A (Slightly) Happier 4 Percent Rule

“The Leisure of the Theory Class” is, I’m pretty sure, the title of an article I long ago read. I don’t recall the meat of the thing, which means it probably wasn’t great stuff, but I went through it anyway because of its clever(?) riff on Veblen’s treatise, The Theory of the Leisure Class.

That latter work is where we get ideas like conspicuous consumption and other goodies, including, for instance, Veblen goods. Which is a pretty neat trick considering the thing was published around the time “Little Ben” Harrison became POTUS after a controversial election, in 1889.

Now, for most FIRE types, there’s probably all at once a ton of insight and a bunch of obviousness in Veblen’s stuff. And so it’s maybe worth picking up at the library. But this article’s not really about Veblen or conspicuous consumption or peaceful transitions of presidential power.

Really, I mention Veblen and theory and leisure because most FIRE types are probably both part of the leisure class (in some form) and theory class. And most (good) FIRE writing is pretty thoroughly baked through with theory. And the best of that writing comes with some practical pointers.

In that tradition, then, but presupposing no quality value in what follows, here’s some theory. And a (maybe) gaping hole where practical pointers should be.

What this post is really about is the 4% Rule. And why it’s (probably) engineered to make you miserable. And what you can (maybe) do about it.

A (Slightly) Happier 4 Percent Rule
A (Slightly) Happier 4 Percent Rule

Spilling Ink

There’s a specialty dish in Venice that’s now pretty common to find all over. It’s the squid-ink pasta or black pasta thing, and it’s basically noodles soaked in calamari cream. Which is pretty cool as long as you’re good with iodine.

I’m reasonably confident less ink has been used in the history of man to create this dish than has been spilled writing about the 4% Rule. If you’re a one-trick bro like Pfau or Kitces or some other actuarial types, you have no choice. Publish or perish. And nothing kicks up readership like controversy. So it’s molto bene to stir the pot or kick it over or smoke it or whatever to keep people coming back for more.

The fact of the matter is that, for all the worry about safe withdrawal rates and sequence risk and portfolio allocations, et cetera, et cetera, something like the 4% Rule pretty much seems to work pretty damn well pretty much all the time (when there’s at least a reasonable attempt to not be an idiot by, say, going all-in into Argentine tech stocks or negative-yield bonds or “precious” metals or subscribing to bizarre notions that the wheels could fall of the global economy any time because all this economic history we look at showing persistent increases in output is really just a short-run aberration so we should keep everything in cash under the Serta). I say all this despite some pretty shaky theoretical foundations for, and lots of leisuring by those who write about, the ~4% Rule.

Us theorists don’t much like facts that can’t be readily explained by a favored theory. And, yet, there they are. It appears something like the 4% Rule works, despite itself.

Now, I like a draw rate of 3.5% or lower, and I think an equity-favoring portfolio with some global allocation (but U.S.-heavy listings) is useful, and I think it’s best to temper withdrawals in the face of dramatic stock market devaluations. And all the noise about particulars and worry about “what ifs” are probably not really material. And that’s about the best anybody’s gonna be able to say about this 4% Rule construct until we can get around to chalking up a better theory.

(Note: I have looked into this 4% Rule/safe withdrawal rate issue at length. The bottom line, in my mind, is that there’s some risk in everything. But following the FL-Approved 3.5% Rule and just forgetting about it pretty much guarantees a satisfactory financial outcome, recognizing that nothing in life is fully guaranteed, and further recognizing that just because something’s not fully guaranteed doesn’t mean it’s worth fretting over.)


“Um, FL, did you, like, have a stroke or something?” you ask. “You do realize you’re spilling yet more ink about the 4% Rule.”

Sure thing. But I have, like, a really good reason.

Sucking It Up

That prefatory note was meant to set the stage for what follows. And it’s there because I don’t want y’all getting distracted by the mechanics of the 4% Rule or “controversy” or quantitative quibbles. I want us, at least for now, to leave it as a given that something like the 4% Rule is pretty okay from a purely financial perspective.

But it’s, like, totally not okay from a psychological perspective. Stupid psychology.

The 4% Rule and all its variants work by establishing an initial annual withdrawal amount at ~4% of a portfolio value. Then, each subsequent year, the withdrawal amount is ratcheted up (down) by the rate of inflation (deflation) such that every year’s withdrawal provides identical purchasing power for the retiree. The retiree is accordingly allowed a constant standard of living that, presumably, is agreeable and sufficient.

Which makes excellent quantitative sense and virtually no human sense.

Bear with me if you’re skeptical. But you might already have intuited this, so maybe you’re way ahead of the narrative at this point. Either way, it’s worth mentioning that we humans are tortured beasts. We live not only in the present. We also live, in a way, in the future.

