Mindy Jensen: How much do you really need to retire? And is the 4% rule still safe for early retirees? In this most listened to episode, Ben Felix breaks down portfolio risk, flexible spending, and why a lower withdrawal rate may make sense. Listen to episode 746 to catch the rest of the conversation.
Scott Trench: You know, there’s a couple conflicting opinions, but there are several answers that seem to be accepted as correct for an end state portfolio. I’d love to hear one of those from you. Like, what is a portfolio that’s suitable for withdrawal versus accumulation? But what I think is really missing is this gray zone in the middle, right? So I’m approaching my FIRE number, or I want to preserve financial independence and I’m still working. How do I think about my portfolio in that context? So could you help us walk through how you would think about those portfolios in the decumulation phase, or approaching retirement, or sustaining a level of financial independence while continuing to work?
Ben Felix: It’s complicated, isn’t it? That’s the very short answer. There are so many different things that are going to play into that decision. Really talking about the mix between stocks and bonds, right? Those are the big asset classes. Stocks have higher expected returns. They are historically much more likely to at least keep pace with and exceed inflation over very long periods of time. Bonds, in particular nominal bonds — in the US you do have TIPS, which are inflation-protected bonds. In Canada, we have real return bonds, but that market is becoming thinner because our government has actually discontinued the real return bond program. Anyway, nominal bonds means bonds that are not adjusted for inflation. Those have historically, if you look around the world, been pretty risky in real terms. The probability of losing money in nominal bonds over a long period of time is actually pretty high, for very long-term investors, which we’re talking about — FIRE folks. Of course, they will be, if you’re retiring at 30 or 40, your time horizon is enormous. I do think that there are risks to at least nominal bonds. Inflation-protected bonds can solve some of the problems, but they’re not perfect either, especially at really, really long horizons. A lot of it comes down to the individual’s preferences. Their psychological ability to take risk is one big constraint. If I said 100% equity portfolios make sense and someone said, well, last time the market dropped 20%, I sold everything and didn’t get back in the market for six years, they probably shouldn’t be in a 100% equity portfolio. We do have on our website, and I can give you guys a link, a tool for psychological risk profiling. I think it’s 31 questions that people can go through, and it spits out their range of stock-bond mixes that make sense based on their psychological profile. It also gives a bunch of other cool pieces of feedback, like about overconfidence and other little psychological traits. Anyway, it’s a neat tool. I think stuff like that, that’s meant to be a predictive tool about how you will react in a major market downturn — I think that’s one big input, because if people are in portfolios that are too risky for them in terms of volatility, that can be disastrous, right? If they end up bailing out of the market. I think people hear stuff like that and they’re like, well, no, I wouldn’t do that. I wouldn’t do that when the market crashes. But you have to remember, when the market crashes, it’s crashing for a reason. And that reason is usually some very scary thing. Like if we look at the COVID market crash, markets dropped a ton and it looked like the world was ending, and we didn’t know when things were going to go back to normal and all that kind of stuff. So I think that narrative that accompanies market declines is a really important piece of understanding psychological risk tolerance. It’s never just, oh, the market’s down 20%. It’s the market’s down 20% because of this terrible thing that’s happening, and we don’t know how much further things are going to go down before they get better, if they’re going to get better at all. Anyway, all that to say, big constraint is the psychological piece. Another piece is capacity to take risk. If somebody has, whatever, a million-dollar portfolio and they need to spend $700,000 to buy a house next year, they can’t take very much risk with those assets. On the other hand, if someone’s spending 3% a year from their portfolio, they can take quite a bit of risk. That’s another big consideration. I think with equity portfolios particularly — well, for any retiree, but for early retirees, I know it gets talked about a lot — people worry about sequence of returns risk. If you get a bunch of bad years of returns in a row and you’re spending from your portfolio, you can run out of money a lot sooner than you hoped. Analysis like the 4% rule is designed around finding the spending rate at which you would not have run out of money, even in the worst cases in US stock market history, with a stock and bond portfolio in the original analysis. That’s fine, but I like to reframe sequence of returns risk as sequence of withdrawals risk, because no one’s forcing you to continue taking inflation-indexed withdrawals from your portfolio every year regardless of what’s happening in the market. And I do think that flexibility in spending is a really good way to mitigate sequence of returns risk. If the market drops a whole bunch, you can spend a little bit less. That also allows you to take more equity risk in your portfolio without worrying so much about running out of money if things go poorly for a bit.
