THE END OF THE 4% RULE | Goodbye Savings

What's up Grandma? It's guys here! So here's the thing: if you want to invest your money, build your wealth, and earn enough passive income, then never have to work another day in your entire life ever again, there's an easy calculation for that called the four percent rule.

For the last 30 years, this has been the Holy Grail of financial independence, early retirement, and always making sure you have enough money to spend without going broke. Although, as time went on, it became apparent that there was a problem. Just recently, new information surfaced from Vanguard calling out the flaws of the four percent rule that need to be addressed. Charles Schwab warned that our investment returns could substantially decline over the next decade, and the inventor of the four percent rule himself says it's no longer valid. It needs to be updated to reflect today's environment where people are retiring sooner than ever because of meme stocks and Dogecoin.

But now in all seriousness, the math behind the four percent rule could easily be the most important calculation you're ever going to learn throughout your entire life. And it applies to nearly everybody investing your money, no matter who you are, how old you are, how much you have invested, or what you're invested in. So watch this one all the way through, and I'll cover exactly what the four percent rule is, how you could use this to build your wealth, the problems brought up by both the inventor, Vanguard, and Charles Schwab, and then finally, how you can avoid the biggest mistakes that could wind up leaving you with nothing.

Although before we go into that and why this McDonald's ice cream machine led to a restraining order, I just want to say a huge thank you to the sponsor of today's video... myself! All right, there's actually no sponsor, but it would help me out a ton if you smash the like button for the YouTube algorithm or commented anything down below. That's it! Thank you guys so much, and with that said, let's begin.

All right, so all of this begins back in 1994 when the four percent rule was first invented and used as a method of calculation to make sure you never run out of money in retirement or basically, if you want an endless supply of passive income spilling into your bank account without you ever needing to get out of bed. This tells you how much you need and how much you could spend. The objective was that if this calculation was done right, you would always have money left over.

But for that to actually be a success, then two things had to occur. One, they wanted to make sure you didn't spend too much money in the event your investments didn't perform as well as you thought they would, like investing right before the dot-com crash and still being down 50% ten years later or investing in Corsair gaming, which come on, give me a break. And two, they wanted to make sure you didn't spend too little to the point where you could have spent money on Lambos and Yachts but didn't. So, as a result, your future children get to blow it all and influence or promote NFTs and random advertisements that they see in TikTok.

So in order to calculate the precise amount of money that you need invested, they simulated every single 30-year retirement at various starting points from 1926 through 1992, and then they projected how much would have been left over at the very end of those 30 years, assuming the worst possible case scenario: which is you retiring at the peak of the market and then slowly watching your investments plummet in value.

Well, you have to constantly sell them off to pay for a lifestyle you thought you could sustain but couldn't. When you finally put away your pride to go back to your old employer to try to get your job back, you find out that they filled your position with a college intern who took an 80% pay cut to get the experience. So you go back home defeated only to find that your wife has gone to Cancun with the show... For you know what, I'm going way off topic. Let's get back to the four percent rule.

Anyway, long story short, throughout history, there's a very clear guide in terms of how well our investments typically perform versus how much of it we could spend without running out of money, and that amount is what's known as the safe withdrawal rate. As you can see from the chart right here, if you're 100% invested in the stock market and spend only three percent of your portfolio a year, it's safe to say your money is going to last a 30 to 60 year retirement with a 100% success rate that you won't run out of money.

On the other hand, if you're 100% invested in the stock market and spend five percent a year, you only have a 76% chance of not running out of money by the end of those 40 years. That's why the more money you spend and the longer you need that money to last, the higher the chances are that you wind up with nothing. And that, of course, is where the four percent rule was born. This is the Holy Grail of retirement that says you have a 99% chance of your money lasting you at least 30 years, as long as you don't spend more than four percent of your portfolio annually.

But now, according to new information, the four percent rule no longer applies the same way it did when it was first calculated. To go into those changes, we should first start with Vanguard. The first piece of criticism is that the four percent rule relies on historical averages, which might not be true today. See, initially, it was assumed that if investors from 1926 to 1992 could spend four percent of their portfolio, they'd be totally fine—that should work today. But as we all know, past performance is not an indicator of future results, as every stock market disclaimer ever says. And as you're about to see, four percent could end up getting you in trouble.

