Is the 4% Rule Too Stingy? A Value Investor's Look at the 5% Withdrawal Rate

The 4% and 5% rules are not arbitrary numbers but the product of rigorous historical analysis. Their credibility rests on two landmark studies that tested withdrawal rates against decades of real market data, establishing a factual basis for their use as starting points.

The foundational work came from in 1994. He analyzed 50-year periods beginning in 1926 using a hypothetical portfolio of 50% common stocks and 50% intermediate-term U.S. Treasury notes. . This result, where the portfolio survived in 82% of the worst-case historical scenarios, became the origin of the widely cited "4% rule." Bengen concluded that for a typical 30-year retirement, a 4% initial withdrawal, adjusted annually for inflation, was a safe starting point.

The , published in 1998, offered a different perspective on the same question. It examined 60 rolling 30-year periods from 1926 to 2014, using a similar 50/50 stock/bond mix. . This study popularized the concept of "portfolio success rates," framing the 4% rule as having a near-100% chance of success in historical data, while the 5% rule carried a notably higher risk of failure.

Both rules share core assumptions that are critical to understanding their limitations. They are built on a 50/50 asset mix, a 30-year time horizon, and the principle of annual dollar withdrawals adjusted for inflation. The 4% rule, in particular, is often misunderstood as a guarantee of success. In reality, it is a historical benchmark: it means that in 41 out of 50 50-year periods, a 4% withdrawal would have lasted. It does not promise that a retiree will never outlive their money, nor does it account for individual circumstances like taxes, fees, or changes in spending patterns.

Separating the historical facts from common misconceptions is essential. The rules are based on U.S. history and assume that future returns will resemble the past. They do not incorporate modern realities like lower interest rates or higher inflation. Furthermore, the Trinity Study's success rates are not probabilities for today's retirees; they are statistics derived from data that no longer exists. The rules provide a disciplined starting point, but they are not a substitute for a personalized, flexible retirement income plan.

The Modern Reality: Why the Historical 4% Rule is Less Applicable

The once-reliable 4% rule is showing its age. Morningstar's latest research, published in late 2024, sets a new baseline safe starting withdrawal rate of just for a balanced portfolio, a clear retreat from the 4% standard it recommended just a year prior. This adjustment is not a minor tweak; it reflects a fundamental shift in the investment landscape that makes the historical rule less applicable.

The drivers are straightforward and persistent. First, expected future returns for both stocks and bonds have moderated. Second, current equity valuations are elevated compared to historical averages. Morningstar explicitly credits these factors-the combination of higher equity valuations and lower fixed income yields-for the downward revision. In essence, the market is priced for more caution, and the rule must follow.

This brings us to the rule's most challenged assumption: the 30-year time horizon. The original rule was built on the premise of a long retirement. Yet, for a 65-year-old retiring today, the average remaining life expectancy is . This creates a critical mismatch. The rule's high confidence level-aiming for a 90% or near 100% probability of not outliving one's money over three decades-was designed for a longer, more uncertain future. For many retirees, that level of safety is now excessive, potentially leading to overly conservative spending that diminishes enjoyment in a shorter actual retirement.

The bottom line is that the 4% rule was a useful starting point based on past market conditions. Today's environment of lower expected returns and higher valuations demands a more nuanced approach. The rule's core logic-that you can spend a fixed percentage of your portfolio annually, adjusted for inflation-remains sound, but the specific percentage must be recalibrated. As Morningstar's research illustrates, the appropriate rate is now lower, and retirees must consider their actual life expectancy and spending flexibility to navigate this new reality.

The Value Investor's Toolkit: Flexible Strategies for Sustainable Income

For the disciplined investor, retirement planning is an extension of the core value principle: preserving capital while generating sustainable income. The traditional "4% rule" is being refined by new research, but the more critical insight is that flexibility is the ultimate tool for navigating market cycles and personal needs.

