The End Of Retirement - Major Changes Explained

All right, so we have some pretty big changes for anyone who's investing their money, building wealth, and working towards financial independence. And that would be the end of the four percent rule and why it no longer works, according to the person who invented it.

See, for nearly 30 years, the 4% rule was seen as the holy grail of making sure you have enough money invested to never have to work another day in your entire life ever again. That was until the other day when the inventor himself said that it no longer applies, and he warned that changes need to be made.

Of course, you might be wondering, "But Graham, why should I even care in the first place? I just came here for the funny memes and the free stuff down below in the description when I sign up for public using the code Graham," because that could be worth all the way up to a thousand dollars. That is a great question that I asked myself, but to be completely honest, the math behind this video is probably going to be the most important calculation you'll ever learn throughout your entire life.

Because it's going to tell you exactly how much money you'll need, how much money you could spend, and what you'll have to do if you never want to work another day, if you don't want to. Although, before we start, I would love to thank the sponsor of today's video, the like button, which just needs to be smashed by you. All right, no, but seriously, our sponsor is public.com, so thank you so much—more on them later. And now let's begin.

All right, so here's why the four percent rule was such a big deal. It was invented back in 1994 and used as a method of calculation to make sure you never run out of money or, basically, if you want to have endless amounts of passive income forever, this tells you how to do that.

To figure this out, the inventor back-tested every single year of stock market returns, and then he simulated what your money would have been worth had you retired in each year and then lived off your investments for a 30-year time frame. The goal was that if you did this right, you would never run out of money. And in order for this to be a success, a few things had to happen.

One, you didn't spend too much money in the event your investments didn't pan out as expected, or you decided it was a good idea to invest in Netflix, and two, they wanted to make sure you didn't spend too little money to the point where you have to leave it all to your grandkids to blow it on Fire Festival tickets and SafeMoon. So, in order to calculate the right amount of money that you need invested so you never have to work another day in your entire life ever again, they looked at every single retirement year in modern history and then calculated how much would have been left over, assuming the worst possible case scenario—which would be retiring at the peak of the market and then watching your investments just get decimated each and every year as they get lower and lower and lower and lower.

That was bad, and if you're confused, don't worry. This chart should explain everything perfectly, even though I'm the one explaining the chart. Anyways, you could see on the left if you're 100% in the stock market and spend three percent of it a year, known as the safe withdrawal rate, your money is going to last you indefinitely with a 100% success rate of not running out.

That's because the market, on average, returns six to ten percent a year adjusted for inflation. So, effectively, by you only spending three percent, that gives you a three to seven percent buffer for your money to continue growing without you having to do a single thing. But on the other hand, if you're 100% in the stock market and spend five percent a year over forty years, you only have a seventy-six percent chance of not running out of money. So that leaves you with a one in four chance of becoming completely broke, then having to rely on your lovely viewers and subscribers to hit the like button for the almighty YouTube algorithm.

This guideline is also referred to as the Trinity study, and from all the back testing and research, the four percent rule was born. This means if you want to live off an income of $40,000 a year for the rest of your life, you'll need one million dollars invested, and you'll have a 94% chance of that lasting you for the next 60 years without running out.

But now, according to the inventor of the 4% rule himself, he says that no longer applies and changes have to be made. Just a few days ago, Bill Bengen went on record to say that current market conditions may require an even more conservative approach and that the combination of eight and a half percent inflation with high stock and bond market valuations makes it difficult to forecast whether the standard playbook will work for recent retirees.

The issue today is that there's not a backlog of history that deals with prolonged eight and a half percent inflation during a time where interest rates are coming off record lows and stock valuations are dropping from record highs. After all, if you adjust your spending to simply keep up with inflation, you would need to spend an extra eight and a half percent a year just to keep up at the same pace that products and services are increasing.

So, obviously, that might not be sustainable. On top of that, many investment analysts are calling for lower investment returns in the future, which could very well affect how much money you make and consequently how much money you spend. For example, Credit Suisse and several other investment analysts say that young people stand to make dismal returns on their investments.

They explain that, unlike other generations who have benefited from a relatively uninterrupted economy, Gen Z is forecast to take out a market with higher unemployment, lower earnings, and higher taxes to pay off the pandemic-related debts. So, here's what they found. Throughout the last 120 years, the real returns of the stock market—which is just a really fancy way of saying after taxes and after inflation—comes to an average of five percent a year on stocks and 3.6% on bonds.

From there, they look at the current spread between the completely risk-free return of buying a treasury bill, which is estimated to be negative half a percent after taxes and inflation, and the premium of three and a half percent for the risk of investing in the stock market. That gives us an annualized net return of just three percent a year in the stock market according to this calculation, and it's even lower at two percent if they hold a portfolio of 30% bonds.

LPL Financial also published similar findings when they looked at the returns of bull markets in their first, second, and third year, and they found that the first year's returns were almost always the largest at a rate of anywhere from 20% to 65% from the market bottom. And with the exception of 1987, the second year within a bull market has typically been a lot smaller—usually between a 10% to 25% return. But throughout that second year, they've also found that it’s prone to a pullback, usually at a rate of about 10%.