Mindy Jensen: You said something about nominal bonds, and I don’t know what that is. I don’t have a lot of money in bonds personally, and I don’t like bonds because they don’t return a lot. I like growth, because growth is better. Why would somebody invest in nominal bonds? You said that with nominal bonds, your chance of losing money is pretty high. I thought bonds were the stability of your portfolio.
Ben Felix: Yeah, so it’s super confusing, and it’s really interesting. It’s like, what is risk? It’s a hard question to answer, and I think that’s kind of the crux of what you’re asking about, with why somebody would invest in bonds. A lot of people feel risk as volatility. Stock market drops 20%, that feels like risk. But if we look at long-term investor outcomes, does that 20% drop really matter to a long-term investor, even if they’re withdrawing a bit from their portfolio? Probably not that much. Bonds, on the other hand, are not going to have that kind of volatility. I mean, sometimes they can drop — they did a few years ago, there was a pretty significant bond decline — but they’re not typically as volatile as equities, not even close. And so people see that and they think, well, okay, bonds are safe. And from that perspective, strictly from the volatility perspective, they are relatively safe. They also tend to be imperfectly correlated with stocks. So when stocks go down, bonds are often flat, or maybe even up a little bit. They can still drop at the same time as stocks sometimes. It’s not perfect, but they generally do diversify stock risk. However, if we take the other perspective of, is owning bonds likely to allow you to meet your long-term financial goals, bonds start to look a little bit riskier. So there are two perspectives there.
Scott Trench: Your view is widely shared in the financial independence retire early community. When we poll people in the BiggerPockets Money audience, including those who are at FIRE, very few of them actually allocate any meaningful percentage to bonds. I think there was less than 10% who had any bonds in their portfolio in a recent poll. And at first, I was really struggling with that. I’ve been really trying to wrap my head around portfolio theory the last year. We’ve talked to a lot of experts in the space, and I was like, well, that’s totally irresponsible. If you actually think about it rationally, you get to where it’s just, you know, a losing bet over 50 years if you’re going to have that type of portfolio in place. And so I think that’s the challenge that a lot of people in the financial independence community have. My solution to it was to go into real estate — not leveraged real estate, because I need a safe part of my portfolio, but paid-off rental real estate. My belief is that, yes, I take concentration risk in that asset or that market, but I also fundamentally get an inflation-adjusted store of value and an inflation-adjusted income stream with that investment. And I also have the option to refinance it or sell it at future points, even if there’s a depressed market. How do you feel about that answer to the question that we’re — I think we’re really trying to get at here?
Ben Felix: You can kind of deconstruct the returns of real estate historically, and they look kind of like a mix of stocks and corporate bonds. It’s not the worst thing to do. I think you do have a little bit of control over the outcome because you can manage the property well and all that kind of stuff. I do also think that the idiosyncratic risk that you mentioned is an issue. For me personally — and I know you want to talk about simplicity — there’s absolutely no way that you could convince me to be a landlord. You can barely convince me to be a landlord for myself. I don’t like doing that stuff. Not because I can’t, but there’s always this tension of, my kind of litmus test is always, would I rather do this thing than sit down and write a YouTube video that a few hundred thousand people are going to watch? And house-related stuff, even though I don’t mind doing it, I would way rather sit down and write a YouTube video. Playing basketball with my kids, I would rather do that than write a YouTube video. But fixing the house, or even coordinating contractors and all that stuff — no chance. Dealing with someone else living in a property that I’m responsible to manage — there’s, you couldn’t pay me enough money to do it. It just wouldn’t happen. That’s my personal preference about real estate. So, historically, real estate’s been a perfectly fine asset class. When you look at the total return of capital and net rental yield, there’s a paper that looks at this going back, I believe, into the 1800s, and it’s performed well on a global basis. I do think that the idiosyncratic risk in real estate is a lot higher than people tend to realize. And that’s because you’re taking idiosyncratic risk at a whole bunch of different levels, right down to the individual property level and the individual tenant level. So, I mean, if you can manage that, that’s fine. Some of it’s hard to manage, like the geographic idiosyncrasies. But I don’t hate real estate as an asset class. I think the big challenge is diversification. It’s hard to diversify when you have a handful of properties. But then again, for me personally, it just wouldn’t happen.
