What is the The 4% Rule?

It is never too early to think about funding your retirement.  That was true 50 years ago and it is still true today. Given current financial realities and trends, it is more important than ever to start planning for retirement as early as possible.  You are never too young to get started and there are dozens of calculators, metrics and rules of thumb to get you started. One of the most well known? The 4% rule.

The 4% Rule is a general guideline employed by financial planners since the early 1990s.  It has been widely adopted and proclaims simply that as long as you never withdraw more than 4 – 4.5% of your retirement savings in any year, your retirement nest egg should last at least 30 years. In theory, if you stick to this rule, you shouldn’t run out of money in your golden years. Devised by William Bengen, a Brooklyn-born financial advisor, the 4% Rule is based on an in-depth analysis of U.S. stock and bond returns over a 50-year period (1926 – 1976), a volatile period which witnessed the Great Depression, several recessions and World War II. 

When the 4% Rule Won’t Work

According to “Bengen’s Rule” (as the rule is also known), adhering to the 4% cap on annual withdrawals is all the protection you need against downturns in the investment markets.  Of course, for every rule there are always exceptions. Even Bengen acknowledges that the 4% Rule will not work for everyone. For example, those who are attracted to high-risk funds are subject to larger return fluctuations.  The Rule is best applied to relatively conservative, disciplined portfolios built by people with average incomes looking to provide for a comfortable, if not lavish, retirement. As with any guideline, it has it caveats, but most people agree that it’s a good to start when talking about retirement.

When to Start Applying The Rule

As a 20 or 30-something investor, you might wonder what a Rule pertaining to retirement withdrawals has to do with you. And the answer is – everything!  While you are saving for retirement, it helps to have some target numbers in mind. It’s OK that those numbers will undoubtedly change over time. If, for example, you decide that you will need $75,000 per year to retire comfortably, employing the 4% Rule, you will need $1,875,000 in savings in order to keep withdrawals from exceeding the 4% cap over the span of your retirement.  Of course, this does not take into account any government benefits, pensions or lump sum inheritance you might receive. If you feel you can count on this additional income during your retirement, add it in and adjust accordingly.

The 4% Rule in 2019 

The 4% Rule is also a good reminder of just how difficult it has become to finance a comfortable retirement using traditional approaches to savings. The truth is that things like uncontrollable medical costs, extended recessions, high inflation, the wrong mix of stocks and bonds and bear markets, can all wreak havoc with even the best laid savings plans.  Some financial advisors are already predicting that the double-digit equity returns of the past few years may inevitably yield to a protracted era of low, or even negative returns. It may well be that 4 – 4.5% annual withdrawals may drain some portfolios, particularly in view of the fact that many people are living well into their 90s. If you’re going to have to support yourself on less than 4% withdrawals each year in order to make the money last, you’re going to need to build a larger nest egg to pull from.

Smart Wealth Building

All of this points to the growing need for diversification in anyone’s investment portfolio. A recent landmark study from researchers at UCAL-Davis, University of Bonn and Deutsche Bundesbank found that from 1870 through 2015, residential housing outperformed equities in 16 now-wealthy countries.  Real estate has historically kept pace with or outperformed stocks and bonds over the long haul. Even more importantly, real estate offers investors certain tax advantages, passive income opportunities and leveraging power that stocks and bonds do not have – multiple opportunities to further pad that growing retirement nest egg beyond simple savings.  So, if the secret to The 4% Rule is starting early, and investing wisely in avenues with low risk and high returns, why not get started today?


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