The DANGER of the 4 percent withdrawal rule

riskThe 4% withdrawal rule was established as a safe way to withdraw money from your retirement account and avoid running out of it. If you have read retirement articles or books, you must be familiar with the rule by now.

To understand the danger of the 4% withdrawal rule, you need to understand what happens in retirement and be fully aware of which camp you fall in. Here are the possible retirement options:

  • Pension Plan: You retirement income is covered based on a percentage of their earned income and years of contributions in the plan. Those with a full pension plan don’t have to worry about any 4% withdrawal rule. It’s the gold plated retirement plan.
  • Defined Contribution Plan: Your retirement contributions are matched by your company but investing it is usually left to you to manage. A fee advisor could help you out if you are stuck here.
  • Personal Savings: Just like the defined contribution plan, you are left on your own to manage everything. How much you use in retirement is a very important factor. This is your money in your RRSP, TFSA or non-registered account.

Related: How to calculate your retirement cost

Obviously, you might be retired but still work part-time to keep busy and earn an income but how do you know if you don’t have to work? How much do you need to have? Is the 4% withdrawal rule really safe?

DANGER of the 4% withdrawal rule

What I find is missing from the 4% withdrawal rule is that it is not stress-tested against market crashes. How many soon to be retiree had to keep on working in 2009 because their portfolio got decimated? If the 4% rule is the rule of thumb, what can you do to protect yourself against a market crash? Do you simply move your equity investment to bonds? If so, you lose the potential equity market appreciation that the 4% withdrawal rule is expecting to cover inflation. If your portfolio doesn’t grow, your 4% is less and less. Retirement needs have a fixed requirement of funds and not just a percentage value of a variable portfolio.

Avoid the 4% withdrawal rule DANGER

Large equity exposure can work in retirement. I have seen it, and I hear about it from readers as well. The way they make it work is by investing in income producing assets. That’s why the corner stone of my retirement strategy is Dividend Income and not a 4% withdrawal rule.

Related: Why Dividend Investing

Let’s be clear that I think there is a big difference between getting a 4% dividend income versus withdrawing 4%. Even when you assume the initial amount of money is the same, the dividend income doesn’t require you to sell any investments where as the 4% withdrawal rule might. It’s true that both reduce your net work by 4% but not the same way and the consequences of the action is very different.

As soon as you have to sell investments, you become at the mercy of the markets. Let’s assume you are 70 and you have a portfolio with 70% in a bond index and 30% in equities. With both of the indexes paying less than 3% in income, you have to make up for the short fall by selling. Every time you sell, you reduce the future income you might earn. As you get older, you earn less but you are also shifting more into bonds if you don’t believe in holding equities. By the time you are 80, you spent 10 years selling 1% of your portfolio to cover the short-fall of the income.

The only way to avoid that is to actually have more savings so that the 3% or even 2% satisfies your income needs or that you have another source of income. Obviously, there are so many ways the 4% withdrawal rule can play out but in the end, you always end-upp selling portion of your investment to have the money which consequently impact future growth for however many years you might need it which is also unknown.

Stress Free Retirement is about Income

Dividend Snapshot
As you can see, successful retirement is all about the income. Even the young retirees have many source of income. Their retirement is really a form of Financial Freedom but retirement is no different. Rather than being self-employed or having businesses that generate income you have a portfolio to do that.

I believe the 4% withdrawal rule is a good guideline to help with calculation but there are major risks in applying this rule blindly. If you can find a way to need less than 4% of your portfolio in retirement than you are doing well by restraining your spending but you also need to find a way to prevent your portfolio from doing its work. 90% of my investments increase their dividends annually. Not only can I keep up with inflation, I get a raise!

Retirement’s Unknown Variables

Life expectancy is a big problem for retirement as we can’t predict when our last day will be. The experts got it wrong for the major pension plans in Canada as many were, and still are, underfunded. Not only that, the low interest rate market compounded the effect of longer age expectancy. How do you think you can manage to sustained your retirement in those conditions if you take money out ?

Risks when investing is attributed to the market fluctuations. If the market fluctuations don’t affect your income, which is the case with dividends, then what’s the risk? The risk becomes inherent to the corporations and their ability to stay in business and make profits. Even when you look back at 2009, only some blue chip companies stopped paying dividends and some others stopped increasing their dividends but many continued not only to pay but also to increase their dividends. Even when the shares were trading at a discount. In short, the dividend income was safe while the portfolio value fluctuated temporarily.

Be careful what investment strategy you choose to grow your wealth as it might not satisfy your retirement needs unless you have more than you think you might need. You basically need to stress test your portfolio with the following

  • Market fluctuation at different stages (1st year, 3rd year, 7th year and so forth)
  • Low interest rates (which usually impact bonds)
  • Percentage of dividend cuts (depending on your investments, it’s important to test this)

After you stress test your retirement plan, you should come up with your own withdrawal rule.

Readers: How many millions do you really need?


Image courtesy of renjith krishnan –

6 Responses to "The DANGER of the 4 percent withdrawal rule"

  1. Good article!

    My #1 withdrawal rule is to never withdraw more than my dividend income from my retirement portfolio of dividend growth stocks. This ensures I will, almost certainly, never run out of money.

  2. It is important that our dividend income covers our retirement expense. However, if that’s the case, we may end up with a substantial net worth when we pass on as the principal is not touched at all. This works well if one has dependents to leave their assets to.
    Otherwise, I foresee using dividend income to cover most of the retirement expense but at the same time draw down on the net worth as the years go by (no dependents). To avoid selling at a loss during market crash, one just need to have emergency funds of 2 years so that no selling of net worth is required (to fund retirement expense) during a bear market.


  3. What I plan to do is have a portion of my savings in bonds, say, enough for one or two years of income. In the years that the market is down, I’ll sell bonds to live on and won’t touch my stocks, except for the dividends. In good market years I’ll spend some (or all) of the gain in my portfolio to live on and replenish, if necessary, my depleted bonds. I’m still five years from retirement so I’m working on growing my nest egg now with 100% equities and will fine tune my plan later, concentrating more on high dividend stocks. I’m lucky enough to have a “Gold-Plated” Defined Benefit pension plan as a steady income. My wife has no pension plan so this fund will be for her.

  4. We are mid 70’s and our income exceeds our annual expenses by quite a bit. We are 100% Cdn equities and reinvest approx 60% of our dividends as well as transferring the max to tfsa’s. We hold about $30k in savings. We don’t worry about any potential market crash because we expect that the majority of our holdings would hold the dividend and any increases might be at a lower rate. During 2009 only one cut the dividend, MFL (and we don’t have a large investment in it).
    I pity those who feel Passive ETF Index investing will produce the same results. Those index’s will drop as the market drops and ETF’s are not know for distributions increases.

  5. Excellent article! If your investments yield 4% and you invest in stocks where there is mininmal risk of a dividend reduction you should be able to survive without ever touching your investment capital. Even if the market takes a drastic tumble you have no worries as long as the dividend is not reduced or cut.


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