As Vanguard calculated historically, the markets have a real return of 7.5% for stocks and 2.43% for bonds, suggested for inflation between January 1926 and March of 2021. But over the next 10 years, they're forecasting significantly lower returns, like 2.44% for U.S. stocks and 0.27% for U.S. bonds adjusted for inflation. Charles Schwab also seconds this by saying that the market returns on stocks and bonds over the next decade are expected to fall short of Oracle averages. According to our 2021 estimates, the third warns that a 30-year retirement might not be long enough.

See, originally the four percent rule was crafted to fit a 30-year retirement, not someone who wanted to retire early and then spend all of their free time going and watching YouTube videos like this. Because of that, the standard 30-year retirement calculation might not work for someone who wants to stay retired longer. For example, a 50/50 stock and bond portfolio might have an 82% chance of lasting 30 years, but it only has a 36% chance of lasting 50 years.

So, the longer you want to retire, the riskier it is to use the four percent rule. The third is that the four percent rule does not take into account fees, which could lower your return even further. For example, your retirement account could have annual fees that eat away at your profit. Almost every index fund or mutual fund has an expense ratio associated with it, and as a result, your overall returns begin to decline. Then fourth, the four percent rule does not look at diversification.

See, when the four percent rule was first calculated, it only considered U.S. stocks. But Vanguard's analysts believe that over the next 10 years, international stocks could actually wind up outperforming, which means if you diversify throughout the entire world, you could increase your chances of having enough money from 36% all the way up to 56%. And then finally, fifth, they say there's risk in simply spending four percent and that's it.

Even though the four percent rule was meant to be sustained through a time when the stock market crashes out of nowhere, even though Jim Cramer tells us to buy, in reality, Vanguard says that if the market crashes, it's probably a good idea to cut back on your spending long enough until things recover, just to make sure you have enough money to last as long as possible. However, the inventor of the four percent rule himself somewhat disagrees and says his calculation was treated a little bit too simplistically.

That was because during his simulations, he took into account the worst possible case scenario in the event you retired at the worst possible time, or in his case, that could more recently be 1968, where the stock market peaked and runaway inflation was just about to begin. However, even someone who retired at that time would still be okay if they just spent four percent of their account for 30 years.

So this was basically taken with the worst-case scenario in mind first, and then you work backwards to make sure you will still be okay. But more recently, he added that at other points in history when inflation was low and stocks and bonds were cheap, a new retiree could have spent much more money and been just fine. Historically, he says a safe withdrawal rate could have turned out to be seven percent and at some points as high as 13%. Of course, the only way to know about this was in hindsight, after the fact, at which point it's probably too late.

But almost a year ago, he said that he would feel comfortable changing the four percent rule into the five percent rule, meaning you would be able to spend an extra one percent a year and still have money left over by the time you, uh, you know, go to the big like button in the sky. But of course, that relies on low inflation, which is not exactly something we're seeing right now. Now, even more concerning was that one recently asked about his own retirement, he said that they normally have a 50% allocation to stocks. I'm at about 25%. I just have a very uncomfortable feeling about the speculation in the market, the extremely high valuations, and the disparity between the stock market and the economy with the virus.

Then after being questioned that his allocation violates the own rule that he invented, he responded by saying, "My position is a temporary one. The 40 to 75 average is a long-term average you'd like to maintain. I'm doing this because of short-term conditions that I consider dangerous. I'm hoping after this is over, I'll return to my normal allocation for stocks. I may even go higher than normal." So if even the inventor of the four percent rule is not following his own guides that he discovered, it does make you question whether or not this is actually a viable strategy.

And there are quite a few people arguing against this line of thinking. For example, the popular finance blog, The Financial Samurai, explains that the four percent rule was created during a time when the 10-year treasury bond was averaging five percent. But now, when 10-year bonds are paying just 1.3%, you should plan for a safe withdrawal rate of 0.5%. Yeah, you heard me correctly: not five percent, but point five percent.

