Today we’re going to take a look at the well-known Trinity Study. For those who aren’t familiar, don’t worry. I will start by explaining what the Trinity Study is, how it was done, and how to use its results. The Trinity Study is all about saving and planning for retirement.
PS: Here’s a straightforward financial independence and 4% rule calculator where you can input your own data.
But then I’m going to take a look at a few possible visions of the future. We will create an updated Trinity Study to use as part of our retirement planning. We’ll see how the Trinity Study birthed the famous “4% rule” (and you can read here how most DIY investors use the 4% rule completely incorrectly).
I’m also going to introduce an interesting risk-mitigation tactic. It’s called consumption smoothing. Bears do it, trees do it, and it feels like it should work for retirees. But we’ll see why Mother Nature’s tactics fail in retirement planning.
The What: Describing the Original Trinity Study
If you’re already intimately familiar with the Trinity Study, please skip to the Wade Pfau section of the article. Right now, we’ll introduce the original Trinity Study.
The Trinity Study was a retirement planning study published in the February 1998 issue of AAII by three professors at Trinity College, in Texas. They based their work on William Bengen’s SAFEMAX study (1994).
The goal of the Trinity Study was to determine a safe withdrawal rate (SWR) for retirement accounts. A withdrawal rate is the “salary” that you pay yourself during retirement by withdrawing money from your retirement nest egg—investments like mutual funds, taxable accounts, tax-deferred 401k, tax-advantaged Roth IRA, annuities, defined benefit pensions, etc. (Social Security income is not part of the Trinity Study).
A safe withdrawal rate is a withdrawal rate that allows a retiree to not run out of money by the time they die. SWR can also be thought of as a portfolio success rate. What’s a sustainable withdrawal rate and asset allocation that leads to retirement success?
Running out of money would be bad; not safe for one’s retirement plans! The Trinity Study aimed to provide a reliable SWR so that retirees would know how at-risk they were to run out of funds.
People in the FIRE movement frequently reference the Trinity Study when planning early retirement withdrawals. If you Google “4% Rule” or “retire with 25x your annual spending,” you’ll see what I mean. Many FIREees directly tie their Savings Rates to the Trinity Study so they can figure out when it’s safe for them to retire.
Study Assumptions, Method, and Outcome
Let’s dig into the specifics of the Trinity Study. It has more nuance than most people in the FIRE community know.
The study assumed that most retirees’ portfolios can be categorized based on their stock and bond allocations. The study looked at portfolio that were 100% stocks + 0% bonds, 75% stocks + 25% bonds, 50/50, 25/75, and 0/100.
That’s fair. Most retirees’ portfolios contain a mix of stocks and bonds.
Both the Trinity Study and Bengen’s original research incorporated long-term, high-grade corporate bonds. Corporate bond returns are typically higher-but-riskier than government bonds (note: as of January 2024, 10-year treasury bonds are yielding ~4.0%. In 1995, they were yielding 7.9%).
The stocks in the portfolios were assumed to be a diverse mix of stocks from developed market countries i.e. a portfolio with returns using historical data. For example, a Vanguard or Fidelity total market index fund.
Summary: the Trinity study examined many mixes of stocks and bonds.
The study also looked at various lengths of retirement. Some people will retire at 50 and live until 90—a 40-year retirement. Other people retire at 65 and live until 80—a 15-year retirement.
A short retirement might succeed even if the retiree withdraws a high percentage of their nest egg every year. A long retirement, on the other hand, might fail even if the retiree withdraws a lower percentage of their nest egg every year.
Different Withdrawal Rates
The study authors varied their withdrawal rate from 3% to 10% per year.
A 3% withdrawal rate is likely to be more successful—you’re spending less money every year and allowing more of your money to remain in your portfolio to (ideally) grow. However, a low withdrawal rate also leads to a more restricted retirement lifestyle.
A 10% withdrawal rate is opulent but more likely to fail. An unfortunate side effect of spending more money is that you’ll quickly run out.
The question, then, is, “How do we find the highest withdrawal rate possible while not running out of money?”
Heart of the Trinity Study
The real heart of the study—the question being asked and answered—is:
“If a person retired in Year A, stayed retired for B years, and withdrew C% of their portfolio each year, will they run out of money using a D ratio portfolio of stocks and bonds?”
The researchers asked this critical question for every single combination of
- Year A (from 1926 through 1995)
- B years of retirement (from 15 to 40, in multiples of 5)
- C% of annual withdrawal (from 3% up to 10%)
- and D ratio of stocks and bonds
Ostensibly, a retirement that is too long, suffers through a bad market, or withdraws too much money each year could run out of money. That retirement could fail.
The various scenarios are tested using historical market data from 1926 to 1995. For example, when B = 30 years, the authors tested all 30-year rolling periods from 1926 to 1995.
