Does the 4% spending rule for retirees still apply? Morningstar’s Director of Personal Finance and Retirement Planning, Christine Benz, explains why this traditional advice might need some updating when it comes to future market conditions and your clients’ spending habits.

Well, Julie, I don't know, for the past, what's it been six months now, it just seems like you can't count on any market to do anything, what the experts say it's gonna do or what you might expect to do. And I can remember during similar times back in 2008 when we had increased market volatility, I began to think that everything I ever learned about financial planning might be wrong, right? So we think about these things like the 4% rule, for example, or the rule of 70. Well, we know the rule of 72 works, but you know, the 4% rule, which talks about, you know, how much our clients should expect to withdrawal, it seems like clients have that fixed in their head no matter what is going on in the markets. And you know, I guess when things get a little bit crazy, I start to wonder whether all those rules of thumb that we had are still applicable.

I'm right there with you. It feels like my crystal ball is getting murkier by the day. And I think some of these learnings or even habits that have been formed, it might be time to hit the pause button and just go back and reassess. So I, I couldn't agree with you more. I'm educating myself anew every single day it seems.

Which is when recently, uh, Julie, when we met up with Christine Benz at Morningstar, uh, I was really intrigued by learning about some work that they had begun just a couple of years ago, looking at some of these rules, in particular, the 4% rule that we've all kind of accepted as, as financial gospel and questioning whether it is still applicable in ways that many people think it automatically applies. So, uh, why don't you share Julie a little bit with, uh, with everyone listening about who our guest is today.

Christine Benz from Morningstar.

Absolutely. Christine is director of personal finance and retirement planning for Morningstar and senior columnist for morningstar.com. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar called The Longview, which features in- depth interviews with thought leaders in investing in personal finance. She's a frequent public speaker and is widely quoted in the media, including the New York Times, the Wall Street Journal, barons Cnbc, and pbs. And in 2021, Baron's named her as one of the 10 most influential women in wealth management. We're very lucky to have her with us today.

Let's listen in on the conversation we recently had with Christine. Hi, I'm John.

And I'm Julie.

We are the hosts of the Hartford Fund's Human-Centric Investing Podcast. Julie Genjac (02:48):

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Welcome Christine to the Human-Centric Investing Podcast. We're so excited to have you here with us today.

Well, thank you so much. It's great to be here with both of you,

Christine. You know, when I joined the financial planning industry, oh, 35 years ago now, uh, the 4% rule was kind of a, I mean, it was like written in stone. It was, if you remembered one thing or two things, it was the rule of 72 and the 4% rule. And yet I know you and your colleagues at Morningstar have done a fair amount of work over the past couple of years about whether the 4% rule is still applicable. And so, uh, for folks like me who have had it kind of burned into our memory, is the 4% rule still a rule? How do you view it?

I view it as a useful starting point. I often mentally reference some research that Fidelity did several years ago where they asked individual investors how much they thought they could withdraw from their portfolios in retirement. And there was a fairly high percentage of those individuals saying 10% they thought was a safe withdrawal amount. So people need to use something as a gauge of the viability of what they've managed to save and how much they can reasonably withdraw. But the 4% guideline that we have all had burned into our brains over the past few decades was developed by William Bengen.

And it's based on backward looking historic data where Bengen said, well, if someone came into retirement and encountered Armageddon, encountered just the worst possible convergence of events, bad equity returns, bad bond returns, high inflation, what would've been the highest amount that he or she could have withdrawn on a balanced portfolio over a 30 year time horizon?

And he focused on that period in the late 1960s, early seventies is sort of the worst period that one could have retired into, where you had exactly that convergence of a bear market in 73, 74, uh, high interest rates, which pummeled bond prices and runaway inflation during that time for much of the 1970s and even into the early 1980s a little bit. So he focused on that and determined that on that balanced portfolio, if someone wanted their funds to last, they would need to take up 4%. Our research attempts to kind of look at current yields as well as equity valuations with an eye toward determining if we're kind of looking into the future and thinking about where we are today, what would be a safe amount to take out. So when we did our research in the end of, uh, 2022, based on September 30th, 2022 data regarding yields in our team's estimation of equity valuations, we converged pretty close to 4%. So 3.8% was our recommended starting point, a hair below 4%, but we also modeled out all sorts of different withdrawal strategies, variable or dynamic withdrawal strategies, and we found a lot of power in those where if people can be a little bit, uh, willing to adjust, uh, specifically if they're willing to take

their spending down a little bit, if the market is not performing well, that redowns to the benefit of being able to take a higher starting withdrawal amount.

