Financial advisors and scuba diving instructors share similar responsibilities. They each guide clients into ever-changing waters. Scuba divers need to trust that their tanks are full. When retiring, clients need to know that they won’t run out of money.

A fee-based Certified Financial Planner (CFP) recently created a comprehensive financial plan for one of his clients. The client, whom I’ll call Jim, sent me the plan and asked for my opinion. The report included an assessment of Jim’s risk tolerance. It said Jim should have a low-cost, diversified portfolio. It also showed how much he should save each year to fund his retirement.

This all looked good. But what I read next gave me cold-water shivers. The advisor wrote:

“When you retire, you can withdraw an inflation-adjusted 4 percent per year, and your money should last until you’re 95 years old.”

The advisor inserted a bar graph. According to the report, if the portfolio averaged a compound annual return of 7 percent per year, and if inflation averaged 3 percent per year, and if Jim withdrew an inflation-adjusted 4 percent per year and if Jim didn’t live past his 95th birthday, then Jim wouldn’t run out of money. There were a lot of ifs in there. But something else worried me more.

Jim’s financial advisor abused the 4 percent rule. For example, Jim pays total investment fees of 1.7 percent per year. If Jim withdraws 4 percent and he pays investment fees of 1.7 percent, that’s 5.7 percent coming out of his portfolio during the first year of his retirement.

The 4 percent rule is part of financial-planning lore. Plenty of studies have back-tested a variety of conditions for diversified portfolios. Such research says retirees should be able to withdraw an inflation-adjusted 4 percent from their portfolios every year. When doing so, their money should last at least 30 years. Such back-tests started in 1926. That means the 4 percent rule would have survived a 30-year period that included the crash of 1929-1930. It would have survived the stock market crash of 1973-74. It would have survived runaway inflation in the 1970s. It would have survived the Bear Markets of 2001-2002 and 2008.

But the 4 percent rule might have a single kryptonite: high investment fees.

First, let me explain how the 4 percent rule works. Assume a 60-year old man retired in 1973. He had $100,000 invested: 60 percent in U.S. stocks and 40 percent in Intermediate U.S. government bonds (*see endnote). During his first year of retirement, he withdrew 4 percent, or $4000. He then increased each annual withdrawal to cover the rising cost of living.

Annual Inflation-Adjusted Withdrawals On A $100,000 Portfolio
The First Ten Years Of Retirement: 1973-1983

Year Annual Inflation Amount Withdrawn
1973 8.71% $-4,348
1974 12.34% $-4,885
1975 6.94% $-5,224
1976 4.86% $-5,478
1977 6.70% $-5,845
1978 9.02% $-6,372
1979 13.29% $-7,219
1980 12.52% $-8,122
1981 8.92% $-8,847
1982 3.83% $-9,186
1983 3.79% $-9,534

In 1973, he would have withdrawn $4,348. This is based on 4 percent of his portfolio, plus an upward adjustment for that year’s inflation. In 1974, he would have withdrawn $4,885. That’s $537 more than the previous year. But it covered the 12.34 percent inflation rate in 1974. In 1975, the investor would have withdrawn $5,224. That covered the 6.94 percent inflation rate for 1975. By continuing to match withdrawals with inflation, the retiree ensures the same year-to-year purchasing power until he’s pushing daisies.

At this point you might wonder how long the money would last. The portfolio itself would gyrate with the market. Sometimes it would rise. Other years it would fall…sometimes a lot. But if the investor paid low annual investment fees, he would still have money left, even if he lived to be 105 years old.

You might not want to live until you’re 105. But if you pay 1.7 percent in annual investment fees, like my friend Jim, you might run out of money before running out of breathe. Note the yellow and the green lines on the chart below. Both lines represent $100,000 portfolios, comprising 60 percent U.S. stocks and 40 percent U.S. bonds.

chart represent $100,000 portfolios, comprising 60 percent U.S. stocks and 40 percent U.S. bonds

The yellow line represents an investor who paid 0.15 percent in annual fees. They would have withdrawn $640,671 from the original $100,000 portfolio between 1973 and 2018. By January 2018, they would also have $91,669 left.