The Creation of the 4% Rule
While there are many valuable outcomes from the Trinity Study, the main result has been nicknamed the “4% Rule.” The highlights of the 4% Rule are:
- If you use a 4% as Year 1 initial withdrawal, slowly increasing it each year to adjust for inflation… (Study input C)
- In a 50/50 stock/bond portfolio… (Input D)
- For a 30-year retirement… (Input B)
- Then you would have been “safe” for 95% of starting years in the study (Input A)
So this would suggest that a retiree with $1 million dollars could reasonably expect to withdraw $40,000 (which is 4% of $1 million) in their first year and afterward increase for inflation each year**.
This would have allowed that retiree to successfully live a 30-year retirement without running out of money in 95% of the rolling 30-year periods that the study looked at.
**Note: increasing for inflation is the most-often overlooked aspect of the 4% Rule.
“4%” applies to Year 1 of your retirement. Each subsequent year’s withdrawal assumes you’ve adjusted that number up by the rate of inflation.
Here’s that 4% rule & FIRE calculator again, if you want to check it out.
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The Wade Pfau Updated Trinity Study
Wade Pfau is a professor and PhD in Financial Planning. He’s written excellent pieces on the Trinity Study, including an updated Trinity Study using data through 2014.
Along with the extended data set, Pfau also changed the type of bond the study assumed. The original study used corporate bonds, but Pfau thought looking at intermediate-term government bonds was wiser.
With this change, Pfau’s outcomes look more optimistic than the original study. Pfau found a 100% chance of success (instead of 95%) using the same assumptions that created the original 4% Rule. In Pfau’s update, every 30-year retiree still had money using a 50/50 stock/bond portfolio and withdrawing 4% (plus annual inflation) of their retirement savings each year. This is good news!
But Pfau also asks and examines a crucial question in his updated Trinity Study: will the future look like the past?
Will the Future Look Like the Past?
To call this a “million-dollar question” would be an understatement. It’s a trillion-dollar question!
The Trinity Studies are based on historical market data. That data was taken from a period of fantastic American growth. In the past 100 years, our society has taken unprecedented leaps in manufacturing, technology, and information. Is it wise to assume that the future will look like the past? Will growth continue to be as positive? Should we continue to invest at all-time highs?
The contrarian might point out that the Trinity periods also included the Great Depression, Stagflation in the 70’s, the Dot Com bubble and the 2008 subprime crisis. So, there are some terrible times in there too.
Should We Examine Through Rose-Tinted Glasses, Though?
What will our retirements look like if we achieve global peace, boundless wealth for daily lattes and avocado toast, and we add 4 hours of extra daylight to pursue our passions?
Is that a question worth answering? No! For many reasons, including that, we don’t need to be worried about utopia. They say, “Hope for the best, but plan for the worst.” That’s what we want to do here. We want to plan on things being tough.
We might have to choose lower withdrawal rates. If we’re right, we’ll be thankful we planned for it. But if we’re wrong and things are great…well, great! If I’m wrong, I’ll accept “things are great” as a consolation prize.
The Best Interest Updated Trinity Study Simulation
Riffing off of Wade Pfau, I’m unofficially adding to the Trinity Study to look at possible bleak futures.
To create my version of the updated Trinity Study, I ran Monte Carlo simulations.
I created an alternate reality, used randomness to determine the nature and volatility of that reality, and then figured out how a retiree would fare in that reality. Then I repeated that random reality a few million times for different market returns, SWRs, etc.
Some assumptions in my analysis:
- I looked at average annual market returns varying from 3% to 7%, calculated on a monthly basis. People often cite the S&P 500 having 9%-10% returns. A balanced, lower-risk portfolio might have 6%-7% returns. But remember, we’re looking at worse markets than the past.
- Assumed that monthly portfolio returns have a standard deviation of 3%, due to mix of stocks and bonds. This is based off of historical variations from Burton Malkiel’s data sets.
- Used a Laplace distribution to determine the “randomness” in the simulation.
- Only looked at 30-year retirements, to keep in line with the oft-quoted result from the original Trinity Study (the 4 percent rule is based on 30-year retirement).
- Chose various withdrawal rates using the original study as a guide
- Assumed our investor only withdraws their money once per year. E.g. they withdraw $40K on January 1st, and live off that $40K until the following January 1st, etc.
- Assumed an annual 3% inflation to calculate the inflation-adjusted withdrawal rate
- (For second analysis only) Assumed a 0.5% return on cash (e.g., a high-yield savings account).
Keep in mind, this took me a few hours to set up and get results. The actual Trinity authors are career academics and ran their studies like professionals. I admit that my assumptions and methodology are not as rigorous as theirs. But I think we can glean some insightful information nonetheless.
A lot of people felt that my original analysis was too pessimistic. So pessimistic, in fact, that it lost integrity. That it’s worse than the worst-case scenario.
