Father of 4% Rule Urges Caution, Cash as Market Risk Rises

Bill Bengen, the inventor of the so-called 4% retirement portfolio withdrawal rule, has a crucial message for financial advisors:

“Manage the risk portion of a retirement nest egg actively. Unless you’re willing to vary — reduce — your clients’ allocations to reduce risk, it could be damaging,” the former 25-year advisor argues in an interview with ThinkAdvisor.

But have the pandemic, falling markets and rising inflation torn up the 4% rule? Hardly, he says.

“We’re in a period of rising interest rates, and probably both stocks and bonds will do poorly,” he says. 

This time, the Federal Reserve “may not have the luxury” to use monetary policy to affect “a quick cure,” Bengen cautions.

In a research paper published in 1994, he recommended a 4% withdrawal rate in tax-deferred accounts for the first year of a 30-year retirement, making adjustments in subsequent years according to inflation rates.

But about two years ago, he increased his suggested rate to 4.7% based on new research he’d conducted.

Recently, however, citing “high inflation [as] a huge threat to retirees,” Bengen revised the rate once again and recommended a rate lower than 4.7%.

“If people want to take a few tenths off and take it down to 4.5% or even 4.4%, I wouldn’t argue,” he says in the interview.

Bengen is suggesting a retirement portfolio asset allocation of “55% of your normal allocation to stocks” and “cutting your bond allocation at least in half.”

He advises: “Wait for better values in both stocks and bonds, and then put the cash to work.”

For about 25 years, he helmed Bengen Financial Services in Southern California, then sold the practice to Dean Rowland Russell in 2013, and retired. He has never stopped researching the issue of retirement portfolio withdrawal rates, though.

Before becoming a financial advisor, he was president and chief operating officer of his family’s soft-drink-bottling business.

ThinkAdvisor recently interviewed Bengen, who was speaking by phone from Saddlebrooke, Arizona, where he lives.

About revising the 4.7% withdrawal rate, he notes: “I felt it was probably best for people to err on the side of conservatism just in case we get a new worst-case [market] scenario” more distressing than what occurred from 1968 through much of the 1970s.

“I’ve seen plenty of days now when both stocks and bonds have gone down together,” he says. “It’s kind of frightening.”

Here are excerpts from our interview:

THINKADVISOR: Is there anything that alarms you about the way retirement planning is done today?

BILL BENGEN: My biggest concern are buy-and-hold advisors who don’t modify their allocation in response to market risk.

What could be the fallout?

We’re in a period of very high risk for retirement investors. Unless you’re willing to vary — reduce — your clients’ allocations to reduce risk, it could be damaging.

We’re in a circumstance where the Fed has to fight inflation. We’ve had a series of big declines in the last 15 or 20 years, and the market has come back pretty quickly, primarily because the Fed used monetary policy, like quantitative easing and a zero-interest-rate program.

Would they do that again?

They may not have the luxury to. 

Historically, markets have taken many years to come back, like [after] the Great Depression; and during the 1960s and ‘70s, the markets did nothing at all. Maybe we’re headed for another one [of those].

That’s why I say protect your retirement nest egg because if it gets damaged, there may not be a quick cure. 

Manage the risk portion actively. Retirees should be exceptionally careful in this environment.

What prompted you to recently revise your “4% rule” to a lower amount of withdrawal during the first year of retirement?

I wasn’t the one that [called it] the “4% rule.” That’s shorthand that developed over time in the conversation about my research.

I raised the rate to 4.7% a year or two ago based on my latest research at that time. Since then, circumstances in the market have become unique.

My research has been based on studying rates of return and inflation. I couldn’t find anything that matched the situation we had coming into this year, with valuations at all-time highs and inflation threatening to pick up substantially. 

So I’ve suggested that [retirees] may want to be more conservative than my research had indicated was necessary.

But there are different withdrawal rates for different situations, and financial advisors need to take that into account when planning for their clients.

To what retirement investing situation does the so-called 4% rule apply?

It’s based on a tax-deferred portfolio, like an IRA, not a taxable account. And it’s based on a 30-year retirement — not 40 or 20 years. If you have those numbers, you need a different rate.

What’s the specific rate you’ve recently recommended?

I felt it probably best for people to err on the side of conservatism just in case we get a new worst-case scenario.

The historical worst case [started] in 1968 [and lasted for a number of subsequent years]. There was a bear market and high inflation.

Now, if people want to take a few tenths off 4.7% and take it down to 4.5% or even 4.4%, I wouldn’t argue. But they need to keep a close eye on how inflation goes.

I’m not reducing the rate to anywhere near some forecasts, like 3% or the high 2%’s. It would take a real catastrophe to get to something that low. But I think lowering it a little is prudent right now.

Wade Pfau, professor of retirement income at The American College of Financial Services, told me in an April 2020 interview that an investor “taking a modest amount of risk” should be withdrawing only 2.4%. Your thoughts?

I honestly don’t know how that could be possible unless things get much worse. I respect Wade, but we have a parting of visions [here].

I haven’t seen a combination of market conditions that would require such a low withdrawal rate. 

If we had 15 or 20 years of inflation, maybe that would justify it.

Still, high inflation is a big problem now. Just how big a problem is it, do you think?

If the Fed can’t get inflation under control in reasonable order, we may face a situation in the markets that may be more severe, which might eventually lead to a lower withdrawal rate than the 1968 worst-case scenario I had discovered. 

Why did you increase your recommended rate from 4% to 4.7% a few years ago?

When I wrote my book [“Conserving Client Portfolios During Retirement”] in 2006, I added asset classes to my research that raised it to 4.5%. Then I added more asset classes a couple of years ago and made it 4.7%. 

I felt pretty comfortable with that until we started entering this period of high inflation. It’s a huge threat to retirees.

What are the implications?

Inflation forces you to increase your withdrawals, which are kind of locked in. Once you get a period of inflation, you’re not likely to get a period of deflation to offset it.

So you’re going to be stuck with high withdrawals for the rest of retirement.

Where do higher interest rates come in?

I don’t normally look at interest rates in my research other than how bond returns are affected.

We’re in a period of rising interest rates, and probably both stocks and bonds will do poorly. This doesn’t happen that often. 

I’ve seen plenty of days in the market now where both stocks and bonds have gone down together. It’s kind of frightening.