8 Reasons Why The Safe Withdrawal Rate Is Not That Safe

Is the Safe Withdrawal Rate safe? What Are the Risks of the Safe Withdrawal Rate strategy?

If you look at the financial independence/early retirement (FIRE) community, about 98% of them are following only 2 strategies to reach FI:

  • invest in index funds until they reach a specific level of invested money that allows them to live off the 4% safe withdrawal rate forever.
  • Or buy stocks/funds that pay them enough dividends to cover their expenses

For those who are not familiar with these concepts, here’s a quick summary: past stock market trends show us that the market grows on average by about 8% every year. They assume that inflation will be about 4% on average. So, if your total expenses are, let’s say 25K (euros or dollars) per year then you need to have about 625K invested in index funds or ETFs (25K is 4% of 625K).*

If the market grows by 8%, you subtract 4% for inflation, withdraw 4% a year for your expenses (by selling some of your funds), and you end up not losing any of your money. You do that every year.

Obviously these are average numbers but basically, in a nutshell this is the 4% rule (safe withdrawal rate / SWR).

If all goes well (your costs don’t go up, and you believe that past market trends will continue) you never have to work again. Sounds great, doesn’t it? You just need to save up 625K. Factor in some side hustles, bit of luck, maybe inheritance, some good stock market years plus compounding … and it’s perfectly achievable for a couple within 10 years.

Nice, simple, logical and achievable. Isn’t it? So where’s the problem?

I think that this strategy is based on factors and assumptions that we have no control over. It can work, but it can also fail.

Why I don’t believe in the 4% rule or the index fund strategy:

1. It’s based on past trends. This strategy is based on how the stock market developed in the past. Over the last 40 years, technological progress has been astronomical. While we should learn from the past, I don’t think that these trends will necessarily continue. They might do, I just simply can’t be sure enough.

2. The market is not predictable. Nobody, even expert investors, can predict how a stock will perform. There are so many variables that this is simply impossible. Ok, you might have some insider information. In which case, congratulations! You can be lucky. But just like you can’t predict the performance of a stock or fund, you can’t predict the whole market’s performance.

We don’t know how long the next crash will last. Yes, we’ve seen that the market always goes up. After a crash, quite quickly the market recovers and ends up higher than before. But how do we know how long it will take to recover from the next crash? Will it take 2-3 years or 20-30 years? If you base your retirement on the 4% SWR, you’re in big trouble if the market doesn’t recover in 20-30 years!

3. The stock market is just ONE entity. We hear that all the time: “diversify your investments”, “don’t put all your eggs in one basket”. We also know that investing in an index fund means investing in hundreds, thousands of different businesses. Real businesses. If a dozen go bankrupt who cares? Right? You cannot possibly lose all your money, right? Well, I think that the stock market (or an index fund for that matter) as a whole can be seen as a single entity and its crashes and trends don’t follow real life. We’ve seen that in past crashes too: even though most of the companies in an index did pretty well in real life, sometimes the overall index lost more than half of its value.
It’s very unlikely that companies like Coca Cola, McDonalds, GE, Chrysler etc. will suddenly go bankrupt at the same time. But I think there’s a good chance that at some point people will simply stop believing in the stock market and rush to get out.
Who can guarantee that we’re going to have a stock market in its current form in 5, 20 or 30 years? Is it that unthinkable that, with the next crash and panic exits the stock market will stop existing? Maybe a new system will replace it… we don’t know.
The stock market only exists because investors believe that it represents real businesses. But what if they lose faith in it?

4. Legislation can mess up the SWR strategy. A few years ago Germany introduced a tax of 25% on income from capital gains. So basically over here, all the money we make from dividends, interest, trading stocks, ETFs or other funds is suddenly taxed at 25% (ok, you have €800 per year tax free per person). Now, this tax alone makes it a lot more difficult to plan your early retirement on this sort of income. You have to either have a much better ROI or much more invested money to apply the 4% retrieval rate or maybe apply a lower SWR. At the same time tax rate on other income varies progressively between 0-45%. In fact as a family of 4 you could have 30K of income without being taxed at all! The US does not have such high capital gains taxes but how can you be sure that in the coming years this won’t change?