Mindy Jensen: Today.
Scott Trench: So we hate real estate. We’re not going to go into real estate. Sorry I brought it up. Let’s talk about just public securities here. What are some of the frameworks or solutions to this problem of, hey, I’m at my FIRE number or approaching it, or I’m actually going to begin decumulating and I’m younger than 50. What do I do? How do I begin answering that question?
Ben Felix: I mean, there are two ways that you can solve it. One way is on the portfolio side. You could do something like build a TIPS ladder for the portion of your income that is non-negotiable, not flexible. In Canada, you can’t do that, as I mentioned. In the US, you could. You could duration-match your expenses to TIPS and build an inflation-indexed income stream that’s going to be pretty safe over a long period of time. You’re going to lower your expected return a bit relative to investing in equities. I prefer the spending solution, where you’re not going to try and change your portfolio and do anything fancy over there. You’re just going to accept the fact that you’re spending — and it’s interesting, it kind of ties into the FIRE principles more generally. If you can spend conservatively and be flexible in your spending, I don’t think you have to diversify outside of equities.
Scott Trench: That is the most popular answer in practice in the financial independence retire early community — I’m just going to keep my portfolio flat and keep rolling. And in practice, what happens is the portfolio swells after a few years. Like Mindy’s a classic example of this, right? You achieved financial independence, kept everything in equities, and now your net worth has ballooned to many, many times what you’re spending — so many more times what you’re spending, Mindy, that it’s all academic, this discussion on safe withdrawal rates, because you’re probably spending close to 1% to 2% of your portfolio. Is that right, Mindy?
Mindy Jensen: Not including when I’m building a house. Yes. When I’m building a house, it’s significantly more than 1%.
Ben Felix: I’m renovating a house.
Mindy Jensen: I hear you.
Scott Trench: I’m always renovating houses.
Ben Felix: Oh, I can’t imagine.
Mindy Jensen: I’m living in a house that I’m renovating while somebody else is building me a house around the corner, and I am much more enjoying them building the house than me renovating the current house.
Ben Felix: Yeah, I’m also living in a house being renovated. It’s, yep, it’s something.
Mindy Jensen: It’s something.
Scott Trench: Ben Felix is a live-in flipper. That’s what we just heard today.
Ben Felix: I’m not leaving. I’m not leaving this house.
Mindy Jensen: Oh yeah, I know. I move into it because it’s awful, and fix it up while I live there, and then I sell it and do it again. This is my last one.
Ben Felix: Yeah, no, I bought a house. This is the first house that I’ve ever bought. We’ve been here for six years, did some small renovations along the way, and now we’re doing some pretty significant renovations. But we’re doing that with the intent of staying here indefinitely. I don’t know, we don’t have a timeline.
Scott Trench: This is great. And I want to go back to what I think is a really simple, powerful, and elegant answer. We cannot move away from this, because this is something we’ve been searching for, for the last year. We’ve had several different conflicting opinions on what a FIRE portfolio ought to look like. We’ve gone to this risk parity portfolio, where we’ve got percentages in stocks, percentages in bonds, allocation to gold, managed futures, and international or cash to get different correlated returns. You’re saying, no, I would just stay all in equities, maybe with some factor tilts here and there, ride it for the long term with flexible spending. That’s a very simple solution. So, for example, we’ve had big debates about the correlation between all of these things. What drives a higher safe withdrawal rate? What does that mean if I’m going to be all in stocks? Does it mean I have to take a lower safe withdrawal rate? What are the assumptions that I’m making here, from a portfolio theory perspective, that back up that just-stay-in-all-equities assertion that you have?