Even Charlie Munger agreed, who's one of the investors that I respect the most. He says that nobody's gotten by with the kind of money printing now for a very extended period of time without some kind of trouble. We're very near the edge of playing with fire. His warning is that the stock market may see lower-than-average growth over the next decade simply because we've already seen such a huge return.

And when it comes to the decade-by-decade data, it's rather surprising if we consider that 2012 through 2021 had an average annualized return at 12.62 percent. We could extrapolate that based on past performance, the next 10 years might not be so good. So, given all of this data, we have to ask ourselves, what is the solution?

Well, one option is all thanks to the sponsor of today's video, public.com. And on top of being a convenient mobile app, they've also launched a desktop version that offers an enhanced portfolio overview with customized ways to track and analyze your positions over time. They also incorporate an optional social aspect into the entire experience where you could make a profile, follow other investors to see what they're buying or selling, and read their comments and current events.

Plus, I just went live the other day to talk about index funds and how you could use them in conjunction with everything we're talking about in this video. I'm planning to do a lot more of these in the future, so you have the option to follow my profile and I'll keep you posted on the next session. It's just a really great app.

It's free to download, they have a very simple, easy-to-use interface, they allow for fractional investing, and as a thank you for signing up and giving them a try, they want to invest in you by giving you a free stock worth between three dollars and a thousand dollars just for signing up and making a deposit with the link down below in the description using the code Graham. So thank you guys so much. Now with that said, let's get back to the video.

All right, so in terms of the solution to the four percent rule, the creator himself says it depends. Prior to the pandemic, Bill Bengen went on record to say that the four percent rule was treated too simplistically and that it took into account the worst possible case scenario.

First, because of that, he said that historically when times are good, the average safe withdrawal rate has turned out to be about seven percent, and at points, it's reached as high as 13%. Of course, you would only know if this works after the fact in hindsight, at which point it's probably too late. So, in early 2022, he changed the four percent rule to the five percent rule, meaning you could spend an extra one percent every single year until eventually, you hit the, uh, the big like button in the sky.

But with inflation running as high as it is, not everyone agrees, and Morningstar recently came on record to say that if inflation—which is at a 30-year high—remains at or near today's level for an extended period, even a reduction to 3.3 percent could prove optimistic. They also suggested that if you want to spend more than that, it's a good idea to be flexible.

No, not that flexible, this flexible. You could always work a little bit longer, you could delay Social Security, or you could save a lot more money so that that way, you could spend more money. Other advisors recommend that you change your spending every single year in response to the market, meaning you'll spend more when times are good and you'll spend less when Netflix sees slowing subscriber growth.

This way, you could preserve your wealth as best as possible, and you never spend more than the market can sustain. Although in terms of what I think about this, as a YouTube connoisseur who has an obsessive fascination with personal finance, here's what I found the most surprising. When you look at the rolling returns of the S&P 500 going all the way back to the good old year of 1872, it was found that a 20-year holding period has never once produced a negative result adjusted for inflation.

And the worst result ever realized was a half a percent return over 20 years. However, that was during a time in the 1960s right before runaway inflation, which realistically might not happen as bad—hopefully. But, of course, during any other time, you would see an average return of six percent and a best-case return of 13% a year. Now, another chart found that over a 30-year rolling period, the worst-case scenario was an 8% annual return before inflation, and the best case was nearly 15%.

And a third chart shows the average dating all the way back to 1909, coming in at 10% with dividends reinvested. Now, of course, as you can see, we're certainly in the middle of what looks to be a very prosperous run, but that comes with the chance that in the future, things may not look as good.

So, given all this information, if you're looking at a 30-year retirement and you want to be 100% sure that you're not gonna run out of money, given all the data that we have available, spending three and a half to four and a half percent of your money every single year should be okay as long as you're good with being flexible and cutting back when needed.

But let's be real; for most of us watching, none of this matters. As long as you're okay being flexible with your spending, it doesn't mean that you have to spend four percent every year, otherwise you've failed personal finance 101. And it doesn't mean that you can't scale back to two and a half percent a year if there's nothing to spend money on, and you decide to cancel your Peloton membership instead.

The metric we should use is that it's okay to spend three to four and a half percent of your portfolio annually as long as you're okay cutting back in the event the market goes down, inflation remains high, and you don't make as much as they say you will in Wall Street Bets. For example, if the market goes down 10 percent, then maybe that's a sign that, hey, you shouldn't be flying first class to go and see me box Michael Reeves in Tampa, Florida on May 14th—link down below in the description. Yes, it is real: May 14th.

So, as long as you have some flexibility in your spending, you should be okay. Plus, this does not take into account that realistically you'll have some sort of paid work throughout retirement, which means you could spend more money as long as you have a recurring consistent income. And really, all of this should just be used as a rule of thumb, and by understanding the math behind this and how it works, you'll be able to better budget how much money you'll need and how much money you could spend.

So, with that said, you guys, thank you so much for watching. Also, make sure to add me on Instagram and on my second channel, The Graham Stephan Show. Thank you so much for watching, and until next time.