You will be able to explain what Bengen and the Trinity study tested, and what their results show and do not show.
Find the yearly spending base you worked out in module 1 and multiply it by 25. A lot of financial independence writing online would call the result your target. Two shortcuts come up in that writing again and again. One says that if you withdraw 4% a year, the money lasts. The other says that once you've saved 25 times your yearly spending, you're done. People quote both so often that they sound like laws of nature. In fact both come from a small number of studies that used American data. If you know what those studies tested, you can use the shortcuts with your eyes open.
This module takes your spending base from module 1 and turns it into a target number. To do that, you need the second input introduced in lesson 1.1: how much you can withdraw from your investments each year without running out.
William Bengen was a financial planner in the United States. In 1994 he published a study in the Journal of Financial Planning. He started from a common client situation. Someone retires with a portfolio and wants a steady income. How much can they take in year one, and then raise each year in line with inflation, without running out over a thirty-year retirement?
He answered it with historical US market data. He imagined a retiree starting in each past year in turn, holding a mix of large American company shares and US government bonds. He set the first-year withdrawal as a percentage of the starting portfolio. Each year after that, the withdrawal went up by inflation, whatever the portfolio was doing. He then ran each case forward through the thirty years that actually followed. Some of these imaginary retirees started just before the Great Depression, and others just before the high inflation of the 1970s. He looked for the highest starting withdrawal that lasted through every starting year, including the worst one. It came to about 4% of the starting portfolio.
From this comes the 4% rule: withdraw 4% of the starting portfolio in year one, then raise that amount by inflation each year, regardless of what the portfolio is worth. Say you have S$1,000,000, an example figure. You would take S$40,000 in year one, S$40,000 plus inflation in year two, and so on each year after.
The 4% applies only to the starting balance. From year two on, the withdrawal follows inflation and ignores the portfolio's value, and you take it whatever the market does. Also, 4% is the rate that survived the worst historical start. In most starting years, the retiree would have died with plenty of money left over.
A few years after Bengen, three finance professors at Trinity University in Texas ran a broader test, known as the Trinity study. It also used US historical data. They didn't look for one safe rate. They tested a range of withdrawal rates over several retirement lengths, with different mixes of shares and bonds. For each combination they reported a success rate: how often, across past periods, the portfolio lasted the full retirement period. The output was a table of these rates.
Success rates fell when the withdrawal rate went up, when the retirement period got longer, and when the mix held a smaller share of stocks. Much of the later talk of a "safe" 4% comes from these tables. A high success rate means the portfolio survived most past US periods. It tells you nothing certain about the next thirty years in your own markets, with your own costs.
A 4% withdrawal rate and a target of 25 times spending say the same thing in two forms. You can convert any rate in three moves. First, write the rate as a decimal, so 4% becomes 0.04. Next, divide 1 by that decimal to get your multiple. 1 divided by 0.04 = 25, which is where the 25 times rule comes from. Finally, multiply your yearly spending base by the multiple to get your target number.
This works for any rate. The lower the rate, the bigger the multiple and the bigger the target. At 3.5%, 1 divided by 0.035 = about 28.6 times. At 3%, 1 divided by 0.03 = about 33.3 times, usually rounded to 33.
Priya, from module 1, has a spending base of S$44,000 a year at today's prices (an example figure). At 25 times, her number is S$1,100,000. At 33 times it is S$1,452,000, and at the unrounded 33.3 it is about S$1,466,667. So moving from 4% to 3%, one percentage point, raises her target by over S$350,000: S$1,452,000 minus S$1,100,000 is S$352,000.
The results show that in US history, a retiree who started at about 4% and raised withdrawals for inflation got through thirty years in every period Bengen tested. They also show that taking out more raises the chance of running out.
They can't show that 4% is safe for you, for these reasons:
the periods tested were thirty years; the data were American, from a century in which the US market did well; most of the costs people pay today were left out; the retiree in the model never adjusted spending, whatever happened.
Lesson 2.2, "Four reasons the rule may not fit you", goes through each of these limits in turn.
The rule is still useful. It gives you a sensible starting point, and it turns your spending into a target in one step. Just don't read it as a promise that your money will last.
For the activity, you need only your spending base from lesson 1.4 and a calculator. Keep both figures it asks for, because lesson 2.4 uses them when you choose your own rate.
Multiply your yearly spending base by 25. Then multiply it by 33, which matches a 3% withdrawal. Write both figures down.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).