Does the 4% Rule Still Work?

For over a decade, the investment narrative has been singular and overwhelming: the S&P 500 has dominated virtually every other asset class. From foreign stocks and emerging markets to value plays, nothing could keep pace with large-cap U.S. growth. However, recent market movements in 2025 and early 2026 suggest the script may finally be flipping. With international equities and small caps showing signs of life, investors are asking if the long-awaited rotation is finally here. Alongside these market shifts, we are tackling pressing questions on liquidity, the golden handcuffs of low mortgage rates, and the modern viability of the 4% retirement rule.

Key Takeaways

• Diversification is back in play: After years of U.S. dominance, international markets, small caps, and bonds are showing renewed strength, reinforcing the value of a diversified portfolio.
• Liquidity matters more than tax optimization: Maxing out every tax-advantaged account can leave you "cash poor" and inflexible; taxable brokerage accounts offer necessary optionality.
• Don't let low rates dictate asset allocation: Holding onto a previous home solely because of a 3.5% mortgage rate often leads to dangerous concentration risk and operational headaches.
• The 4% Rule requires flexibility: Rigid withdrawal strategies rarely survive contact with reality. A dynamic spending approach that adjusts to market conditions is often superior to a static inflation-adjusted withdrawal.

Is It Finally Time for Diversification to Pay Off?

For the strictly U.S.-focused investor, the last ten years have been a golden era. Rolling 10-year returns show that large-cap U.S. stocks have decimated international counterparts. However, recent data suggests a potential regime change. In 2025, developed international stocks and emerging markets surged roughly 30%, significantly outpacing the S&P 500. As we move through 2026, this trend appears to be holding, with small and mid-cap stocks also joining the rally.

The Macro Trends Supporting a Rotation

Several macroeconomic factors support the argument that this is more than just a short-term blip. A weakening dollar generally acts as a tailwind for international returns for U.S.-based investors. Furthermore, if interest rates stabilize or fall, it could alleviate pressure on small and mid-cap companies that rely more heavily on floating-rate debt than their large-cap peers.

However, investors should be wary of declaring a permanent shift based on 13 months of data. The largest and most profitable corporations in the world remain within the S&P 500, and the AI revolution could continue to drive their margins. The true utility of diversification is not about predicting which asset class will win next year, but rather ensuring survival regardless of the outcome.

The only reason diversification works is because you don't have to determine the winners in advance. If you hold a diversified portfolio... you're going to be covered regardless of what happens next. You give up on the home runs, but you also avoid striking out.

Understanding the Boom and Bust of Emerging Markets

For investors frustrated by emerging markets (EM), it is helpful to zoom out. Between 2010 and 2023, EM returns were essentially flat, offering cash-like returns with equity-like volatility. Yet, history shows that EM is defined by massive boom-and-bust cycles. From 1999 to 2010, emerging markets crushed the U.S. market. The cycle then reversed entirely.

Investing in these asset classes requires accepting long periods of dormancy for the potential of explosive growth. If you wait until the trend is undeniably established to diversify, you often miss the "turn," which is where the bulk of the excess return is generated.

The Liquidity Trap: Tax-Deferred vs. Taxable Accounts

A common dilemma for high-income earners is the tension between tax efficiency and liquidity. Many diligent savers fill every "bucket"—401(k)s, Roth IRAs, HSAs, and mega-backdoor contributions—before putting a cent into a taxable brokerage account. While this minimizes current taxes, it can create a liquidity trap where a high net worth is locked away behind penalties and age restrictions.

The Case for the Taxable Brokerage Account

Financial flexibility is an often-undervalued asset. Unlike retirement accounts, a taxable brokerage account offers immediate access to capital without the hurdles of 72(t) distributions or penalties. Furthermore, these accounts allow for margin loans, providing a way to access liquidity without triggering capital gains taxes—a strategy often employed by the wealthy.

It is worth considering reducing retirement contributions—once the employer match is met—to build a robust taxable portfolio. This ensures you have funds available for mid-life opportunities, such as buying a business, purchasing real estate, or bridging a career gap, without raiding your retirement nest egg.

Real Estate: The "Golden Handcuffs" of Low Mortgage Rates

Many homeowners currently sitting on 3% to 4% mortgage rates face a difficult choice when moving: sell the home and cash out the equity, or keep it as a rental to preserve the cheap debt. While the math of a low-rate mortgage is seductive, the operational reality of being a landlord is often underestimated.

Concentration Risk and Opportunity Cost

If keeping the old home requires you to raid your brokerage accounts to fund the down payment on a new property, you are significantly increasing your concentration risk in real estate. You end up with two highly leveraged, illiquid assets in the same asset class, while simultaneously depleting your liquid investments.

Furthermore, being a landlord is not passive income; it is a part-time job. Between maintenance, tenant management, and potential vacancies, the "spread" between your mortgage and the rent can quickly evaporate. Unless you are a professional real estate investor, the simplicity and liquidity of selling the home and rolling the equity often outweigh the financial engineering of keeping a cheap mortgage.

Does the 4% Rule Still Work?

The 4% rule—withdrawing 4% of your portfolio in year one of retirement and adjusting for inflation thereafter—is the standard benchmark for retirement planning. However, in practice, strictly following this rule can lead to unintended consequences. In favorable market environments, retirees often end up dying with significantly more money than they started with because they refused to spend their gains.

Implementing Dynamic Spending

A more practical approach involves dynamic spending rules. This strategy suggests increasing withdrawals during bull markets to enjoy the fruits of your savings, and tightening the belt during bear markets to preserve capital. One effective framework is a hybrid approach:

• The Safety Bucket: A ladder of bonds or TIPS (Treasury Inflation-Protected Securities) designed to cover essential expenses for a set number of years (e.g., 5 years).
• The Growth Bucket: A diversified equity portfolio that fuels discretionary spending.

By securing your "needs" with stable assets, you can afford to be more flexible with your "wants" based on stock market performance. This psychological safety net allows retirees to navigate volatility without panic, knowing their immediate lifestyle is not at the mercy of the S&P 500.

I don't know that anyone actually does the actual 4% rule and follows it to a T. I think you have to be kind of flexible with this depending on what the environment is... the timing of bear markets, the sequence of returns.

Conclusion

Whether you are debating the merits of international diversification or calculating your safe withdrawal rate, the common thread is the need for flexibility. Markets move in cycles that rarely align with our personal timelines. The U.S. market won't outperform forever, low mortgage rates shouldn't trap you in bad business decisions, and rigid spending rules shouldn't dictate your quality of life in retirement. The best financial plan is not the one that is mathematically perfect on a spreadsheet, but the one that is robust enough to handle an uncertain future.