Why the 4% rule is the ultimate "sequence of returns risk" insurance

One thing that many people don't realize is that the "4% rule" is not based on "average investment returns". It's based on backtesting 150 years of data, identifying the worst case 30-year pay-out period in the data set, and then determining the asset allocation that would allow for the highest inflation adjusted withdrawal during that worst case 30-year period, and all other 30-year pay out periods examined.

As a result, the 4% rule is very likely to leave you wealthy. As it happens 1994 to 2024, the first 30 years of my early retirement, was just about at the median (or "average") of the historical distribution of returns. If you kept a 60% stock/40% fixed income portfolio throughout those 30 years of 4% inflation-adjusted withdrawals (i.e., Vanguard's VBINX), you closed out that 30 years with a portfolio balance of over 5 times your starting balance. If you decided to increase your stock exposure as your portfolio balance rose, (and withdrawal rate declined as a percent of assets), you likely had 10 times your initial balance, or more after 30 years.

Conversely, the worst time to retire in the past 30 years would have been the year 2000, just before the historic Dot.com bust and 50%+ stock market decline. After a limited recovery, you then had another 50% stock market decline in 2008 with the Housing Crash and Home Mortgage Meltdown. Someone taking a 4% inflation-adjusted withdrawal from VBINX still has his starting balance intact after 24 years of withdrawals. There's little reason to believe he won't make it another 6 years to the end of the 30-year pay out period. And that's reflected in the data set. In about 95% of the payout periods examined, the portfolio still has the initial balance intact after 30 years of withdrawals. Payout periods where you're spending your initial capital are pretty rare

Of course, it's unlikely that a retiree in a declining market would be actually increasing his stock exposure, but if he did, the results would be disasterous. There's a lot of risk that a stock heavy, Year 2000 retiree wouldn't make it 30 years without running the portfolio dry.

What to conclude from these results?

No one can predict the short-term future of the stock market. While over a 50 to 60 year retirement investing lifetime (i.e., 25-30 years of saving for retirement, and, God-willing, 25-30 years of spending the money in retirement) you're like to converge on something close to the average long term stock market return. But as you start retirement, you need an asset allocation and withdrawal rate that can survive what Dickens called "the worst of times". That would mean a 60/40 portfolio, the ability to earn some outside income during a recession/depression when finding a job might be tight, or the ability to temporarily reduce spending until the stock market recovers. If you happen to retire into a favorable sequence of returns as I did, you can increase your spending, or take on more risk with a higher stock allocation.

One thing that appealed to me when I investigated William P. Bengen's method using a larger data set from Yale economist Robert Shiller was the distribution of the terminal value of the portfolio after 30 years. As you can see from the table below, in 95% of the one hundred 30-year payout periods examined you ended that 30 year period with a higher balance than you started -- a higher balance despite 30 years of annual withdrawals. There's about a 50/50 chance you'll have 4X your starting balance and a 10% chance you'll end 30 years with nearly 8X. As long as you don't happen to retire on the eve of the next Crash of 1929 and the Great Depression, there's a good chance that the 4% rule will make you rich.

Don't bargain away your upside to a life insurance company by purchasing an annuity. {{ LOL }}

Resources for more information

How much do you really need to retire?, Quora.com post from w.w. Lenzo Ph.D Quantum Physics, Stanford University 1990

Life Expectancy vs. Income in the United States -- Opportunity Insights Harvard University

PortfolioCharts.com - site that shows lowest cost ETF/mutual fund choices for a retirement portfolio

Bengen, William P, Determining Withdrawal Rates Using Historical Data, Journal of Financial Planning, October 1994, pp 171-180, Volume 7, Number 4.

Investment Company Factbook 2019, ICI.org

You ll Spend Less As You Age -- Time Magazine, Feb 26, 2014