Can I safely apply the 4% rule outside of the US?

By Slow Dad - November 08, 2016

The FIRE community espouses a 4% safe withdrawal rate can safely fund their retirement. Read why the 4% rule doesn't work outside of the USA.

Does the 4% SWR doesn't hold true for non-US domiciled portfolios

As it turns out, no.

4% rule not applicable for investments domiciled outside the US.
4% rule not applicable for investments domiciled outside the US.
In 1994 American financial planner William P. Bengen published an article in the Journal of Financial Planning titled “Determining withdrawal rates using historical data”. This article formed the basis of what many in the financial independence / early retirement community refer to as the “4% rule”.

Bengen’s paper proposed the following approach:

  • … determine first the ‘safe’ withdrawal rate. Do so by computing the shortest portfolio life acceptable to the client (generally the client’s life expectancy plus 5 or 10 years, depending on the conservatism of the client)…
  • … determine the highest withdrawal rate that satisfies the desired minimum portfolio life
  •  “The withdrawal amount for the first year (calculated as the withdrawal percentage times the starting value of the portfolio)…
  •  “[The withdrawal amount] will be adjusted up or down for inflation every succeeding year.
  •  “After the first year, the withdrawal rate is no longer used for computing the amount withdrawn; that will be computed instead from last year’s withdrawal, plus an inflation factor.
Using American historical data from 1926 to 1994, Bergen computed the average rate of return for stocks was 10.3%, bonds was 5.2%, and inflation was 3%. These figures assume the reinvestment of all dividends and interest.

Bergen concluded that applying an annual withdrawal rate of between 3% and 4% to a portfolio allocation of 75% stocks / 25% bonds would result in some residual portfolio remaining after 30 years of retirement in the vast majority of cases.

Bengen's 4% rule safe withdrawal rate
Bengen's 4% rule safe withdrawal rate.
Think about that for a second.

"Some" means more than zero, not necessarily enough to live on.

Retiring early means your wealth needs to last longer, possibly more than Bengen’s 30 years.

To give credit where it is due, Bengen’s research was ground breaking. However Bengen acknowledges some oversimplifications that many financial independence / early retirement experts naively choose to ignore.

Firstly Bengen excluded transaction costs. Funds charge management fees. Brokers charge trading commissions. Governments may charge stamp duty on purchases and capital gains taxes on sales. Collectively these will reduce the “safe” withdrawal rate.

Secondly Bengen ignored income taxes. In the real world the tax man wants his share… either on the way into tax-free accounts, or on the way out of tax deferred accounts.

Can Bengen’s 4% be reasonably applied to countries outside the United States?

Looking at portfolios containing non-US portfolios

Morningstar published a 20 county analysis that factored in an assumed 1% combined annual expense rate over the 1900-2015 period. Unfortunately Morningstar also assumed a 50/50 split between equities and bonds, which was the absolute minimum Bengen found to be worthwhile. This may not be representative of everyone’s appetite for risk.
Initial Safe Withdrawal Rates at Various Target Success Rates by Country.
Initial Safe Withdrawal Rates at Various Target Success Rates by Country.
Morningstar’s findings can be summarised as “no”, it would neither be safe nor prudent to apply the 4% rule outside of the US. The average safe withdrawal rate was found to be only 2.3%.

Adopting a globally diversified approach to investing, weighting holdings by their market capitalisation, would see an investor holding just over 50% of their investments in US domiciled stocks. Again a safe withdrawal rate from such an approach was found to be around 2.5%.

So what?

Getting your withdrawal rate wrong is the difference between eating well and eating cat food in retirement, when you’re too old to do anything about it. As always: trust, but verify.
trust, but verify.
To evaluate alternative asset allocation options examine the Dimson, Marsh and Staunton study that Morningstar’s analysis was based upon.

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