5. And there’s the inflation thing. Western countries have accumulated impressive amounts of debt in the past decades. Do you know how long this is going to last without any consequences? I don’t. Nobody does! Not even politicians. Nobody has a plan for solving this problem. I haven’t even heard anyone putting forward any potential solutions. Nobody talks about it. Interesting… High inflation is one way of dealing with the situation. What are the consequences? How would you feel if your money lost 50% of its value overnight? Is that impossible? In Romania, where I come from, we had 150% inflation not so long ago (1997). That is a crazy number! Do you think this is impossible in the US or EU? It’s worth thinking about.
These things sometimes depend on political decisions and can have a huge impact on our finances. If you’re not prepared, you could be in for some ugly surprises.

6.The 4% SWR could turn off your brain. Yes: actually turn off your brain! What I mean is that some people applying the SWR strategy could switch to autopilot blindly believing in it and having no plan B. Although, to be fair, I am sure that most early retirees are flexible and smart enough to react to ugly scenarios.

7. Going the hard way makes you stronger and safer. Following the SWR strategy is the easy way. It’s easy to follow, you don’t need to think that much about investments. Just save as much as you can and pay into some index funds and at some point…BANG! you reach FI. When you build up a business, think about other types of investments, things get more complicated. They do, but that’s exactly what you need to learn. And all that experience and knowledge makes you stronger and better prepared for the future. It’s the hard way, but it’s worth it.

8. You need too much money. Too much. For many people it could be very difficult to save enough money to reach FI with the SWR. FI can be reached with a lot less money than 625K. But it’s harder. You need to work more and try things out. For a fraction of that money you could put down the equity for several rental apartments, furnish them and rent them with Airbnb. It’s not 100% passive, but after you made enough money on them and paid them off, you can rent the properties long term. It’s not easy, but you learn a lot and … make nice money, a lot quicker. You could invest no money, only time and build up your online business (see 4 hour work week by Tim Ferriss) and generate passive income like that. Or you could do a combination of all these and still end up paying a lot less than you need for the 4% SWR strategy.

So what now?

I am not saying that the SWR strategy is completely wrong. It’s far better than doing nothing or stock picking. People who set financial independence as a goal are smart. They do some research, think, are frugal and don’t spend most of their money on bullshit. That’s good news! But, I strongly believe that you should have a mixed strategy. I want you to USE your brain and diversify your investments. Don’t limit your strategy to stocks/bonds/index funds etc. but look into real estate, land, startups you believe in, maybe precious metals and, most importantly, your own business! Stuff that you create, grow, understand, have control over and provide you with fairly passive income.

Still, this is not an anti-SWR post. This strategy is good and many smarter people than I (see footnote) did some serious research on it that you should definitely check out. It also is a strategy that you can start right away. You don’t have to wait or do much research.

All I am saying is: it relies 100% on the market and I would not put ALL my money in something that:
– I cannot control
– I don’t fully understand
– I can’t predict
– Is very volatile
– Can drop a huge amount within days and hours
– Is based only on past trends

The keyword is: DIVERSIFY!

– The safe withdrawal rate cannot predict the future. It’s based on the past.
– In my opinion, it’s worth having more control rather than 100% passive income.
– The SWR is good but as part of a strategy and not as the only strategy.
– Diversify to be independent of the stock market.

* If you want to learn more about the SWR:
– @madfientist wrote a great post about the SWR that you should check out here.
– Don’t invest in the stock market in ANY way before you read Jim Collins’ Stock Series over here.
– Jacob wrote a very good book about it: earlyretirementextreme.com/.
– And of course you should read what MrMoneyMustache writes about it here.

These people are all legends! Event though I only agree with them 99% 🙂


P.S.1: November 23rd 2017: From a value investing point of view, a stock/index is only  interesting if its CAPE (or PE) ratio is below 16 (the smaller the better). The current CAPE ratio of MSCI World Emerging Markets is 16.5. The MSCI World is at 23.2. The current Shiller PE Ratio (CAPE) of S&P is 31.5 (!!!). Which is…yes, MAD!