Now note the green line. It represents an investor who pays total annual fees of 1.70 percent. The investor would have withdrawn $285,336… before running out of money. If he retired at 60 years of age, he would be broke at 87.

According to Social Security statistics, there’s about a 50 percent chance that a 65 year-old woman will live past her 85th birthday. The typical 65 year-old man is expected to see his early 80s. That’s why we shouldn’t gamble with longevity or high investment fees. If you’re paying total investment fees of more than 1 percent per year, don’t roll the dice with the 4 percent rule. Instead, withdraw an inflation-adjusted 3 percent or less.

You Know the 4% Rule. But Do You know the don't worry about money so you can enjoy your retirement rule. Click to start enjoying retirement.

Unfortunately, Jim’s financial advisor thinks he can take out more. The guy is testing fate–with somebody else’s money.

Year-By-Year Inflation Levels, Withdrawals and Balances
For 60% U.S. Stocks, 40% U.S. Bonds
January 1973- January 2018

Year Annual Inflation Calendar Year Inflation-Adjusted Withdrawals End of Year Balances After Paying 0.15% In Annual Fees End of Year Balances After Paying 1.70% In Annual Fees
1973 8.71% $4,348 $86,382 $84,832
1974 12.34% $4,885 $68,920 $66,281
1975 6.94% $5,224 $81,263 $76,924
1976 4.86% $5,478 $93,038 $86,585
1977 6.70% $5,845 $85,565 $77,883
1978 9.02% $6,372 $83,796 $74,493
1979 13.29% $7,219 $90,437 $78,441
1980 12.52% $8,122 $101,216 $85,497
1981 8.92% $8,847 $93,503 $76,283
1982 3.83% $9,186 $107,318 $84,680
1983 3.79% $9,534 $114,461 $86,993
1984 3.95% $9,911 $112,757 $81,970
1985 3.80% $10,287 $133,490 $92,963
1986 1.10% $10,400 $142,633 $94,732
1987 4.43% $10,861 $134,682 $84,335
1988 4.42% $11,341 $139,960 $82,094
1989 4.65% $11,868 $159,625 $87,449
1990 6.11% $12,593 $147,016 $73,492
1991 3.06% $12,979 $171,776 $78,239
1992 2.90% $13,355 $172,902 $70,267
1993 2.75% $13,722 $177,854 $63,045
1994 2.67% $14,089 $160,243 $46,730
1995 2.54% $14,447 $193,068 $45,344
1996 3.32% $14,927 $203,607 $35,695
1997 1.70% $15,181 $233,280 $27,825
1998 1.61% $15,426 $259,961 $16,990
1999 2.68% $15,840 $277,214 $3,049
2000 3.39% $16,377 $258,398 $0
2001 1.55% $16,631 $232,180 $0
2002 2.38% $17,026 $198,739 $0
2003 1.88% $17,346 $220,366 $0
2004 3.26% $17,911 $221,671 $0
2005 3.42% $18,522 $212,813 $0
2006 2.54% $18,993 $215,974 $0
2007 4.08% $19,768 $211,627 $0
2008 0.09% $19,786 $155,780 $0
2009 2.72% $20,325 $160,987 $0
2010 1.50% $20,629 $161,367 $0
2011 2.96% $21,240 $147,130 $0
2012 1.74% $21,610 $141,219 $0
2013 1.50% $21,934 $145,580 $0
2014 0.76% $22,100 $136,626 $0
2015 0.73% $22,261 $115,225 $0
2016 2.07% $22,723 $101,548 $0
2017 2.13% $23,202 $91,669 $0
Total Withdrawn Total Withdrawn
$640,671 $285,336

*Endnote:

Never assume that low-inflation rates are here forever. And don’t assume that the stock market will perform splendidly in the future. These are unknowns. As such, it’s prudent to maintain conservative levels of withdrawals. They should be lower than 4% for those who pay high investment fees.


Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas