Rethinking the 4.5% Rule

Rethinking the 4.5% Rule

By Fred Sloan, CFA and Carl Friedrich, CFA Posted In: Economics, Portfolio Management

Is the standard for calculating a retirement portfolio’s maximum withdrawal rate all wrong?

In “Rethinking Retirement Rules,” Reshma Kapadia challenged the idea that a 4.5% spending rate should be applied consistently over an extended period.

The root of the problem, of course, is that we are in a protracted period of historically low interest rates.

This means that expected returns may fall below historical averages, especially in the short to intermediate term. So setting a single withdrawal rate for a 65-year-old retiree and assuming no adjustments will be needed is imprudent at best and reckless at worst.

Asset class returns, volatility, and correlations work together to create many different possible return combinations over the retirement period. We created a Monte Carlo statistical simulation to determine what spending rate best serves retirees should they encounter low returns for an extended time.

Even if returns are close to the long-term average over 30 years, we sought to home in on the question: What happens if retirees experience lower returns in the early years?

Model Assumptions

To test the utility of a 4.5% spending rate, our Monte Carlo simulation generated 2,500 iterations for each of our scenarios. We made the following assumptions in accordance with our proprietary models:

A 65 year old invests their $1-million portfolio in a taxable account.The retirement period spans 30 years based on a 95-year life expectancy.The dollar amount of spending increased by 2.5% inflation each year.The spending rate was calculated by dividing the dollar amount of the first year’s spending by the portfolio value.The annual expected investment return was 7%.Long-term returns for all asset classes remained in line with long-term historical averages.Annual volatility of return was 9%.The overall portfolio carried 90% tax efficiency.


We tested three base case scenarios as well as a fourth “correction” to the third scenario.

1. Average Returns, Consistently Achieved

The investor received a 7% annualized return, with 9% volatility, over all 30 years.

2. Higher Returns in the Early Years

The retiree generated an 8% annualized return, with 9% volatility, during the first 15 years, and a 6% return, with 9% volatility, over the next 15.

3. Lower Returns in the Early Years

The investor received a 6% annualized return, with 9% volatility, in the first 15 years, followed by an 8% return, with 9% volatility, for the subsequent 15.

4. Lower Returns in the Early Years, But with Spending Adjustment along the Way


1. Average Returns, Consistently Achieved

The 4.5% rule succeeded 80% of the time, a result in line with Kapadia’s analysis.

2. Higher Returns in the Early Years

Spending down at a rate of 4.5% meant the retiree had an 88% chance of not outliving their nest egg.

3. Lower Returns in the Early Years

This scenario worked only 71% of the time, which is problematic since a conservative financial plan should have at least an 80% chance of success.

4. Lower Returns in the Early Years, But with Spending Adjustment along the Way

Achieving the 80% success rate required a spending reduction of 6%, from $45,000 to $42,300, or a 4.2% rule rather than a 4.5% rule.


In the base case, our results correlate with Kapadia’s hypothesis that the 4.5% rule still holds if returns stay consistent over the retirement period.

But what if volatility comes into play?

Assuming that returns over the 30 years are in line with long-term historical averages, a sustained period of low market returns early in the retirement period may warrant a spending rate adjustment for a retiree drawing down assets.

By our estimates the reduction called for could be over 5%, or the difference between a spending rate of 4.5% and 4.2%.

This suggests that, given the current interest rate environment, retirement planning should be conducted in a dynamic fashion that takes into account reasonable estimates about market volatility and asset class performance,

Advisers should watch closely for the opportunity to adjust the spending rate to ensure their clients don’t run out of savings in retirement.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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