It's interesting, Christine, when you share some of the framework, what, was there an event or a story or something specific that inspired you to really dig into this? You know, I put this in the bucket of sort of what got us here today isn't gonna be what gets us to there tomorrow. Could you share with us sort of where this, where this began and, and how you started peeling back the layers on the 4% rule?

Right. Uh, it's a great question and I would say it goes back to some discussions that my colleagues and I were having in 2021 where we were looking at the fact that bond yields were very, very low. So we knew that the raw materials for a big component of retirees portfolios weren't that great. Um, and so we wanted to take a forward looking view for people attempting to determine what would be a safe withdrawal amount, and we wanted to specifically drill into some of these variable or dynamic strategies. A lot of the great research that's been done by others in the withdrawal rate space, so people like Wade Fow, Michael Kites, our former colleague at Morningstar, David Blanchett, much of that research points to the value of being variable as, as I said before, but there are trade-offs associated with that variability. And I think it does depend very much on the retirees circumstances.

So more affluent retirees can more me more readily in, in many instances, make those adjustments to their spending where, you know, the difference might be they had four vacations planned and you're telling them that they should probably only take three big, big vacations, maybe not a big deal there, but a bigger deal if, um, the market doesn't perform well and you're telling someone, well, last year you lived on $60,000, you pulled 60 from your portfolio this year we think you should just take 40. And so we wanted to examine some of the volatility that accompanies, uh, the dynamic strategies, dynamic withdrawal strategies, the, the cash flow volatility, the buffeting around, um, as well as some of the trade-offs associated with residual values. So we know that oftentimes the 4% guideline or sort of a fixed real withdrawal system leaves people with significant sums of money at the end of their lives that may or may not be what they want. And some of the variable or dynamic strategies actually get you spending in good market environments too, have you spending a little bit more. And the net effect of that is that you're consuming more of that portfolio in many instances. There's less of the portfolio left over at the end of that, uh, 30 year period.

You know, Christine, when you mentioned the 10% withdrawal rate that some may, it took me back to actual clients that I worked with years ago. Good friends of ours, uh, who retired and had heard that as long as they kept their withdrawals less than 10%, they should be set for life. He was probably 58 years old at the time, and three years later, their portfolio is worth about two-thirds of what it started at. And they came to me saying, what do we do now? , right? And uh, right. So I think as a, as a rule, I think what I hear you saying is still applicable with some flexibility, but a question for you, thinking about the changing regimes that we've had over the past year or two and equity returns, fixed income rates, you know, even today the Fed is still mired in the question of how far for how long, so on and so forth.

Um, do you, how far back did your historic data go? Is it a year or two that you've done this, look at the 4% and, and do you have any experience with what changed, uh, one year to another?

Right. It's such an important question. And so we do use starting yields as a gauge of what sort of fixed income return assumption we make. So the good news is, is that even though it has caused a little bit of a dislocation in the stock and bond markets that we've seen rising interest rates, it makes everything so much easier from the standpoint of retirement spending if we have higher safe yields come online.

Yeah, and that's something we haven't had to think about for the past 20 years, right? Because interest rate rates were on almost a one-way trip straight down to the seller, right?

That's right. And the wild card in all of this, of course, is inflation that, uh, with higher inflation, even though safer yields are much, much better today, we do have higher inflation. And that is an argument for not overdoing very safe investments because you do need that long-term return potential. You need that shot at outrunning inflation, and that's what you have with higher risk investments. So when we looked at, uh, the optimal asset allocation, the optimal stock bond mix that would deliver the highest possible withdrawal rate, interestingly, it's not the 90% equity portfolio, the 80% equity portfolio, it's the balanced portfolio that gets it done and, and leads to the higher safe withdrawal amounts.