William Bengen's updated analysis provides a more nuanced starting point. His research, which accounts for a more diversified portfolio mix including small-cap and international stocks, suggests a default safe withdrawal rate of . This is a meaningful increase from the classic 4% benchmark, reflecting a broader asset base. However, Bengen's work also underscores the vulnerability of the sequence of returns. He notes that a substantial bear market early in retirement can force down withdrawal rates, as the portfolio is depleted just as spending begins. This isn't a new rule to be rigidly followed, but a framework that demands vigilance and adjustment.

The real power for the value investor lies in flexible spending systems. Morningstar's latest research confirms that retirees who adjust their spending in line with portfolio performance can achieve higher lifetime withdrawals than those with a static plan. This approach directly addresses the sequence-of-returns risk Bengen identifies. By allowing withdrawals to dip during market downturns and rise when the portfolio recovers, a flexible system can prevent a portfolio from being decimated early on. It trades the comfort of a fixed income for the resilience of a dynamic one, a trade-off that aligns with the long-term, compounding mindset.

Guaranteed income sources further enhance sustainability, though they come with a trade-off. Building a laddered portfolio of (TIPS) can support a higher initial withdrawal rate with a high probability of success. Similarly, delaying Social Security or purchasing an annuity provides a predictable cash flow floor. Morningstar's analysis shows that retirees who prioritize lifetime spending over leaving a bequest can significantly raise their sustainable income by incorporating these guaranteed streams. The cost is a reduced inheritance, a choice that forces a clear prioritization of security versus legacy.

The bottom line for the value investor is that the toolkit is more flexible than the old rules implied. A starting rate of 4.7% offers a better baseline, but the strategy must be dynamic. Combining a diversified portfolio with a flexible spending plan and a portion of guaranteed income creates a more resilient path. It's a system designed not for a perfect market, but for the long, uncertain journey of retirement.

Catalysts and Risks: What to Watch for the 5% Withdrawal Thesis

The core of any retirement plan is the withdrawal rate-the percentage of the portfolio spent each year. The long-standing "4% rule" is a starting point, but its success hinges on a narrow set of future conditions. The primary catalyst for a 5% withdrawal thesis is the actual sequence of market returns in the first five to ten years of retirement. This period is critical because of what financial researchers call the "Sequence of Returns Risk." Even if a retiree's portfolio averages a solid return over a 30-year span, a bear market early on can be devastating. When the market declines and withdrawals are taken simultaneously, the portfolio's principal is depleted faster, making recovery much harder. As one study concluded, spending more than 5% annually carries a significant risk of running out of money due to this sequence effect.

Key risks that could derail a 5% plan are prolonged periods of high inflation and an early bear market. Inflation erodes purchasing power faster than historical data accounts for, and if it spikes during retirement, it can force retirees to withdraw more from their portfolios just to maintain their standard of living. This creates a dangerous feedback loop: higher withdrawals deplete the portfolio faster, which then needs to grow even more to keep up with inflation. Similarly, a severe market downturn at the start of retirement can permanently lower the portfolio's trajectory, making a 5% withdrawal rate unsustainable. As one researcher notes, enduring a substantial bear market early in retirement "drives down your withdrawal rates" because it sucks a lot out of the portfolio at the same time you're drawing from it.

The most critical watchpoint, however, is the retiree's own spending discipline. The historical 4% rule assumes a retiree will adjust their spending in response to portfolio drawdowns. A rigid 5% withdrawal, without any flexibility, ignores this fundamental principle. Morningstar's latest research, , explicitly assumes a retiree will hold real spending constant. The report's key insight is that retirees who are willing to adjust their spending based on portfolio performance can support higher lifetime withdrawals. Therefore, the success of a 5% plan isn't just about market luck or inflation; it's about the willingness to cut back when the market is down, to preserve the portfolio for the long term. Without that discipline, even a favorable sequence of returns may not be enough.