Ben Felix: Relative to all of those other asset classes, the challenge that I would pose is that backtesting asset classes like those in a portfolio and saying, hey, look, we got a higher safe withdrawal rate — I would put very, very little faith in that type of analysis, is the simple answer. Correlations are unpredictable, fees and costs matter, and some of those asset classes have higher fees and costs. Future returns are unknowable, all that kind of stuff. If someone says, hey, look at this backtest, it gives me a 6% withdrawal rate, I would put very little weight in that type of analysis.
Scott Trench: What can we assume from a safe withdrawal rate? Because if we’re simply saying — there’s a whole body of work that is produced by very smart people who try very hard to get to an answer around safe withdrawal rates, and you’re like, nah, screw that, let’s move on to something more that we can actually defend here — what can I assume for safe withdrawal rates? What is well-researched in your view?
Ben Felix: I mean, it’s all based on historical backtesting, is part of the problem, right? But if you’re in an equities portfolio, and we’re using fixed safe withdrawal rates where you’re spending an initial amount of the portfolio and then increasing it over time with inflation — so that’s the inflexible spending — somewhere around 3% to 3.5% based on historical analysis is probably fine. If you introduce flexibility, where you’re going to change your spending based on how things have done previously, instead of just doing a fixed inflation-adjusted spend, it’s going to be higher than that, depending on how flexible you want it to be.
Scott Trench: Okay, so we’re kind of back to the 4% rule with all equities and just be flexible.
Ben Felix: Yeah, I don’t know, 4% still fails a bit too much. But the difference between 3.5% and 4% is not immaterial.
Scott Trench: You clearly, the way you phrase that, have done your homework on sequence of returns risk and withdrawal rates, and specifically the next level of thought around assuming inflation-adjusted fixed spending — that you’ve really nailed your numbers there, don’t have flexible. Clearly there’s a lot grounding what you’re saying there. In terms of safe withdrawal rates, one of the things that I think the FIRE community misses is that in a well-run Monte Carlo, assuming some of these 4% safe withdrawal rate numbers, your portfolio dwindles over the 20, 30 years leading up to traditional retirement age. So if you start with $2.5 million, you dwindle it to $1 million in real inflation-adjusted dollars by 65. You can still survive from there, with Social Security layered in, into a retirement at your targeted inflation-adjusted level of spend. I think that is academically understood by some people, but in practice, the experience of watching that portfolio dwindle relative to inflation is going to be very, very painful in practice, which I think is an argument for lower safe withdrawal rates, in the range that you suggested. Could you let me know if that’s something that you agree with or have observed advising retirees, early or traditional?
Ben Felix: I mean, the perception of the portfolio declining, I can see that being a psychological challenge. But I mean, I just think that having a higher, a high safe withdrawal rate, it introduces a lot of risk of running out of money, period. That’s the issue. I mean, I don’t think 3.5% is particularly low. I also don’t love the idea of fixed inflation-adjusted spending. I think flexible spending makes a lot of sense to me. We just had a guest on our podcast, our episode with Elroy Dimson, who’s like one of the leading researchers in stock market history. He was on our podcast and we talked about this. We talked about bonds, we talked about long-term portfolios. We didn’t talk about safe withdrawal rates specifically. When we were asking about the role of bonds in portfolios, he talked about how he’s like, well, I’ll tell you what I do. He talked about how he’s in equities, doesn’t own bonds, and he keeps his spending low. He didn’t say exactly what his withdrawal rate is, but he said he keeps his spending low and he’s got a lot of flexibility in his expenses. He’s got a simple lifestyle. I mean, that’s from someone who’s spent more time thinking about financial markets than I’ve been alive. When he said that, I was like, I love it, because it’s exactly how I think about this. I don’t know, I think that’s a simple, elegant way to think about this stuff. I think the idea of layering on a whole bunch of funky asset classes is, I don’t know, man. I don’t like it. I think adding complexity in general is not a good thing. And when it comes to financial markets especially, it’s generally speaking a bad thing.
Mindy Jensen: You said the 4% rule fails too often, but according to Bill Bengen’s research, it fails about 4% of the time.
