4% For Life: Can the 4% Rule Support You Throughout Your Retirement?

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4% For Life: Can the 4% Rule Support You Throughout Your Retirement?

It appears to be a relatively simple rule. It’s the 4% rule. Just withdraw 4% of your nest egg every year of your retirement and guarantee yourself a lifetime of income. Right?

Where does the 4% rule come from?

The rule came about in the mid 1990s as the result of a study conducted by financial advisor Bill Bengen. He looked at historical interest rates and stock prices and tried to see how much he could withdraw from a portfolio over 30 years and make sure he had enough money the whole time. After analyzing the data, he determined you could take out 4% plus inflation every year.

So then what’s the problem?

The simple 4% rule is based on historical conditions from one specific era in time. But what if conditions are different from the time period he studied? Does the rule still hold?

Sometimes it does, sometimes it doesn’t. In bull markets, with everything going well, many following the rule would find they had too much left during their later years. While they had a lot of nest egg left, it left them realizing they could have spent more during their early retirement years. In bear markets, some people’s portfolios devalued so quickly they barely had enough money to last retirement, or ran out.

For many retirees, it is not good enough to assume they will spend money in a linear fashion the rest of their golden years. Not only do they need to adjust to the market, they may wish to spend different amounts in different years. Withdrawing 4% denies one the flexibility to do this.

With the current economic climate, it makes it difficult to know if the 4% rule will work. Having negative interest rates is unprecedented. The rule was based on a portfolio with a large percentage invested in bonds, and with historically low rates bond holders are not getting a good return. We’ve also experienced extreme volatility in the markets, and with no clear answer on where the economy is headed, it makes it difficult to know if you should be withdrawing more or less than the recommended 4%.

Are there alternate strategies?

Some strategists recommend changing your withdrawal rate from year to year in order to match the market. However, this kind of forecasting and attention could be difficult for retirees to follow.

You could work to change the makeup of your portfolio. Looking at other financial instruments could provide you with a more stable stream of income. Whatever your strategy, it is best to find an advisor you trust to help you figure out the details. Withdrawal rates can be a moving target that depends on too many variables–the lifestyle you want, interest rates, stock prices, taxes and more. While the 4% is a simple starting point for planning, developing a more comprehensive approach to fit your individual needs is going to require help. 

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