Bengen’s 4% Rule Around The World
How much can I draw from my retirement savings without running out of money?
This is the 64-million-dollar question Bill Bengen attempted to answer in his seminal 1994 paper published in the Journal of Financial Planning. Bengen, an MIT-trained aeronautical engineer, was going to join the US space programme NASA. He wasn’t accepted into the programme, for some reason, so he did the next best thing and became a financial planner.
Bengen’s central accomplishment was to propose what he termed ‘Sustainable Withdrawal Rate’ (SWR) from a portfolio of equities and bonds. Bengen used actual historical return and inflation, as opposed to a linear projection of average return. He calculated the maximum withdrawal amount that you could take from a portfolio each year, then adjust for inflation, without depleting the portfolio over a given period. To do this, he calculated the maximum initial sustainable withdrawal for all the rolling 30-year periods using US historical data since 1926. He then identified the worst-case scenario within that dataset.
Bengen made an undeniable contribution to retirement income planning for millions of people across the world. However, the framework has to be adapted to take account of each person’s unique goals, asset allocation, time-horizon and preference.
In this post, we apply Bengen’s approach to illustrate sustainable withdrawal from an investor’s point of view in five different countries: US, UK, Canada, Ireland and Australia.
Bengen’s original approach
First, it’s worth revisiting Bengen’s original approach; it was to calculate the maximum initial withdrawal from a portfolio consisting of 50% US equities and 50% intermediate bonds for every 30-year rolling period between Jan 1926 and Dec., 2018.
- Bengen’s original took no account of investment fees or taxes (more on this later).
- Based on his work, the historical worst case for this dataset is the 30-year period starting in May 1965. It resulted in an initial withdrawal of $40,700 from a $1m portfolio. The withdrawal is subsequently adjusted for corresponding CPI inflation during that period.
- The best case is the 30-year period starting in August of 1982, when you could have taken a withdrawal of $112,900 from a $1m portfolio and subsequently adjust the withdrawal for inflation. This translates into an initial withdrawal rate of a whopping 11.3%.
Bengen’s rule modified
OK, now that we’ve got that out of the way, let’s see how the framework fares in five countries. We’ve used an initial portfolio of 1,000,000 in the designated currency and withdrawals are adjusted for inflation (CPI) in each country. We made some modifications to Bengen’s original framework, including:
- Fee: we’ve assumed fees of 1% of the outstanding portfolio each year. So, the withdrawal presented below is net of 1%pa fees. In his original research, Bengen assumed a 0% fee, for the simple reason that investor fees vary significantly. However, this assumption has come back to haunt his work; many people incorrectly assume that a 1% fee translates to an equivalent reduction in the sustainable withdrawal rate. It doesn’t.
- Asset allocation: for each country, we use two asset allocations, local and global. So, for instance, for a US investor, the local asset allocation is 50% US equity (large cap) and 50% US aggregate bond. The global allocation is 50% world equity and 50% global bond.
- Time Horizon: we stick with Bengen’s original 30-year retirement period. It goes without saying that the framework can be applied to different time horizons, although one might argue that the framework wasn’t intended for a retirement period longer than 50 years, since the dataset would be limited.
- Taxes: for the purpose of this research, withdrawals are gross of taxes because tax varies by each person in each country. However, advisers can illustrate the impact of taxes using the Timelineapp.co software.
- Periodicity: for most asset classes, we have data extending all the way back to 1900. However, there are exceptions such as the UK, where data only goes back to 1915, or Ireland where data goes back to 1923. Long data have their pros and cons. Longer data allow more scenarios, including some of the most severe market conditions and economic instability created by WW1, WW2, the Great Depression and aggressive inflation. For some people, this allows a wide range of scenarios. For others, it’s way too pessimistic as it includes the darkest hours known to man.
US investor — local 50⁄50 portfolio (50% US equity + 50% US aggregate bond)
The chart below shows the initial maximum withdrawal for every 30-year rolling period between Jan 1900 and December 2018. As noted, we applied 1%pa fees deducted from the portfolio.