Ben Felix: Ooh, are we doing Bill Bengen’s research? Yeah, okay, okay, okay.
Mindy Jensen: Well, he said 4%, and Michael Kitces redid it in like 2008 and came up with the same numbers. Wes Moss did it, I want to say, in 2015. He came up with the same numbers. What do you consider an acceptable failure level? Because Bengen’s research said that there was only one period— or no, maybe that was Kitces, because he has the amazing chart— there was only one period where they ran out of money, and it was in year 31, and they were all doing 30-year timelines. Let’s put all the caveats out there.
Ben Felix: Yeah, so there are two issues with all of those pieces of research. I’m not familiar with who Moss is, but I know Kitces’ research and I know Bengen’s research. Of course, they all arrive at the same result because they’re all using the same data. The big issue is that they’re using US historical data, and we know now, looking back in time, that the US market is the best-performing financial market that has existed in modern history. I think there are a couple others that have maybe done better. Like, I think Australia— I don’t know if that’s still true. A couple years ago, Australia had done better and South Africa had maybe done better. But, you know, big markets, US is the best-performing market that exists. If we go and recreate Bengen’s analysis and Kitces’ analysis using two little changes, including international data, which I think makes sense, because when we’re thinking about what are the expected returns of the stock market, I don’t think looking at the single best-performing market in history is a good place to anchor our expectations for the future. So that’s one thing. So we use just what has happened to stocks everywhere. And we can argue about whether other economies are comparable to the US. I would counter that that is true, but the greatness of the US economy is reflected in its currently high stock prices, which makes it very hard to expect similarly high returns in the future, because you’re paying a lot for expected future earnings today. So if we introduce international stocks, and then the other one that you did mention, Mindy, is if we extend the time horizon past 30 years, which for an early retiree is certainly a reasonable thing to do, I would say that number starts to go down below 4%. So Bengen’s analysis was great. I mean, what he did was something very unique, and it’s obviously become an important part of how people think about retirement planning, even if it’s not perfect. I think dynamic spending is much more sensible. But the 4% math gives people a very quick way to think about how much they need to save for retirement and how much they can spend in retirement, which is very cool. I like that. I mean, we had Bill on our podcast. I actually asked him, what about international stocks? And his answer was very simple: I look at US stocks, I’ve never looked at international. I was like, okay, that’s fair enough. But there are other researchers who have done the analysis using international stocks, and it does change the results, for the simple reason that international stock returns have not been as good as the US market. I think the only other country— Wade Pfau did a study on this where he looked at the safe withdrawal rate for a bunch of individual countries. I think Canada was the only other country that has historically sustained— this is back when he wrote his paper— had historically sustained a 4% safe withdrawal rate. Most other countries supported much lower rates, and the global index supported, I think it was around a 3% safe withdrawal rate in that study. And then there are more recent papers that use different approaches, using something called bootstrap simulation, to take a whole bunch of historical data and simulate future returns using that. And they similarly find lower withdrawal rates.
Scott Trench: Well, Ben, you can’t just drop that and then not tell us how low. Does the international data support this 3.25% to 3.5% withdrawal rate range? Is that what we should take away from what you just said?
Ben Felix: Yeah. With equities, it does look pretty good. With fixed income, that more recent research finds much lower withdrawal rates, but with those heavy fixed income allocations using international bonds from lots of countries that have had struggles historically. I mean, that research does an interesting thing where— the way that they sample from global stock markets, they’ll randomly pull a country from their dataset and they’ll set that as one, say, 10-year block on average. They have varying block lengths, but it’ll be 10 years on average. So say it’s 10 years. So they’re going to pull a 10-year block out of their sample from, I think, 38 different countries. So they’re going to say, okay, this 10-year block is Canada. So we’re going to look at Canada as the domestic country. For that pull, the domestic stock return will be Canadian stocks, the bond return will be Canadian bonds, and the international stock return will be global stocks excluding Canada measured in Canadian dollars. That’s one 10-year block of returns. Then they’re going to pull another 10-year block. This time, maybe we’re going to get, I don’t know, Denmark. Now we’ve got 10 years of Denmark equity returns, international ex-Denmark equity returns for international stocks, and Denmark bond returns. They keep stringing together those blocks. This is a method called block bootstrap, and that produces these long samples of simulated returns where you can test stuff. They’ve done this. They’ve looked at optimal portfolios for long-term investors, and that’s where a lot of the— although this paper is not published yet, it’s still academic research, but that paper supports 100% equity portfolios over target date funds and over 60/40 portfolios. It supports a big allocation to international stocks, which I think is also interesting, especially for a US audience. Then those co-authors have also written a paper looking at safe withdrawal rates. In that paper— they don’t include an internationally diversified all-equity portfolio, but the safe withdrawal rates that they find with stocks and bonds using that approach are below 3%. I’m not saying that’s what people should use. It’s just what that paper found. I can give you guys links to all these papers.
