Back-testing the 4% rule

Four Five Six

The 4% rule

Retiring is easy, all you have to do is save 300 times your monthly expenses. This is until you do the math and see that this isn’t walking around money. The 300-times-your-monthly-salary rule and the 4% rule is one and the same thing. Whip out those calculators if you must. The 4% rule assumes that if you live on 4% of your capital, the growth on your investments will be enough for your capital to grow faster than inflation. This rule is widely accepted, and it feels like we’re at the point where no-one is questioning it all.

So, don’t worry, I will question it for you. Our model investor retired with R7.3 million back in 2000. The average inflation rate in South Africa since 2000 was 5.7%. The 6% we always quote as inflation isn’t too far of. If you increased the R7.3 million in 2000 with inflation, you would require R20 million capital in today’s money to have the same buying power (Yes the round number was planned).

Tested on the JSE

The average performance of the Johannesburg Stock Exchange (JSE) was 10.1% in the past 18 years, yielding a sweet dividend of 2.8%. If linear growth is assumed at 12.9% and the drawdown is 4%, your capital should grow to R38.81 million (Projected line on the graph). This is well above inflation. Even if you incorporated the erratic growth of the actual JSE, you still come out on top with a capital amount of R38.85 million (Actual line on the graph):

It almost looks planned how well the actual and projected lines join up in the end.

Tested on the NYSE

Instead of investing in the JSE, you could decide to invest in another market like the New York Stock Exchange (NYSE). Your average performance would then have been 7.55% with a dividend of about 2.5%. The 7.55% accounts for 3.67% growth and an average of 3.88% that the rand has weakened against the dollar.

Again, if linear growth is assumed at 10.05% and the drawdown is 4%, your capital should still grow to R22.64 million (Projected line on the graph), which is above inflation. It is marginally below the growth of the JSE though. Even if you incorporated the erratic growth of the actual NYSE, you still come out on top with a capital amount of R31.8 million (Actual line on the graph):

The reality is that at the age of 65, your investment horizon is still on average about 20 years. Be careful of going into cash products when you retire since this can deteriorate your capital faster than Zuma can achieve junk status. Cash products are typically earning 8% on your retirement capital. Inflation of 5.7% will catch you sooner than later if you draw down 4%.

So, why should you care about everything that I said above? Well, you shouldn’t, the 4% rule holds true when backtested on JSE and NYSE data. Granted, historical performance is no measure of future performance.  Just make sure you are invested in enough markets to get the average performance. Historically you should be fine if you draw down 4% of your capital. You will leave your grandchildren enough to blow it on gambling and Ferraris. Or gambling in Ferraris, if that tickles their fancy.

Be safe out there,


Quote of the week

"Know the rules well, so you can break them effectively.” – The Dalai Lama Click To Tweet


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  16. Jacques

    Great blog Hendrik. Thanks for all the info. Just a question. It’s generally known that you should move your money to less risky investments as your approach retirement to avoid you having to draw down some of your capital when markets are doing bad. Does the 4% rule assume you are invested in shares (like you described above)? If you have less risky investments, say cash or bonds, those investments would not nearly give you the long term return of the JSE. Is the 4% rule still valid in this scenario? How should you approach this? Maybe one should be so diversified when invested in markets, that you only draw down money from markets that are currently performing well (assuming no global market crashes haha).

  17. Post
    Hendrik Brand

    Hey Jacques, thanks for the comment. Very few people will be invested in shares alone hitting retirement as you mentioned. I’m not entirely convinced that we should be moving our money out of shares as we approach retirement, but that is a conversation for another day.

    Bonds have started yielding decent returns as well, so you should be fine drawing down 4% from them as well. However, cash might not get you there, especially if you need to access it quickly.

    I think as long as you keep to high equity RAs, invest in ETFs (international and local) in your TFSA and reduce the volatility in your portfolio with bonds rather than cash, the 4% rule will still hold true.

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