You, you mentioned spending Christine, in terms of a lever obviously, that the retirees can pull. And it's interesting, I always think about during anyone's life cycle, obviously there are ebbs and flows or peaks where spending maybe is a little bit higher versus another point. But if we really hone into the life cycle of retirement, uh, I'm confident that in the research that you've done, you've seen where spending, you know, has peaks and valleys. If I'm a financial professional, having that conversation with my clients that are, that are either in, in retirement or maybe it, it's, it's coming up in the near term horizon, are there questions or how do, how to dig into that so that I can really hone in on some of those specific ideas needs versus wants? It's just interesting because I think oftentimes we set a budget, right? We fill out the worksheet and we, we come up with this number and then start to apply it at, at through every single year. Are there ways to hone in on some of those peaks and valleys so that we could kind of really figure out what that percentage withdrawal rate looks like at different periods in that life cycle?

Right. It's such an important dimension in all of this is that when we look at the data on retirees at, at large, what we see is that there is some variability and, um, this is a pattern that my former colleague, David b Blanch had identified identify that has been subsequently called the retirement spending smile.

And this'll probably be something that will resonate with your listeners who have, uh, no doubt worked with older adults where in the early years of retirement the go-go retirement years, there's a lot of pent up demand. Oftentimes people, they're younger, their health is good. So those tend to be the high spending years of retirement. And then as folks move into their seventies, early eighties, their health may, may still be good, but they may be a little more sedentary to the extent that they're doing travel. It might be a bit closer to home in the US versus outside the US and so on.

So spending definitely trends down in those middle to later retirement years and then trends up later on coinciding with uninsured healthcare expenses. Certainly if someone encounters long-term, long-term care need later in life, that would necessitate a higher spending. So I do think that advisors working with their clients should be thinking about, uh, such a spending pattern, but also talk it through with their clients their, to the extent that someone does want to model in kind of that go-go slow go, no-go sort of pattern. It would potentially allow for higher spending in the early retirement years. And we spent a little bit of a time in our research trying to model that in. So higher spending early in, in retirement, lower spending later on. And that does allow for those high, higher early expenditures. Um, I also think advisors can do a lot of good just sitting down with their clients and looking year by year with an eye toward determining, okay, here's when you think you'll need to replace that car maybe five years from now. Or, um, your furnace is 15 years old, you think it'll make another, make it another 10 years model in some of those lumpier expenses. So that, um, it's not a big surprise to the cash flow planning that goes on.

That's what I was gonna say, Christine, is that it seems like, you know, if we look at a 4% rule or we adjusted on an annual basis, those are really the, the regular recurring expenses almost. And even then, there probably ought to be some discussion with clients about if we had to trim back in any given year, because the idea being we don't wanna take money when markets are down, uh, uh, where would we look in the spending portfolio to do that? But I think what you said is extremely important. Like sometimes with those lump sum purchases, assuming we don't wait till the car or the furnace is on its last leg, we, we may talk to the client up front to set expectations to say, look, if things are looking up in year two or three, we may accelerate that purchase, right? Because it just makes sense to pull our money out if market expecta market performance is above our expectations. So I think, you know, there's two factors. You you called it lumpy expenditures, I think anticipating what those are, but also thinking about if we had to cut back, where would it be? And I think psychologically having those clients visit that space before we're actually in the position to need to do it is sometimes helpful because then at least we kind of envision our way through it.

Exactly. And you know, another dimension of this is that the client's cash flow sources probably will change over the life cycle as well. So many older adults have gotten the message about the value of delaying social security if they possibly can, especially if they think they have longevity on their side or they have a younger spouse, if they've been the primary earner and they have a younger spouse, there can be an enormous benefit in delaying, but that does necessitate higher withdrawals earlier on in retirement from the investment portfolio before that higher social security payday comes online. So factoring in that, how, how cash flow demands on the portfolio may change, and then also there may be assets that come in to the portfolio. So a common situation, especially for more affluent households is perhaps where they've had two homes, uh, maybe the one in the warm climate and the one in the cold

weather climate. And then at some point, one of those homes gets sold. Often it's the cold weather home, but, um, that is a new asset that's coming into the portfolio. So factoring in life events like that can be really v really value valuable. It's not just the spending that needs to change. It may be that the, the cash flows from the portfolio will change as well.

