Best of BiggerPockets Money: Ben Felix on the 4% Rule

The Complexity of Retirement Portfolios [0:50]

• The "gray zone" between accumulation and end-state portfolios for those approaching FIRE or maintaining independence while working is complex.
• Decisions about portfolio mix, particularly stocks versus bonds, are crucial.
• Stocks offer higher expected returns and historically outpace inflation over long periods.

  "It's complicated is the very short answer."

Risks of Bonds and Inflation [2:10]

• Nominal bonds, especially those not adjusted for inflation, carry a significant risk of real-term loss over long periods.
• While inflation-protected bonds exist, they are not perfect solutions for very long time horizons.
• The Canadian real return bond program has been discontinued, thinning the market.

  "Anyway, nominal bonds means bonds that are not adjusted for inflation."

Psychological and Capacity Risk [3:31]

• An individual's psychological ability to tolerate risk is a major constraint on portfolio allocation.
• A tool is available to help assess psychological risk profiles and suggest appropriate stock-bond mixes.
• Capacity to take risk is also influenced by immediate spending needs versus portfolio size.

  "So if I said, you know, 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."

Sequence of Returns Risk and Flexible Spending [6:25]

• Early retirees often worry about sequence of returns risk: consecutive bad years depleting a portfolio during withdrawals.
• Reframing this as "sequence of withdrawals risk" highlights that spending can be adjusted.
• Flexibility in spending, by spending less during market downturns, can mitigate sequence of returns risk and allow for more equity exposure.

  "And I do think that flexibility in spending is a really good way to mitigate sequence of returns risk."

The Dual Nature of Bond Risk [8:18]

• Risk can be viewed as volatility or as the likelihood of meeting long-term financial goals.
• Bonds typically have lower volatility than stocks, making them seem "safe" from that perspective.
• However, bonds can look riskier when considering their ability to help meet long-term financial objectives.

  "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 riskier."

Real Estate as an Alternative [12:20]

• Some in the FIRE community opt for paid-off rental real estate as an inflation-adjusted store of value and income stream.
• Real estate returns historically resemble a mix of stocks and bonds.
• Challenges include idiosyncratic risk at property, market, and tenant levels, and the difficulty of diversification.

  "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."

Solutions for Early Retirees: Portfolio vs. Spending [14:54]

• Two main solutions exist: portfolio adjustments or spending flexibility.
• Portfolio solutions include building a TIPS ladder for non-negotiable income (feasible in the U.S., not Canada).
• The preferred solution is flexible spending, aligning with FIRE principles, which may negate the need for complex portfolio diversification.

  "I prefer the spending solution where you're not going to try and change your portfolio and do anything fancy over there."

The All-Equity Approach and Safe Withdrawal Rates [17:45]

• The popular FIRE approach is to remain in equities with flexible spending, often leading to a portfolio swelling significantly.
• This can make traditional safe withdrawal rate discussions academic if spending is a very low percentage of the portfolio.
• Backtesting complex asset classes is unreliable due to unpredictable correlations, fees, and unknowable future returns.

  "The challenge that I would pose there is that backtesting asset classes like those in a portfolio and saying, hey, look, we get a higher safe withdrawal rate. I would put very, very little faith in that type of analysis."

Re-evaluating Safe Withdrawal Rates [23:20]

• The 4% rule, based on U.S. historical data and 30-year timelines, may not be universally applicable.
• Including international data and extending time horizons past 30 years lowers the supported safe withdrawal rate.
• Research using block bootstrap simulations and international data suggests withdrawal rates below 3% for stock-and-bond portfolios.

  "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."

The Case for Flexible Spending [28:15]

• Safe withdrawal rates are less useful than flexible spending strategies.
• Amortization-based spending or simple variable spending rules can increase sustainable withdrawal amounts.
• Ignoring spending flexibility when discussing retirement income is a significant oversight.

  "What is a good metric? 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."