my patience with people who promote this message. You might be complicit in causing a whole lot of unnecessary stress, prompting people to take unnecessary risks, and making money more central to their lives than it needs to be. It breaks my heart, and it makes me angry.


(HT to Eliezer Yudkowsky for his article, “Politics is the mind-killer”, for inspiring the title to this article.)


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