Which means that these three examples are all overvalued. Simpy far more expensive than they are worth. How much can they grow before the market crashes? I don’t know the answer, but it worries me.

What I understand from this whole thing is that now is a pretty bad time to start investing. Maybe it’s a good time to sell if you’re in, but I’m not an expert. And I definitely have a crystal ball.

  • David Wendelken

    Excellent points and ideas. But the word for you to be using in this context is “lose”, not “loose”.

    • mysticaltyger

      Yes, I agree. The way to remember it is that 99% of the time people mean “lose” with one “o”.

  • mysticaltyger

    These are all valid points, but I think a lot of them can be applied to any investment, especially the political stuff. I.E. High debt levels in many developed countries are a problem (and I agree, the politicians don’t want to do anything about it because it requires making hard decisions that make voters angry). But if we end up with a lot of inflation, it will affect the investment landscape across the board.

    • well, you can do some hedging here and there. For example, if you buy some rental real estate with a fixed rate bank loan, it’s quite nice to have inflation: your tennant is going to pay more plus your loan inflates away. So, I agree that inflation is bad news for many investments, but there are obvious cases where it helps you. I’m a fan of having an investment portfolio where different investments react in a different way to market situations. I am not an expert, I am just raising some questions and doubts

      • mysticaltyger

        Yes, I think those are reasonable. Personally, I am not a real estate person. And you rightly point out that what you’re doing takes more work. For some people, it’s worth it. For me, I would never want it in a million years. I will also say that I believe that American mutual funds charge a lot less than funds from other countries, and the American stock market has generally performed a lot better than most European countries as well. So between the higher fees and poorer overall performance, that might tip the balance in favor of other investments if you’re outside America.

        Of course, I think it’s a valid point to say that just because America’s stock market has performed well in the past, it doesn’t mean it will do so in the future.

  • Ted Leber

    This on the mark. Diversify. Reduce your costs (fees). Reduce turnover costs.
    As always understand what your fees really, really cost.
    Bud Hebeler’s http://www.analyzenow.com

  • Woody

    “If the market grows by 8%, you subtract 4% for inflation, withdraw 4% a year for your expenses (by selling some of your funds), and you end up not losing any of your money. You do that every year.”

    Sorry, but this the completly wrong reason for the 4% rule and an even “dangerous” explanation. Your “calculation” only works if the market grows each year with the same rate. Otherwise you would have a sequence-of-return risk.

    If you want to understand the reasons for this SWR-rule, please start reading here:

    And when you start reading this really good blog, please continue to read the articles about Sequence-of-return risks. Since you are reading the MMM forum, just take a look at my posting where all important articles to this topic are listed:

    Best regards,

    PS: I agree, that the 4% rule should be treated with caution. I would not rely on this completely. At least you should consider some margin in your calculations and a lot of flexibility to react on any “game changers” like you mentioned in your list above.

    • Hi Woody. Thanks for your comment. It’s obviously a simplified explanation. There are many smarter people than me who can explain it better. How would you describe it in the same sort of length?

      • Woody

        yes, you are right: It’s hard to explain the 4% rule within just a few words, but if somebody really bases his financial future on the concept of a SWR, he should really understand the origins of this rule.
        Two studies made the 4% rule “famous”: The Bengen study and the Trinity study. Both studies investigated historical 30-year periods and simulated different withdrawal rates. Both studies came to the conclusion, that a withdrawal rate of (about) 4% had a high probability of success (at least 95%) to survive these 30 years. Important things to note:
        * If the final value of the retirement nest egg was 1 USD after 30 years, it was a success. So if you want to withdraw for more than 30 years, chances are worse to live from the same amount of money.
        * Historical data was considered – there is no guarantee, that the same percentage will be sufficient in the future. A 50/50 asset allocation (stocks/bonds) has a continuously decreasing yield due to the decreasing returns of bond during the last 20 years.
        * The studies did not include any taxes or fees. Reality is a little different. Unfortunately.