So if you want to retire off forty thousand dollars a year, you're only going to need eight million dollars. Easy! Now, to be fair, there's never been any point in history where this stock market has performed so low over 30 years to require 8 million dollars for a forty thousand dollar a year income. So maybe he was just having an off day. We all have those! But that also doesn't stop people like Suze Orman from telling people that if they want to retire in a nice, comfortable middle-class lifestyle, they will need five million dollars.

She says that's enough to support a family, live a nice middle-class lifestyle in a high-cost-of-living area, go on a few vacations, and have a safety net in case things go wrong, the market goes down, and tattooed chef doesn't do as well as you initially expected. Now obviously both five and eight million dollars are ridiculous amounts of money to come up with, especially if you're not the type to spend frivolously.

So I think if Baron is here, I will give you my own independent calculations of my own thoughts coming from somebody who makes videos here on YouTube with the car in the background. So first, in order to do this, we're going to take a look at what's called the rolling 30-year return of the S&P 500. This is basically the average return that you're gonna get over any 30-year time frame, and by doing this, we'll be able to see the best and worst case scenarios for your money.

We'll start with this chart that goes back the very furthest, all the way back to the wonderful year of 1872. This found that a 20-year stock market has never once produced a negative result adjusted for inflation in history. And the worst case scenario ever realized so far in the market was a half a percent return adjusted for inflation. However, that would be a 20-year time frame during the 1960s, right before runaway inflation, and the likelihood of that happening again to such a high degree is rather slim.

But during any other time in history, you'll see an average return of about six percent in a best-case return of about 13%. Now another chart shows that the worst possible case 30-year rolling period was 4.3% after inflation, and again, that would be during the 1960s. If we look back throughout the last 30 years today, we could see that the average return was about 5.96% adjusted for inflation with dividends reinvested.

The only catch here is that these types of returns are not guaranteed, and we've got quite a few warnings that say that the future return might not be as good as what we expect. For example, Charlie Munger says to prepare for lower returns because the stock market has been fueled by a retail frenzy and easy monetary policy that boosts prices beyond their fundamentals. Charles Schwab says that rising inflation, slow economic growth, and high equity valuations will lead to less room for stocks to move upwards, and PW Capital mirrors the same conclusion with the mention that strong returns might be coloring investors' perception of how much they should be earning from the stock market.

So given all of this information, I think if you're looking at a 30-year retirement and you want to make sure with a hundred percent certainty that you have money left over after those 30 years, throughout all points in history, spending four percent a year would be okay if you're willing to diversify, cut back on your spending at the Ritz Carlton in the event the market goes down, and potentially get a job in the event you absolutely needed to. Otherwise, if you want a much longer retirement, like 40 or 50 years for all of you early retirees out there, then I think it's probably more appropriate for a three to three and a half percent safe withdrawal rate, just in case something happens and everything we think we know about the market is entirely wrong.

And really at the end of the day, all of this is just a rule of thumb. By understanding what this is and what it does, you'll be able to better budget how much you need to save and invest.

Oh, and then regarding the story about the McDonald's ice cream machine, here's the scoop—pun intended! Anyway, the ice cream machines are manufactured by the Taylor company at an IC 18,000 each, and they have a reputation of not exactly working. In fact, in the servicing agreement signed by McDonald's, the Taylor company is the only one licensed to actually go and work on those machines because of how complicated they are.

Well, in 2019, a company called Kitsch released their own diagnostic device that figured out what was wrong with the tailor machines and allowed McDonald's to make their own necessary repairs without having to call a Taylor technician. As you would expect, Taylor was not exactly happy about this, so allegedly Taylor tried to purchase their own kitchen product to reverse engineer it, and then they would just be able to make it themselves and cut out the middleman. Well, a judge just sided with Kitsch, saying that their product was above board and issued a restraining order preventing Taylor from buying their products.

I guess you could say this is kind of a shaky situation!

Okay, hit the like button; that's all I want. So with that said, guys, thank you so much for watching! I really appreciate it. As always, make sure to subscribe and hit the notification bell. Also, feel free to add me on Instagram; I post pretty much daily. So if you want to be a part of it there, feel free to add me there as my second channel, The Graham Stephan Show. I post there every single day I'm not posting here, so if you want to see a brand new video from me every single day, make sure to add yourself to that.

Thank you guys so much for watching, and until next time!