Scott Trench: Another analyst who brings a very comparable level of rigor to what you do is Karsten Jeske, over at Early Retirement Now. Are you familiar with his work?
Ben Felix: A bit.
Scott Trench: I would say he’s arrived at a very similar range to what you have from a different direction, which is from valuations. He takes the cyclically adjusted price-to-earnings ratio and then he modifies it. He thinks that there are certain components that are unfair about the way that we’re comparing a CAPE ratio today to 1999, like when companies do share buybacks, or the tax code changes that have happened around corporate earnings. So he adjusts that. It’s still high regardless of how you— after you modify for those things. But that is how he’s arriving at this kind of, yeah, I think the safe withdrawal rate is lower. And I think he arrives at a similar conclusion to you in terms of portfolio construction for early retirees. So I think it’s interesting that you two have arrived kind of independently, from different angles, at that same conclusion. And I also think that there’s a pretty hardcore, very staunch part of the investment community that will really push back hard against what you’re saying here and say, no, 4% already is conservative enough. Like, what am I going to do, delay my life by 4, 5, 6 years, my retirement by 4, 5, 6 years, just to get a few marginal extra bumps of safety in my portfolio? That’s a real criticism of this that I think is valid, if you’re willing to take on a little bit of that risk that your portfolio could begin depleting or you will need to be flexible at some point in time.
Ben Felix: I agree with that. Listen, I did a video a while ago when one of those papers I mentioned came out, and I titled the video— which I knew was going to be provocative— and it pissed a lot of people off and made them say stuff like that.
Scott Trench: They of course only— rage bait.
Ben Felix: It was definitely rage bait. They’ve of course only read the title and didn’t listen to the video. But I talk about how that paper had found a 2.7% safe withdrawal rate. But then I also talk about how safe withdrawal rates just aren’t— they’re not a good metric to figure out how much you can spend from your portfolio. There’s just not.
Mindy Jensen: What is a good metric?
Ben Felix: I think using tools like amortization-based spending, which is just kind of a pretty simple calculation, but it helps you figure out how much you can spend from your portfolio without any probability of running out of money by adjusting the amount that you spend each year based on how things change over time, is the simplest way that I can explain it. But even just using some relatively simplistic variable spending rule, instead of assuming fixed inflation-adjusted withdrawals, is going to increase the amount that you can spend over your lifetime. I think ignoring flexibility when we’re talking about safe spending just doesn’t make sense. It’s a huge miss. I mean, I agree, if you introduce flexibility, 4% starts to look pretty reasonable as a starting point. You could probably go even higher.
Scott Trench: Where I would beat up the 4% rule is from the complete opposite side here. There’s so much high-quality research on withdrawal rates when they’re adjusted for inflation in a static lens. But the reality of life is very different than that. And there are so many ways the 4% rule can be way too aggressive or way too conservative, depending on the pattern of your spending in your particular situation.
Mindy Jensen: As a reminder, you can listen to the full episode, which is 746, or find it in the show notes below. We know you have a lot of trouble finding flat fee advisors or advice-only, no-AUM planners who actually understand financial independence. We are building a network of these professionals and more over at biggerpocketsmoney.com/fipro. That’s biggerpocketsmoney.com/fipro. That wraps up this episode of the BiggerPockets Money Podcast. Thanks for watching.
