The 4% Rule—At What Price?

The 4% rule is the advice most often given to retirees for managing spending and investing. This rule and its variants finance a constant, non-volatile spending plan using a risky, volatile investment strategy. As a result, retirees accumulate unspent surpluses when markets outperform and face spending shortfalls when markets underperform. The previous work on this subject has focused on the probability of short falls and optimal portfolio mixes. We will focus on the rule’s inefficiencies—the price paid for funding its unspent surpluses and the overpayments made to purchase its spending policy. We show that a typical rule allocates 10%-20% of a retiree’s initial wealth to surpluses and an additional 2%-4% to overpayments. Further, we argue that even if retirees were to recoup these costs, the 4% rule’s spending plan often remains wasteful, since many retirees may actually prefer a different, cheaper spending plan. 1 Jason S. Scott is managing director of the Retiree Research Center at Financial Engines, Inc., Palo Alto, California. 2 William F. Sharpe is STANCO 25 Professor of Finance, Emeritus, Stanford University, and founder of Financial Engines, Inc., Palo Alto, California. 3 John G. Watson is a fellow at Financial Engines, Inc., Palo Alto, California.