And I would imagine, Christine, that emotions sometimes are attached to some of these life changes as well when you're thinking about the smile and spending when I love that analogy. So I think that just arms financial professionals with, with additional conversation points to really talk through the pros and the cons before we wrap up. Any final words of wisdom as it pertains to the 4% rule, if you will, from a financial professional standpoint, is they're continuing to engage in conversations with clients about this and think ahead and look forward as opposed in the rear view mirror, as you've said. So aptly

One really important point in all of this, I think is, um, probability of success. So in our research, we modeled in a 90% certainty. So we're assuming that someone's taking sort of that fixed real withdrawal from the portfolio, never wavering, never varying, and that they're targeting that 90% chance of not running out of funds. A lot of, um, investors might say, well, I want a hundred percent chance of success. But the, I think the point is we're not saying to set one withdrawal rate that you have to stick with through the rest of your life. You can look at this and periodically revisit and advisors sh should and, and are doing this w work with their clients all the time where you're looking at, okay, based on what we saw last year in the market, our probability of success has gone down a little bit, or maybe it's gone up a little bit, or whatever it might be. That that will vary over time. And that's okay. And if you're okay with, uh, that probability of success changing a little bit, you should also be okay with varying withdrawals on an ongoing basis.

And Christine, as a financial professional, I, I anticipate that, uh, Morningstar is gonna continue with this analysis. And if so, uh, when might I start looking for your newest assessment on the fourth percent rule?

Yes, our plan is to revisit this research each year, roughly in the fourth quarter of each calendar year. So we'll be rolling up our sleeves probably, um, early fall and getting to work and releasing something around, um, kind of November, December period. Thanks for that question, John.

Absolutely. Well, we have a few more questions for you, Christine. This is, uh, for Julie and I, one of our favorite part of the podcast because aside from the 4% rule, we get to learn a little bit about you through what we call our lightning round. So okay. If you're up for it, Julie and I are gonna fire questions at you. We want top of the mind responses, um, and these aren't gonna be nearly as hard as analyzing withdrawal rates, uh, across the spectrum. So, uh, fairly simple questions, but Julie, if you wanna start with Christine and then we'll roll from there.

Perfect. Christine, on a scale of one to 10, how good of a driver are you?

Oh gosh. Well, you know, we're all above average drivers, right? According to that famous Swedish study. Yes. Um, I am a six.

Are you a morning person or a night owl?

I'm more, uh, I would say I'm a balanced person, a lean night owl, but, uh, go to bed typically between 10 30 and 11 every night. So I'm not able to exercise my night owl tendencies too much.

I like that answer, A balanced person. I think that's what I strive to be in life. But Christine, what's the best age?

The best age? Um, I would say my forties were pretty happy. Kind of a good, uh, balance of experience, but still feeling pretty youthful, still feeling like I was in my twenties

Milk chocolate or dark chocolate

Milk chocolate. Um, yeah, I'm not one of those chocolate purists. And recently have you been reading this stuff about the heavy metals showing up in dark chocolate? Um,

I think I did. Yeah. Yeah, we've been sold to bill goods.

Right? But yeah, milk, I'm a milk chocolate person.

Do you prefer a paper to-do list or a digital one?

I keep paper to-do lists. I always have a little notebook with me where I take all of my notes on an ongoing basis and, um, sketch out my calendar for the day and kind of do a weekly to-do list as well. But, um, I do certainly keep up a, a digital calendar for my work so that people can see, you know, when I'm available and so forth. But for my own kind of to-do tracking, I really like a a paper list.

Agreed. Well, thank you Christine, for allowing us to see the human-centric side of you here today on our podcast. And for those listeners that are interested in hearing more about Christine's thoughts, be sure to view her podcast The Long view@morningstar.com. She also has a host of articles, uh, on that website at morningstar.com as well. And check out her book, 30 Minute Money Solutions, a step-by- Step Guide to Managing Your Finances. Christine, we can't thank you enough for being here today and sharing your wisdom on our Human-Centric Investing podcast.

Julie and John, thank you so much. It's been my great pleasure.

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