- As we can see, a withdrawal of $40,000, increasing annually with inflation, from a $1m portfolio has a success rate of 77%.
- The historical worst case is $33,200 for the 30-year period starting in Nov. 1905. The result is different from Bengen’s partly because of the 1% fee, but also because it extends over a longer period.
US investor — global 50⁄50 portfolio
- But, if you’re a US investor with a globally diversified portfolio split equally between equities and bonds, a withdrawal of $40,000 a year, net of 1% fee only has a 52% chances of success for a 30-year period.
- The worst-case scenario is the 30-year period starting Nov., 1905, giving a withdrawal of $28,500, net of the 1% fees.
UK investor - local 50⁄50 portfolio
- The 4% initial withdrawal for a UK investor with a local 50⁄50 portfolio has a success rate of 70%. (One point to note is that UK monthly inflation data only goes back 1915.)
- The historical worst case is the 30-year period starting in June 1947, resulting in a withdrawal of £29,700, adjusted for inflation, from a £1m portfolio.
UK investor - global 50⁄50 portfolio
- The historical worst case is the 30-year period starting in May 1961, resulting in a withdrawal of £30,500, adjusted for inflation from a £1m portfolio.
Canadian investor — local 50⁄50 portfolio
- The 4% initial withdrawal didn’t fare too badly for a Canadian investor with a local 50⁄50 portfolio, with a success rate of 89%.
- The historical worst case is the 30-year period starting in Jan 1903, with an initial withdrawal of C$32,000, adjusted for inflation, from a C$1m portfolio.
Canadian - global 50⁄50 portfolio
- The historical worst case is the 30-year period starting in March 1905, with an initial withdrawal of C$27,300, adjusted for inflation, from a C$1m portfolio.
Australian investor - local 50⁄50 portfolio
- The 4% initial withdrawal for an Australian investor with a local 50⁄50 portfolio has a success rate of 84%.
- The historical worst case is the 30-year period starting in July 1968, resulting in a withdrawal of AU$33,400, adjusted for inflation, from an AU$1m portfolio.
Australian - Global 50⁄50 Portfolio
- The historical worse case is 30-year period starting in May 1965, with a withdrawal AU$27,800, adjusted for inflation, from AU$1m portfolio.
Irish investor — local 50⁄50 portfolio
- At an 86% success rate, the 4% initial withdrawal rate didn’t fare terribly for an Irish investor with a locally diversified portfolio of equities and bonds. (Note the data series started in 1923, in line with the establishment of the Irish Free State in 1922.)
- The historical worst case is the 30-year period starting in July 1936, with an initial withdrawal of €30,400, adjusted for inflation, from a €1m portfolio.
Irish investor — global 50⁄50 portfolio
- The historical worst case for an Irish investor with a global asset allocation, is the 30-year period starting in October 1968. It has an initial withdrawal of €27,000, adjusted for inflation, from a €1m portfolio.
People are often puzzled by the fact that the 4% rule produces different results in different countries — and even different asset allocations in the same country. But that’s sort of the point; the 4% rule wasn’t designed to be — and shouldn’t be — applied blindly.
Yet, Bengen’s framework itself — the idea of stress-testing a withdrawal strategy using extensive historical data — is a very useful way to think about sustaining income from a portfolio. Prior to his research, retirement income planning was based on straight-line projections of average return and inflation.
It’s easy to draw the wrong conclusion from this; that is, the 4% withdrawal tends to have a greater success rate with local asset allocation than global. But a German investor or a Japanese investor would disagree. Pfau 2014 conducted perhaps the most extensive study on the impact of global diversification on SWR. The study looked at SWR from the perspective of retirees in 20 different countries, investing locally and globally. Across the 20 countries, global portfolios supported higher withdrawal rates than domestic portfolios in 66.4% of cases.
One possible area worth exploring is how global equities plus local bond allocations might work better due to the unique relationship between inflation, interest rates and bond returns in each country. But, that’s a discussion for another day.