The 4 % Rule: What is it and what does it mean for retires. How do retirees determine the amount of money that they will need to survive on, each year, given their living needs and the number of years they would need the money for. In short, it determines how much will the retirees savings last without worrying about having the money run out.
Based on academic research there is a 4% rule that helps determine the amount of money retirees would need each year.
The 4 % rule says a retiree can withdraw 4% of their portfolio without incurring the risk of running out of money. Each year thereafter, inorder to keep up with the cost of living you would increase that initial amount by the rate of inflation.
I have illustrated a simplistic view of how the 4 % rule works.
The assumption here is that this person retires at Age 62. This person has a portfolio value of $1,000,000. The money is not in the market so there is no rate of return. The portfolio is not inclusive of social security benefits. As you can see the portfolio value diminishes over time. The amount this person withdraws diminishes over the years.
|Portfolio Amount||Age||Portfolio Value||Portfolio Amount Reduced by|
There are Pro’s and Con’s to using this rule.
- Consistent withdrawals year after year maintain a steady standard of living
- No need to cut spending during an economic downturn or consider altering one’s lifestyle to reflect poor market returns
During market drops, such as the 2000 tech crash and the 2008-2009 financial crisis, the 4% rule can cause a lot of stress for retirees and potentially fail some of them altogether.