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The Problem with the 4% Rule (and Why You Could Retire Even Sooner)

Have you ever questioned the conventional wisdom of the 4% rule for retirement?

You’re not alone. It’s not that the 4% rule is inherently flawed; it’s simply not designed with early retirement in mind.

Imagine this: picture a retiree in their 70s, set in their ways, tied to one place, and most of their expenses go towards necessities. Now, think about someone in their 30s or 40s, dreaming of early retirement, enjoying a flexible lifestyle, able to pick up part-time work if needed (or side gigs), and free to explore affordable and beautiful places to live. Can you see how these two scenarios call for different retirement approaches? It’s all about tailoring your strategy to fit your unique situation as an early retiree, especially for physicians like you who are looking to break away from the traditional retirement path.

This post is a collaboration with Nick Maggiulli from Of Dollars and Data.

I read Nick’s book, Just Keep Buying, and the thing I loved most was how he backed up all his arguments with data.

I was chatting to him on Twitter about why I enjoyed his book, and he said, “If you ever want to collaborate on something (or want me to run a simulation of something for you), let me know.”

I had a topic I thought would be perfect to collaborate on, and this article is the result.


The 4% Rule: Why It’s Not Ideal for Early Retirement

I’ve always had a problem with the 4% rule for early retirement.

It’s not because it’s bad or wrong.

It’s because it’s not for early retirement.


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My biggest issue is that it doesn’t account for the flexibility of most early-retirees.

It’s for standard retirement, and “traditional” retirees in their 70s or 80s aren’t likely to have as much lifestyle or spending flexibility as someone in their 30s or 40s.

By the time someone has reached the end of their career in their 70s, it’s likely they:

  • Have settled on a level of spending they want (or need) to maintain
  • Have no desire (or ability) to get another job, if the shit hits the fan
  • Are bound to a particular area (or even house)
  • Have a high percentage of their spending going towards essential expenses, like food and healthcare
  • Are more sensitive to inflation (due to a high percentage of essential expenses)

Compare that to someone in their 30s or 40s who retires early and has:

  • A more flexible lifestyle with less fixed expenses
  • The ability to pick up part-time or full-time work, if necessary
  • The freedom and/or desire to live in beautiful but cheap places, like Southeast Asia or South America, to reduce expenses without reducing their quality of life
  • A high percentage of their spending going towards discretionary expenses (e.g. travel, dining, drinks with friends, etc.)

The 4% rule doesn’t account for any of that flexibility.

It assumes you’re going to spend 4% of your portfolio’s value in your first year of retirement, and then increase that spending with inflation every year after.

Speaking of inflation…


What About Fixed Costs?

In a recent Money with Katie episode with the guy who created the 4% rule, William Bengen, Katie brings up the point that 4% is already conservative because of the way it treats inflation.

It assumes you’re going to inflation adjust ALL of your spending every year, whether inflation impacts every expense or not.

If you have a 30-year-fixed mortgage, for example, your biggest expense may not be impacted by inflation at all!


Other Reasons the 4% Rule is Conservative

I recommend you listen to the entire Money With Katie interview, but here are a few other reasons from that episode that 4% may be overly conservative:

  • The 4% rule was originally the 4.15% rule, but it was rounded down by mainstream media because 4% was easier to say/remember
  • The 4.15% rule is now actually the 4.8% rule, based on Bill Bengen’s updated analysis (which includes additional asset classes)


But the Money Has to Last Longer?

So the 4% rule is conservative for a 30-year retirement, but don’t we need to pick a lower withdrawal rate for a 40+ year early retirement?

Yes, but not as low as you may think.

We explored this topic in depth during my interview with Michael Kitces (still one of my most-popular episodes of all time).

If you want to add 10 years to a standard retirement, you should decrease your initial withdrawal rate by ~0.6%.

And surprisingly, a portfolio that survives for 40 years is likely to survive for 50 or 60+ years (see my post on Sequence of Returns Risk to learn why).


Are We Back Where We Started?

So if the 4% rule is actually the 4.8% rule, but we need to decrease that by ~0.6%, aren’t we back to roughly where we started (i.e. 4%)?

Yes, but we haven’t accounted for early-retirement flexibility yet!

And that’s what this whole post is about.


Incorporating Flexibility Into Your Withdrawal Strategy

Before Nick started crunching the numbers, we went back and forth to figure out the best way to factor flexibility into the withdrawal rate, and here’s what we came up with…


Discretionary Spending Percentage

First, figure out the percentage of your spending that goes towards discretionary expenses.

Discretionary expenses are any expenses you feel you could do without, if necessary.


Calculate New Withdrawal Rate

Once you have your discretionary spending percentage, find it on the following table and then pick a comfortable success rate in that column to find your withdrawal rate (the table assumes an 80/20 stock/bond portfolio allocation).

Or, if you have a FI Laboratory account, you can use the calculator I created to compute your withdrawal rate using this method.

If you don’t have a FI Laboratory account, you can get one for free here!


Withdrawal Rules

Now, you should have a withdrawal rate that is higher than 4%, so you could retire sooner (because a higher withdrawal rate means you’ll need to save up less money to cover your annual expenses)!

