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The 4% Rule and Sequence Risk: How to Safely Draw an Income from Your Portfolio
Key takeaways
- The 4% rule comes from the Trinity Study: a 4% annual withdrawal survives 30 years in most historical scenarios.
- Sequence risk: poor returns in the first 5 years of drawdown are catastrophic, even if the average return over time is good.
- For longer horizons (40+ years) it is safer to lower the withdrawal rate to 3–3.5%.
- A flexible withdrawal strategy (less during downturns) significantly extends portfolio longevity.
- A cash or short-term bond reserve covering 2 years of expenses protects against forced equity sales during a market decline.
The 4% rule is a withdrawal rate at which a portfolio composed of equities and bonds statistically survives a 30-year drawdown horizon — in 95% of historical scenarios. But it conceals one major danger: sequence-of-returns risk.
The Trinity Study and where the rule comes from
The 4% rule originates from the Trinity Study (1998), in which researchers Cooley, Hubbard, and Walz analyzed historical US market data going back to 1926. They found that a 4% annual withdrawal from a portfolio of 50–75% equities and 25–50% bonds survived a 30-year horizon in the vast majority of cases. In simple terms: a portfolio of CZK 1 million, an annual withdrawal of CZK 40,000.
Sequence risk: the greatest threat to the income investor
Sequence risk is the danger that poor returns arrive at the start of the drawdown phase. Why does this matter so much? Because in the early years you are withdrawing from a portfolio that has already declined. You are selling more units at lower prices. Even if the average annual return over 30 years is good, the portfolio may not survive.
- Scenario A: returns of +20%, −10%, +15% ... portfolio may survive
- Scenario B: returns of −30%, −20%, +20%, +20% ... with a 4% withdrawal the portfolio may not survive, even though the average is the same
How to adjust the 4% rule for a longer horizon
For a 40-year horizon (retiring at 40), research recommends lowering the withdrawal rate to 3–3.5% (portfolio of 29–33 times expenses). Flexible drawdown also helps: in good years you withdraw more, during downturns less. This dynamic strategy significantly extends portfolio longevity. Further reading: how to calculate your FIRE number and what is FIRE.
FAQ
What is the 4% rule?
A withdrawal rate at which a portfolio of equities and bonds statistically survives a 30-year drawdown horizon. It originates from the Trinity Study (1998). For a portfolio of CZK 15 million, an annual withdrawal of CZK 600,000 applies.
What is sequence risk?
The danger of poor returns at the start of the drawdown phase. If the portfolio declines in the first 3–5 years of retirement, you are withdrawing from a smaller value and selling more units. The portfolio may not recover even if average returns in subsequent years are good.
Is the 4% rule safe for retiring at 40?
Not entirely. It was derived for a 30-year horizon. For a 40–50-year horizon it is safer to lower the withdrawal rate to 3–3.5%. The portfolio then needs to be 29–33 times annual expenses instead of 25 times.
How do you protect against sequence risk?
Keep 1–2 years of expenses in cash or bonds outside your equity portfolio. During a downturn you draw from the reserve and let equities recover. Complement this with flexible drawdown — take less in a crisis, more in good years.