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The 4% rule, is it legit?

On your path to financial independence, you might have come across the 4% rule.  First of all, there are no rules in reaching FI/RE, everyone has the own way. That being said, some of these “rules” help us to calculate a ballpark figure to aid us in finding solace in a net worth number. The 4% rule is one of these rules.

What is it?

So what is it? Well, the 4% rule can be used to determine the amount of funds to withdraw during one’s retirement each year. This 4% number is considered to be a “safe” withdrawal rate from a retiree’s portfolio.  The rule was created in 1994 by financial adviser William Bengen, who performed a deep analysis of stock market returns going back nearly 100 years, and found that even in severe market downturns, there was no instances in which a 4% annual withdrawal rate exhausted a retirement portfolio in less than 33 years.   We can then infer that for someone retiring at the age of 65, this person can safely withdraw 4% from his/her portfolio up to the age of nearly 100!

Example:

Let’s look at an example of how you would apply the 4% rule to determine how much you need at retirement.  If we assume you need $30,000 per year in spending during your retirement years, the 4% rule states that you would need $30,000 divided by 4% or $750,000 on the day that you retire. This is equivalent to $30,o00 multiplied by 25, a number that I have referred to in an earlier blog post.

Some pundits may argue that 4% is not conservative enough, and that a 3% rule is more justified.  In the above example, that would mean a retiree would require $30,000 divided by 3% or $1,000,000.

It’s a Rule of Thumb

There isn’t a right answer to this and it really comes down to what you are more comfortable with.  No one will ever penalize you for being more conservative with your retirement nest egg than not.  The 4% rule is a rule of thumb, and should be taken as that.

Using the 4% rule, how much would you need to retire?  Feel free to discuss in the comments section below.

As usual, if you have any questions, Ask the Fellow!

 

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