Jonathan Chevreau provided a good overview of the 4% retirement rule, while pointing out some of its problems, in a recent MoneySense article.

Put simply, the 4% rule describes the maximum initial annual withdrawal rate (subsequently adjusted for inflation) that “ensures” investors won’t run out of money over a 30-year retirement.

I’ve put quotes around “ensures” because there is nothing magical about 4%. The percentage was determined by looking at the historical record in the U.S. based on a portfolio that was equally invested in intermediate U.S. Treasuries and U.S. common stocks.

As Mr. Chevreau points out, the rule has been modified over years as new data rolled in. In addition, it has to be tweaked for those who retire early and for investors who use different asset mixes.

Unfortunately, the 4% rule might be more wishful thinking than a rule because it fails when applied in many countries, according to Wade Pfau. He wrote that, “With a 50/50 asset allocation, the 4% rule did not survive in any country, though it came very close in the U.S. (3.94%) and Canada (3.96%). Even allowing for a 10% failure rate, 4% made the cut only in Canada, the U.S., New Zealand, and Denmark.”

He goes on to say, “In eleven of twenty countries, the SAFEMAX fell below 3%. […] Shockingly, the 4% rule would have failed more than half of the time for countries including Spain, Germany, France, Italy, and Austria. Italians attempting to use the 4% rule in their domestic financial markets would have actually faced failure in 76% of the historical periods.”

Compounding matters there is no saying that world markets will perform similarly in the future. It might turn out that the twentieth century was an unusually good one for investors and that following periods might not be so generous.

As a result, those who follow the 4% rule – or even a more conservative 3% rule – might be gambling with retirement ruin. At a minimum they should be prepared to tighten their belts should the markets turn against them.