The 4% Rule – A Retirement Spending Strategy

Summary: What is the 4% rule?  It is the magic formula for early retirement.  Make your money work for you while you no longer have to work.<br> If you want to retire way before 65, listen up.  This is how you can do it.<br> What is the 4% Rule?<br> The <a href="https://www.listenmoneymatters.com/five-awesome-questions-from-you-february-2018/">4% rule</a> is a benchmark that can be used to calculate how much money to withdraw from your retirement accounts every year for at least thirty years without depleting those accounts and outliving your money.<br> In 1994 William Bengen, a financial planner published a study showing the results of testing a number of rates of withdrawal based on historical rates of return. Bengen concluded that 4% was the highest rate that could be withdrawn for at least 30 years without running out of money.<br> Keep it Simple Silly<br> The rule has stuck around for so long in part due to its simplicity. A lot of us don’t like math and complicated formulas, and that’s why the 4% rule has been popular. There are no complicated formulas involved. Even the most math or financially unsavvy among us can understand it and use it as the basis of our retirement plan, and we don’t need to pay an expensive advisor to figure it out for us.<br> Work It<br> Here’s how the 4% rule works. You withdraw 4% of your retirement money. If you have $500,000 saved, you would withdraw and live on $20,000. But you need to account for inflation too, so you increase the amount of that first withdraw ($20,000) to reflect the impact inflation has on your buying power.<br> If annual inflation is 2%, the second year of retirement, you take out $20,400. The next year, $20,800, and so on. You continue these 4% withdrawals and the extra amounts to preserve your buying power no matter what the market is doing or how your portfolio is performing. Adding in the amounts to account for inflation will ensure that you have the same purchasing power in your first year of retirement as your last.<br> Allocate those Assets<br> Bengen and subsequent researchers currently recommend an asset allocation between 50-75% stocks, as close to 75% as you can tolerate and still sleep at night. That sounds high for retirement, but researchers who study probability in the stock market are more optimistic that stocks will outperform bonds over the long term and give you real returns.<br> That allocation is a shift from what was recommended in the original study. The initial recommendation was a 50/50 allocation. Twenty years ago the yield on a three-month Treasury bill was 6%. As late as 2002 the five-year US Treasury yield was 4.5%.<br> But those days are gone. Today a three-month Treasury bill is at a paltry 0.4%, and the five-year yield is an anemic 1.67%. Even your crummy checking account pays better than 0.4%! This is why some people feel the 4% rule had its time and place but is no longer relevant.<br> A Variety of Variables<br> The 4% rule is just a rule of thumb and as such, isn’t one size fits all. There are some things to consider if you want to follow the 4% rule for retirement.<br> The most important variable is having enough money saved for retirement. If you only have $10,000 saved for retirement, and you apply the 4% rule, you would be living on $400 a year which is not enough no matter how many frugal life hacks you employ.<br> People are living longer than ever, and our money has to outlive us. At the same time, medical expenses are not getting any cheaper so that will be an important part of calculating how much money you will need in retirement. While none of us can know how long we’ll live or how much we’ll have to spend on healthcare, there are some clues.<br> How long did your parents and grandparents live? Do you have a chronic disease like diabetes or a family history of a chronic disease? If you’re married, look at the same markers for your spouse.<br> What are your yearly expenses and how much could you...