We look ahead to what’s next. We anticipate. We fear. But, perhaps most powerfully, we hope. The power of abiding hope (or expectation) that tomorrow will be brighter, that we’ll be more productive or smarter or richer or whatever has been proven more ways than squid ink pasta’s been messed up by overzealous home chefs. We can’t seem to help ourselves. It is a profound force that exerts its influence on the psychological side of spending/consumption/money.

And the bottom line is that we are motivated and happier when we have an expectation that tomorrow (or next year) will be better than today (or this year).

And we are depressed by the expectation that “this is as good as it gets.” Or, worse, as Office Space summarizes, that “Every day is better than the next.”

So, for as beautifully steady as the 4% Rule is from a mechanical or financial perspective, it’s infuriatingly unremitting from a human perspective.

If today is the best day we’ll ever have, that’s kind of sad.

(Note: There are some technical arguments for why standards of living would be expected to move upward each year in the face of constant inflation-linked spending (e.g., technology improvements that are not fully captured in inflation measures, or positive externalities associated with changes in others’ spending behaviors). This is fair, but the effect would be very small. There also are some arguments that people can learn to make more of their constant allowance each year by spending more efficiently vis-à-vis happiness. Again, a fair observation, but the effect is likely small and/or non-renewable. For the majority of people it appears there’s a strong link between disposable funds/consumption capabilities and life satisfaction, within a range. Life satisfaction tends to climb as real disposable funds climb, all else equal.)

This is, effectively, a result of hedonic adaptation. We tend to quickly acclimatize to states of things. But we tend to respond to (and feel) change.

So when our eternal ever after is just gonna be the same old same old, we get sad. (We seem to hedonically adapt to the current-period payout quickly and get rapidly unimpressed with simply maintaining that level: diminishing marginal returns on happiness accrue in subsequent periods when a constant real payout rate is provided. In other words, with a constant payout, that Office Space logic applies: “Every day is better than the next.”)

By escalating real withdrawals over time, however, we get less sad. And maybe even a little happy. 🙂

Blowing It Out

Right. So all this probably sounds pretty obvious when it’s framed this way: The ability to spend money is positively correlated with life satisfaction; we adapt quickly to the satisfaction level at a given quantity of disposable funds; when we are forced to hold real spending constant, our satisfaction levels decline over time; we can anticipate this effect, which reduces our current-period happiness; the constant-payout 4% Rule is a problem when it comes to managing happiness in retirement.

And now you’re thinking: “Ok, FL, great stuff. But, uh, what do we do about this?”

Yeah, so this is the part where I get, like, super disappointing. Because, at least among FIRE types, there seems to be something like a race to freedom going on.

There seems to be a dollar portfolio value goal in mind that enables a ~4% initial withdrawal rate that just meets annual expected spending needs. Maybe there’s a small buffer in there, but the basic premise for many is that, when $X in portfolio value is reached, the party can begin. And the 4% initial withdrawal rate will be changed by the inflation rate each year and that’s that.

Which is mechanically and financially fine. But it complicates ratcheting annual withdrawal rates up above inflation each year, which is a preliminary goal that can be drawn from the above reasoning: We need to escalate real spending each period (say, each year) to keep happiness up.

That’s because: 1) First-year withdrawals can’t really be reduced to then allow “safe” super-inflationary growth since that would mean minimum acceptable living standards in year 1 and maybe a few years thereafter wouldn’t be met; or 2) An initial withdrawal rate of ~4% can’t really be grown at a super-inflationary rate without imperiling the long-term health of the portfolio (i.e., super-inflationary withdrawal growth would be “un-safe”).

Hmmmm. Bummer, yo.


So what to do?

Well, there are a couple of suggestions offered up by economists such as Shlomo Benartzi. Who, if you’re not aware, is a pretty smart dude. And Benartzi’s one of the first econ guys to figure out this psychology-side shortcoming of the traditional 4% Rule construct. He observed two things: 1) some, and actually most, people prefer to delay satisfaction in some way because they derive a positive anticipation benefit that seems to outweigh the “cost” (or temporal discounting loss) of delaying consumption of the satisfactory thing/experience itself; and 2) most professional financial and retirement planner types eschew a constant-annual-payout construct for their own retirements, instead preferring an escalating payout structure.

(Note: Both observations, interestingly, pretty much are contrary to what conventional economic theory would predict. Yes, they can be rationalized one way or another, but they point to this very messy intersection among money and happiness and economics and psychology. And they suggest very strongly that, just because the mathematics underpinning the 4% Rule might work, it doesn’t mean the 4% Rule actually produces satisfactory practical financial results for humans in the real world.)

Rorschach Blots

Okay, so I’m gonna splice some non-Benartzi observations into this section. I don’t do this because I’m smarter. I ain’t. It’s actually because I’m not smarter, and so I benefit from belaboring stuff that’s too obvious for him to worry about. What follows are a few suggestions for what we can do about this whole mess. How can we use something like the 4% Rule as a mechanical retirement planning tool that also provides us with an antidote to the dreaded “Every day is better than the next” syndrome?

