Retirement researcher Bill Bengen, known for developing the 4% rule, has stated that early retirees could be living more frugally than necessary. "I think they're cheating themselves a little bit," Bengen told CNBC’s Make It regarding retirees who strictly follow his original guidance.
The issue, according to Bengen, is not that his research was incorrect. He argues that many retirees focus on a static percentage—4% or his updated 4.7%—without accounting for the economic and market conditions that influence whether withdrawals can safely be higher or should be more cautious.
For early retirees, this context is particularly important. Retiring at ages like 45 or 50 means managing a portfolio for 40 to 50 years, making the balance between unnecessarily restricted living and sustainable spending critical.
Bengen's original 4% rule, published in 1994, suggested retirees could withdraw 4% of their portfolio in the first year and adjust that amount for inflation annually, without depleting funds over 30 years. His updated research recommends 4.7% for 30-year retirements and 4.2% for 50-year horizons.
But these numbers represent worst-case scenarios: the withdrawal rates that would have worked even for retirees who started during the most challenging periods in financial history. "My research shows that if you endure a substantial bear market early in retirement, it drives down your withdrawal rates, because it sucks a lot out of the portfolio at the same time that you're drawing from it," Bengen explained to CNBC.
Equally important, if those worst-case conditions are avoided, retirees might be able to withdraw significantly more.
So, how can early retirees determine if they're being too conservative? Bengen points to several economic and market indicators that should inform withdrawal decisions.
Market valuations at retirement start strongly influence future returns. The Shiller CAPE ratio, which divides current prices by 10-year average inflation-adjusted earnings, provides one measure. According to GuruFocus data, the S&P 500 Shiller CAPE ratio was approximately 40 in December. That's well above the historical median of 16 and near levels seen only during the late-1990s dot-com bubble. High valuations typically predict lower future returns, suggesting caution for those retiring today. Conversely, retirees who began withdrawals when valuations were moderate or low could historically safely use higher withdrawal rates.
Inflation trends matter. Rapidly rising costs erode purchasing power, potentially forcing retirees to withdraw more or cut spending. Current inflation, 2.8%, remains above the Federal Reserve's 2% target, according to the Federal Reserve Bank of St. Louis. Early retirees should monitor inflation closely, as sustained high inflation favors more conservative initial withdrawals.
Interest rates and bond yields are also factors. Bengen's updated research assumes portfolios hold 45% in bonds and 5% in cash. When bond yields are high, that portion generates more income, supporting higher overall withdrawal rates. But when yields are suppressed, retirees may need to draw more carefully. Currently, yields have normalized from their pandemic-era lows but remain below historical averages, creating a moderately supportive environment for withdrawals.
Sequence of returns risk is another consideration. The order of investment returns matters greatly. Strong returns early in retirement build a cushion, allowing higher withdrawals. Poor returns in the first few years can create a portfolio "hole" that may be difficult to recover. This uncertainty means retirees should reassess withdrawal rates regularly, rather than setting them once and forgetting.
Flexibility works in favor of early retirees. Unlike traditional retirees who may have fixed expenses and limited ability to return to work, early retirees often have more options. For example, they can reduce discretionary spending during market downturns, earn income from consulting or part-time work if needed, or downsize their living situation if necessary. The more flexible your spending and the more options you maintain, the more aggressive you can be with initial withdrawal rates, because you have choices to make if conditions worsen.
For early retirees questioning whether their withdrawals are too conservative, Bengen's research suggests asking key questions. What were market valuations when you retired? If withdrawals began when stocks were reasonably priced or undervalued, you likely have more room than you think. How has your portfolio performed in early retirement? Strong initial returns can build a cushion. If your first few years delivered above-average gains, you may be unnecessarily restricting spending. How flexible are your expenses? If you can cut about 20 to 30% of spending during downturns, you can likely afford higher baseline withdrawals. What's your earning potential? Early retirees with marketable skills and a willingness to earn income occasionally can withdraw more aggressively than those without a backup plan. How's your health and family longevity? Someone retiring at 45 in excellent health with a family history of longevity should plan more conservatively than someone retiring at 55 with significant health challenges.
Early retirement requires planning for a longer time horizon. While not pleasant to consider, realistic longevity expectations is another factor critical for early retirees to consider.