The theme this week on the One Minute Retirement Tip podcast is: Retirement Rules of Thumb You Should Ignore
Today, I’m talking about the 4% rule. The 4% Rule is a short-hand rule of thumb that helps you calculate how much of your portfolio you can safely withdraw in retirement without running out of money.
If you apply the 4% rule to your retirement savings, you would take your portfolio value and multiply that amount by 4%...so if you get to retirement with $1 million saved, and multiply that $1million by 4%, you get $40,000. So according to the 4% rule, you can withdraw $40,000 from your portfolio in year 1 of retirement, then increase that withdrawal amount for inflation each year without worrying too much about running out of money.
4% is considered a safe withdrawal rate that is backed by some well-documented research. But it’s actually a pretty flawed rule of thumb that doesn’t take into account the complexities of retirement circumstances that change, an investment portfolio that’s changing, and the complexity of adjusting that 4% withdrawal rate years into retirement.
The short answer is that it does work well...sometimes. The long answer is that retirement is too complex to rely on a rule of thumb - taxes, inflation, your returns in retirement vary widely from year to year, and you may be unlucky enough to retire in the midst of a big stock market downturn - these are all circumstances that will make the 4% rule less useful or blow it out of the water all together.
The 4% rule is useful to help you plan for how much you’re going to need saved at retirement, but when you’re 2-5 years out from retirement, it’s time to leave the 4% rule behind and opt for a more sophisticated calculation that takes into account the thousands of different scenarios and circumstances you could face in retirement.
That’s it for today. Thanks for listening! My name is Ashley Micciche and this is the One Minute Retirement Tip.
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Tags: retirement, investing, money, finance, financial planning, retirement planning, saving money, personal finance