1. Start Small

Right. Obvious. Okay, but still. If you can trim down your living costs to something well below ~4% during year 1 of retirement, you can then ratchet up spending in subsequent years above inflation growth and maintain the health of your portfolio. Figuring out specific numbers here that could apply in your situation requires some basic computations no more burdensome than any other 4% Rule-related calculations.

Groovy. But maybe not practicable for some (the starting small thing, not the math).

2. Synthesize

Structure your spending in such a way that there’s an irregular “high-spend period” that provides you with something great. For instance, if your baseline cost of living is, say, $4k a month (representing not the full ~4% allowance you get), and that $4k doesn’t include stuff like travel, then book a sweet vacay several months in advance and look forward to it for awhile.

You’ll get the benefit of positive anticipation and a hedonic kick from the vacation itself without a chance to fully adapt. By altering the structure of the travel year-to-year (say a big trip one year and then a few small trips the next, etc.), this non-adaptive condition would be maintained, keeping happiness up even as real annual spending stays constant.

3. Change Change Change

Uproot your life consistently (assuming it’s in the budget). Or, at least make some fairly dramatic changes to your life with some measure of regularity – say every couple years.

By moving to a new place or changing fundamental routines it’ll be hard to compare past, present and future, so you’ll be more likely to live in the present and not feel like your standard of living hasn’t increased despite not spending more dinero. And you’ll be less likely to dread the tedium and monotony of the future since you know it’ll be very different from the present, while appreciating what’s good about your present and not fretting about what ain’t great since you know it’ll change soon. And, importantly, you won’t be able to get upset that you’re spending an equal amount of money each year because you’ll be spending it much differently.

(Note: This suggestion emanates from a line of research into executive expatriates and their life satisfaction levels during their international stints. It’s very interesting stuff and in no way related to much of the other literature in this research space. Consider the theoretical gap bridged. You’re welcome.)

4. Pad the Portfolio

Squirreling more meat into the nut means your initial retirement standard of living can be accommodated by a lower percentage of the portfolio. Which means you can “artificially” moderate spending during the first couple-few years of retirement so as to build spending over time at a rate above inflation.

Now, this one’s also obvious and is just the flipside of the first strategy outlined above. But there’s some merit in thinking of them separately since they imply different levers that can be pulled in different phases of the pre- and post-retired states.

“Jeez, FL, you are super-disappointing,” you say.

I aim to please.

(Note: Although the majority of people seem to prefer increasing payouts over time, there’s some evidence that certain personalities do not. These minority personalities prefer higher initial payouts that decrease over time. There are also some obvious reasons why certain retirees could prefer higher initial payouts, even with a majority-type personality: health issues that are expected to worsen, once-in-a-lifetime opportunities that come up early in the retirement phase, etc. For these people, the trick seems to be enacting sufficient self-discipline so as to not screw the pooch with spending during the first years of retirement.)

Couch Time

So this is the part where now you’re kinda pissed. You had this whole 4% Rule thing all scratched out on some notepads, and your abacus is all banged to hell from the computations, and everything was perfect until old FL told you you’d be miserable spending the same amount of real money every year in retirement.

And, moreover, FL provided “solutions” to the problem that would earn most first-year economics students a D-minus and a kick in the teeth.

But, look, I told you at the outset there’d be plenty of theory and a big gaping canyon where practical solutions should be.

So we’re good, right?

Well, just so we can stay friends, let’s end our time together like this. I don’t think the practical solutions are so terrible. They actually suggest some strategies for life-awesomeness that probably are part and parcel of a good existence: simplicity, variety, unconventionality, unpredictability and mindfulness. All of which can be used to great effect in retirement or FIRE or whenever.

These strategies – or lifestyle orientations, maybe – underpin what I perceive as a fundamental part of the emerging field of hedonomics. Conventional economic approaches to solving consumption problems for optimum utility don’t get us all the way from theory to reality.

So maybe we can start thinking about an augmented theory to help bridge the canyon by using our lifestyle orientations as guideposts. For instance, by implementing simplicity, variety, et al. into life, the relative impact of money on happiness would be expected to fall. Or, in the alternative, our lifestyle orientations, brought about by spending less money, would provide happiness-amplification effects on the money that is spent.

And you’d end up doing something that traditional economics would tell you is impossible. You could increase your life satisfaction not despite spending less money – but because of it.

So my advice, fair readers, is to slurp down the theory like so much squid ink pasta, kick over the steaming pot of 4% Rule fear and go live impossibly, one year at a time, armed with as much practical ammunition as any theory allows. Oh, and get leisuring already.

Luchadores, what do you make of all this? Are you planning a constant real withdrawal rate in retirement (as per the 4% Rule)? Or are you planning escalating withdrawals? Do you intend to try other strategies to keep “Every day is better than the next” syndrome at bay?


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