There’s no free lunch though (you can’t just withdraw more every year and expect your portfolio to last as long as it would have with the 4% rule), so there are some simple rules you have to follow for this strategy to work:

  1. While in a bear market (>20% off of highs), withdraw $0 for discretionary spending
  2. When the market is in a correction (>10% below highs), withdraw 50% of your discretionary budget
  3. All other times, withdraw your entire discretionary budget

Let’s see how this would work with an example…


Discretionary Withdrawal Rate Example Scenario

Let’s say a retiree has $1M in an 80/20 portfolio.

Using the 4% rule, that would allow for $40,000 in spending in year one, adjusting for inflation each year thereafter. With this portfolio and withdrawal strategy, there is a 96.55% chance of success (across all 40 year periods from 1926-2022).

But can we keep the same probability of success while withdrawing more with our new withdrawal method?

Yes, if the retiree follows the rules…

If they have 50% of their spending as discretionary spending, they can withdraw 5.5% (instead of 4%) and still have a 98.28% probability of success (across all 40 year periods from 1926-2022)!

Using our $1M portfolio as an example, in year one they would withdraw $27,500 as essential spending (half of the 5.5%) and then withdraw:

  • $27,500 as discretionary (if the market is <10% from its highs)
  • $13,750 as discretionary (if the market is >10% off its highs, but <20% off its highs)
  • $0 as discretionary (if the market is >20% off its highs)

While the essential spending adjusts upwards with inflation every year, the discretionary spending does not move with inflation (research shows that retirement spending tends to decrease over time, so this gradual decrease in real spending power should be manageable, while also ensuring essential expenses are always covered).

So in year two, after a year of 5% inflation, this person would withdraw $28,875 for their essential expenses and then either $27,500, $13,750, or $0 for their discretionary expenses (depending on the past year’s market performance).

Using this method, you’d have roughly the same probability of success over 40 years and, in most years (i.e. good years), you could withdraw more money!

Or, you could use this method to retire years earlier…

In this example, the person would need to wait until they hit $1 million to retire to cover their $40k of annual expenses, using the 4% rule.

If they use this new method instead though, with a 5.5% withdrawal rate, they’d only need to save up $727,273 to withdraw the same $40k for expenses (although, they’d need to cut back on their discretionary spending in down years).


Other Benefits of this Method

This method allows you to spend more and/or retire earlier, which is great, but it also comes with additional benefits…

Buffett’s quote about inheritance applies nicely to early retirement – “A very rich person should leave his kids rich enough to do anything but not enough to do nothing.”

I’ve seen a bunch of early retirees (myself included) race to the FI finish line, only to be left disoriented when confronted with the fact that money is no longer a motivating factor in their lives (and therefore, they could do “nothing”).

Having this discretionary withdrawal strategy seems to solve a lot of the problems I see with full FI:

  • It encourages you to focus on reducing your fixed costs (i.e. the expenses that really matter) but lets you relax with your fun/discretionary spending.
  • In down years, you’re forced to reevaluate your discretionary spending (so you don’t just keep mindlessly spending on things that you may not provide value anymore)
  • It gives you a pot of money specifically for discretionary spending, so you’ll hopefully be more likely to spend on fun things (rather than just keep saving and saving, like I did).
  • When you reach your number, you have enough to do “anything” but not enough to do “nothing” (unless you’re happy with $0 of discretionary spending during bear markets).
  • Money is still a motivating factor in your life, because you may want to have some income coming in during down years
  • Since your spending/lifestyle is changing year-to-year, you’ll hopefully appreciate things more (rather than just get into a routine of spending/doing the same things)


What if my portfolio’s performance differs from the market?

Just because the overall stock market is tanking, that doesn’t mean my portfolio is down 20%…shouldn’t the discretionary budget be calculated based on what my own portfolio is doing?

We thought about this, but we liked the simplicity of using the market as a guide. All the financial headlines will be screaming, “Bear market!!” when the overall market is down 20%, but nobody cares what your portfolio is doing.

Plus, the time to tighten your belt and be more cautious is when there’s fear in the streets. When the overall market is in a big correction, the real economy may also start to falter. That would make it harder to find work, if necessary. So it makes sense to tighten your budget when the overall economy is on shaky ground.


What if I don’t want to cut back so much during down years?

That’s the beauty of the strategy…you get to decide your discretionary percentage.

So if your fixed/essential expenses are 50% of your budget, but you know you want at least 15% to spend on discretionary spending to enjoy life (even in down years), then just treat 65% of your budget as essential and say that 35% is discretionary. You’ll have to work/save longer, but if that results in an early retirement that you enjoy, it’s worth it.


What do you think?

There seem to be a lot of benefits to thinking differently about your essential and discretionary expenses when it comes to early retirement, but what do you think?

Do you like this method, or is it too complicated/risky? Are there any other benefits/downsides I didn’t mention? Let me know in the comments below!


Just Keep Buying

Once again, huge thanks to Nick for taking the time to run all these simulations!

I probably wouldn’t have gotten around to writing about this topic, had it not been for Nick’s kind offer. So if you liked this post, be sure to thank him by checking out his excellent blog (Of Dollars and Data) and book (Just Keep Buying)!

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8 thoughts on “The Problem with the 4% Rule (and Why You Could Retire Even Sooner)”

  1. Subscribe to get more great content like this, an awesome spreadsheet, and more!
    • We prefer the phrase “syndicated with the author’s permission,” which is accurate. Articles that prove to be popular with our audience when shared in The Sunday Best are often featured again in full-length format like this.


      • Ah ok… I just didn’t see that mentioned anywhere. Maybe I glossed over the whole statement if it was posted within the article.


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