Bill Bengen Explains Why the 4% Rule Is Now 4.7% — Full Transcript

James Lange: For years, you said 4%, everybody was following 4%, and then you have this book that says, “Hey, guess what? You can do 4.7%.” Is that because you were wrong back then, or did you make different assumptions or did the economy change? How did you get from 4% to 4.7%?

Bill Bengen: Fair question. It really was a result of increasing sophistication of our research. The first paper I wrote was only based on two investments: US intermediate term bonds and US large company stocks. Of course, modern portfolios have many more asset classes, so I, over time, gradually increased, and I'm up to seven now.

I've added in US small cap stocks, US microcap stocks, international stocks, and treasury bills to the mix, and that got me from the 4% all the way up to 4.7. And I’m probably still understating what the full potential is. I think it's probably closer to 5% if you get all those other assets which I haven't included, such as gold or REITs, alternative investments, commodities, visual currencies, and a lot of things you can invest in today.

James Lange: Alright, so would you say that the biggest factor of everything that you mentioned is the fact that you are now assuming a much better diversified portfolio where the original analysis was just US stocks and US bonds, and now you're having some international, some small, some value, some growth, etc.?

Bill Bengen: Absolutely. In fact, my research attests to the enormous value of diversification in a portfolio and how it can improve performance.

James Lange: Okay, so basically you're saying you should have this better diversified portfolio, which (a) keeps you safer and (b) actually has a higher safe withdrawal rate than if you have a not so well diversified portfolio. Is that right?

Bill Bengen: That's right. I call that a free lunch…diversification.

James Lange: Okay, so now the other thing is some people said, “Well, gee, I'm a conservative investor, and even though I have a 30-year life expectancy, can I have a lot more bonds and more fixed income, and would that be any safer for me?”

Bill Bengen: It turns out to be no, because bonds are a relatively low-returning asset class. Over time, they've averaged 5% versus stocks, which are around 10%. So, if you load your portfolio too heavily with bonds, you're going to reduce the returns and therefore reduce your withdrawal rate significantly.

James Lange: Yeah, and by the way, this is perfectly consistent with what Jack Bogle said. I had the pleasure of interviewing Jack Bogle a couple of times, and he was saying, “People think they're conservative by having a large bond portfolio.” And for the same reason that Bill is saying, “Hey, you can run out of money with a large percentage of bonds.” Is that fair?

Bill Bengen: That is correct.

James Lange: Although I suspect that you and Jack came up with that independently.

Bill Bengen: He is a man I greatly admire.

James Lange: Well, I think that you are, and that both of you have just added so much to, let's call it, the whole financial world.