So, I want to emphasize: I’m only asking What if? there’s a terrible, bleak future. How might someone conservatively alter their retirement goals? How might someone’s current savings plan and savings rate be affected? Is it worth re-checking the retirement calculator?
I, like you, hope the future is as good or better than the past. So I don’t want anyone to start stockpiling precious metals because of my fictional simulation.
In the post-coronavirus investing world of zero percent interest rates, is it so crazy to think that the next few decades might behave differently than the past?
Below is the summary table of results from my random simulations.
The SWR varies by column, and the average annual return varies by row.
The actual entries in the table are the percentage of simulations that created a successful retirement based on a particular combination of SWR and market return.
What sticks out? Where do we start?
To me, I immediately take a look at the 4% SWR column, because that’s what the Trinity Study has convinced us is safe.
If the Market Stagnates Long-term, Then the 4% Rule is in Trouble.
Thankfully, Microsoft Excel has some cool color schemes to help us with the visualization.
If traditional 50/50 portfolios underperform compared to historical precedent, then the 4% rule is in trouble. This isn’t shocking.
If we want to achieve the “security” that the tradition 4% Rule provides, we have to look for a ~95% chance of success. Moving to a 3% or 3.5% Rule immediately provides that safety margin (even in some terrible markets). But, of course, moving to a lower withdrawal rate means that we have to save more money in order to maintain the same standard of living.
A few question, though, immediately arise.
First, what are the good reasons to expect this underperformance? Have we ever seen a period perform this poorly?
And second, can we do anything about it?
On the first question: yes, we have seen 50/50 portfolios perform as poorly as 6.17% per year for a full 30-year period.
With government bond rates at historic lows and the stock market at historic highs, there are legitimate concerns over future returns. The optmistic news: average 50/50 portfolio performance is 8.6% per year.
Can we do anything about it?
One idea that neither the original Trinity Study nor Pfau’s update looked at was the idea of consumption smoothing. In brief, consumption smoothing means “do more when times are good, do less when times are bad.”
To explain more, let’s think about a tree.
Here in chilly Rochester, NY (and other non-equatorial climes) trees only have leaves during the late spring, summer, and early autumn. During the long summer days, the trees absorb as much solar energy as they can.
But during the winter months, days get short. It doesn’t make sense for the tree to maintain its leaves—which consume resources—for such a short day. Therefore, the tree drops its leaves in the autumn and survives off the previous summer’s gathered energy.
Put another way: the tree uses surplus energy gathered during the bountiful summer in order to survive the harsh winter.
For our purposes, consumption smoothing means “withdraw more money when the market is up, and withdraw less when the market is down.”
You know that phrase Buy low, Sell high? Well, consumption smoothing helps you emphasize the Sell high part by withdrawing more money when the market is high. It also prevents you from Selling Low too much, by withdrawing less when the markets are down. You use your extra Sell High money to “smooth out” the bad years that may come later.
Simulation with Consumption Smoothing
So I ran the simulation again, this time using a consumption smoothing algorithm. What did this algorithm look like?
In short, I created a “Cash Reserve” in the simulation, which started at $0. After each year that the market went up, I would pull that both that year’s withdrawal (the SWR amount) and extra money to go into the Cash Reserve. But if the market went down, I used a combination of the previous years’ Cash Reserve and retirement withdrawal to fulfill that year’s spending need.
It’s just like my tree. During good years, we’re the tree in summer. We’re withdrawing money for this year, and money for a time when we’ll need it in the future. During bad years, we’re the tree in winter. We]re borrowing from the good years’ reserve before tapping into our retirement account.
Consumption Smoothing Results
The results might surprise you. It feels like we’re being cautious. We’re “gettin’ while the gettin’ is good.” But what works for bears and trees does not work for retirees.
This is the same exact simulation as before, except with consumption smoothing turned on. Our portfolio failure rate increases slightly across the board. But why?!
The answer is simple: pulling out extra cash—even during “high” markets—will stifle your long-term portfolio growth. Money left alone in your portfolio will continue to grow. Money that you pull out will cease to grow. Consumption smoothing stifles long-term growth.
Remember John Bogle’s advice:
Don’t do something. Just stand there.John Bogle
Living beings are trained for action. Trees need to gather sunlight. Humans reward hard work. A bear who doesn’t prepare for winter will surely starve.
But John Bogle succinctly pointed out that markets work in the opposite manner. Interfering with your portfolio doesn’t help. It hurts.
Parting Thoughts about the Updated Trinity Study
At the end of the day, we don’t know what the future will look like. Today, I chose what most people would consider an overly pessimistic view. It can be scary, but as the Roman civium used to say, “praemonitus, praemunitus.” Forewarned is forearmed.
I’m not suggesting that a 2% SWR is needed. I don’t think it’s the only way forward. But I do think it’s worth the mental exercise. How prepared will you be for a pessimistic future?
I hope today’s post brought you a new perspective, and provides you with some objective possibilities so that you can make your best financial decisions.
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