        If you do the calculation really based on the average return (8%-4% = 4%), you do not consider, that the returns in the stock market are highly volatile. Like the cost-average effect during the saving phase you will have a negative equivalent during the spending phase of your portfolio: You will sell more shares during a market crash. This will reduce the amount you can spent on the average. The effect is called Sequence-of-Return risk and is best explained in these articles (in my humble opinion):

        You can find even more articles to this topic on the same blog. Highly recommended.
        Best regards

        • thank for the details. Basically, you work on a quite stable avg spending/year. So if your average spending is 25K/year and in that year but 4% of your invested money is 50K, you (normally) don’t withdraw 50K (only if you have a strong feeling that tha market will crash next year maybe). So I am talking about averages.
          We will most probably invest in ETF’s and don’t even plan to withdraw anything (if all other investmends work as planned).
          So, the SWR strategy is fine but no mather how much you read about it, study it, digg into numbers: you are looking at the past! I personally don’t want to 100% rely on past trends.
          Let’s take an example: you have 1h of cornfield. Let’s say, that in the past 100 years 20 different studies showed that even in worst years you had enough production to feed your family. Nice. But next year a wildfire burns your cornfield and you starve.
          Might be a shit comparison, but this is basically how I feel about analysing the past and relying 100% on that!
          Back to the original question: how would you describe the 4% SWR in 2-3 sentences?

          • Woody

            Sorry, I don’t get it.
            1) I criticized your reasoning for the 4% rule, which is NOT the difference between the expected market return and the inflation.

            2) You asked me to explain the 4% rule.
            3) I explained the origins of the 4% rule, which is just a result of two studies: These studies showed that in the past it was safe to withdraw 4% of the initial portfolio value for periods of 30 years without depleting the portfolio completely. (I added some details of the assumptions under which the studies were made.)
            4) Now you ask me again to describe the 4% SWR?

            I’m not quite sure whether my English is really that hard to understand (if so, I’m sorry for that) or whether I did not understand your precise question. Do you want me to explain what it means to withdraw 4% of the portfolio?? You already gave the example of 625K and a withdrawal of 4% (=25K) in your article, so I can’t imagine, that you really what me to explain this.

            BTW: If you need 25K/year and 4% of your invested money is 50K, then your withdrawal rate is 2%. The concept of the studies was to take the first year of retirement, check the wealth, determine 4% of it and stick to this value for the whole period of 30 years. So if your nest-egg has a value of 625K, you withdraw 25K each an every year independent of the market flutuations. The only yearly changes will be inflation-adjustments, so if the inflation is 2% in the first year of retirement, you increase the 25K by 2% after the first year (=> 25.5K).

            You don’t have to convince me, that these study assumptions are not really realistic in a real-world scenario. Every sensible investor/retiree will decrease its spendings if the market goes down.

          • so: you were not happy with my short explanation of the SWR. I asked you: how would YOU describe the SWR in a SHORT(2-3 sentence form)?. You gave us a long answer without answering the question. So again: give us 2-3 sentences.
            I specifically wantet to give a SHORT description and included links to detailed analysis and explanation. I id not want to repeat (this article is not about that) what others described in detail. Clear now?

          • Woody

            We can repeat this again and again – I tried to give you these 2-3 sentences in each of my answers:

            “The SWR is a result of two independent studies that investigated by which withdrawal rate a portfolio would survive for at least 30 years. They found out that 4% did the trick in the past.”

            Clear now?

          • It’s clear for me that we should both have a close look at the DGWUWA strategy

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  • Good points, but the only one that scares me is Number 4: Taxes. In Italy taxes are crazy and currently capital gain and dividend taxes are 26% with growing outlook. This means if average return per year is 8%, you get 6%. instead of 4% WR you should go with ~3%, that means you need more money than planned. Way more.

    Food for thought.

    • yeas, it is scary and the possibility in increasing capital gain taxes are completely ignored by many people following the 4% rule.
      What worries me a lot is the worldwide economic situation: low interest rate, shit loads of debt and NO real plans, no strategy whatsoever to face a next crisis. Interest rates can’t go lower. What other tools are they goign to use? Helicopter money (simply throwing free money directly at people)? Are they going to inflate the debts away? Short or lon hiperinflation period?
      No politition is talking about real solutions! That. Is. Very. Scary!
      …and exciting at the same time.
      What do you think?
      Food for thought…