Tag: what is the 4% rule
Can YOU Afford to Retire? | 4% Rule Explained | Safe Withdrawal Rate
Jason 0 Comments Retire Wealthy
How much money do you think you would need to be able to retire? It’s a question that a lot of people have asked their financial advisers and it’s one that seems to have a different answer for just about every time it’s asked. And the reason for that is simple the amount of money that you need to be able to retire depends entirely on how much money you think you can earn in retirement through interest and dividends and maybe even a part-time job if that’s your thing, and perhaps even more importantly how much money you’re actually going to need to survive in retirement. And that number seems to change each and every time you ask as well because projections of things like medical expenses change as time goes on. And I’m sure those of you who are nearing retirement watching this video know medical expenses just seem to be going through the roof, particularly for retirees. But that doesn’t really help us it doesn’t give us a goal to strive for as we’re going through our working careers. We may not be able to come up with an exact number that we’ll need but can we come up with something that’s at least going to be close? Well today I’m going to talk about something called the 4% rule and how it gives us that goal to shoot for.
I’m also going to be talking about some other factors to keep in mind when you’re using this rule of thumb as well as some situations where you’re going to want to avoid the 4% rule in entirely. Let’s get started. So what is the 4% rule? It’s a rule of thumb that’s used to determine the amount of funds that you will withdraw from a retirement account each year. It’s also sometimes called the safe withdrawal rate because the money you take out usually consists mostly of interest and dividends, and thus your principal either stays the same or goes down a little bit but not too much. In fact in 1994 a financial advisor named William Bengan did an exhaustive study of historical returns in the market focusing heavily on the severe Market crashes of the great Depression and the early 1970s and concluded that even during those hard Times no historical case existed where the safe withdrawal rate exhausted a retirement portfolio in less than 33 years.
And for most of us 33 years would easily cover our retirement. The idea behind the rule is that once you have approximately 25 times your annual expenses saved for retirement you should be able to retire with reasonable certainty that you could survive until death on your savings. Because at that point the amount that you take out for your annual expenses would be approximately 4% of your retirement savings. And when I say 4% of your retirement savings I mean your entire retirement savings anything that’s been earmarked to use only in retirement this includes 401ks IRAs and any other ways you’ve saved a nest egg for retirement.
For example if you had $450,000 in your 401k and $50,000 personal IRA then you would have $500,000 in all of your retirement accounts and your initial withdrawal on the first year retirement would be 4% of that $500,000 or $20,000. So some other factors that you’re going to want to keep in mind when using the 4% rule in addition to keeping an eye on your expenses, is to account for inflation. The 4% rule believe it or not actually allows you to increase the amount you withdraw to keep Pace with inflation. You can account for this either by just setting a flat 2% increase to your withdrawals each year which is the target inflation rate by the Federal Reserve or by just looking to see what the inflation rate was for the current year and adjusting based off of that. Now you might be wondering how this could possibly be I mean if you increase how much you would withdraw to keep up with inflation won’t you eventually run out of money? It’s a legitimate question but as it turns out no.
And it’s because over the long term the market goes up. Now there are a lot of numbers that are thrown around by financial advisors about how much the market actually goes up I’ve heard anything from 6 to 10% a year on average. I’m going to be conservative here and go with the 6% end of the scale. So let’s go back to the example I’ve been using in the video you start off retirement with $500,000 in savings, and in the first year of retirement you withdraw $20,000 or 4% of your savings. And I’m also using a compound interest calculator here, and it assumes that whatever you withdraw is withdrawn right at the start of the year.
So the $20,000 is going to be withdrawn on January 1st of every year. I’m only noting that because it makes it a worst case scenario you were to say withdraw $20,000 over the course of an entire year but you did it in installments of $1,600 each month you would be able to earn interest on the rest of the money that you hadn’t yet withdrawn throughout the rest of the year and thus you’re ending net worth would end up being a little bit higher than it will be in this example. So on January 1st you withdraw $20,000, meaning you only have $480,000 left in your nest egg. But over the course of the year the market goes up by 6% which means the value of your portfolio at December 31st would be $508,800. Now in year two of retirement you increase your withdrawal by 2%. So on January 1st of the second year of your retirement you withdraw $20,400. That brings your portfolio value down from $508,800 to $488,400. But again the market goes up 6%, which by December 31st brings the total value of your portfolio up to $517,704. If you were to continue to calculate this out for 30 years you’re ending net worth would be $787,716.90, almost $300,000 dollars more than what you started with in retirement! But of course this is just a rule of thumb so there are situations where you’re going to want to avoid using this all together.
One of those situations would be if your portfolio consists of a lot more higher risk Investments then say your typical index funds and bonds that are usually in a retirement portfolio. This is because obviously a higher risk investment can go down a lot faster than your typical retirement portfolios, which can be extremely devastating especially early on in retirement. Also this rule of thumb only really works if you stick to it year in and year out. And if you’re not going to be able to do that then you don’t want to use this as your retirement goal, because even violating the rule for one year to splurge on a major purchase can have a severe effect on your retirement savings down the road because the principal from which the interest and dividends that you get to survive is compounded from gets reduced. Let me give you an example of how this works: Say that in addition to taking out the $20,000 your first year in retirement, you decide to treat yourself with a new car and figuring that you’ll be traveling a lot during retirement you want to get one that’s good, big, and comfortable as well as reliable.
So for this example let’s say you get a new Toyota 4Runner for about $35,000. Now I know that you could probably find it for cheaper used, but not everybody likes to buy cars used I know my dad didn’t and besides this is just an example. So you drop $35,000 on a new car and you still have to have money to live so the $20,000 still does come out of your retirement, meaning that you only have $445,000 leftover. Now admittedly the market still does go up about 6% leaving you with a nest egg of $471,700 at the end of the year.
And even if you were to stick to the 4% withdrawal rate for the rest of retirement which, would be 30 years in this example, by the 27th year you would be taking out more than you earned an interest and dividends as well as how much the market went up. And by the 30th year of retirement you would withdraw $35,516, but with interest, dividends, and Market appreciation your portfolio would have only gained $33,209 in value.
And that could put you in a pretty dangerous position should the market go down for a couple years, or if you have some kind of medical emergency. Now I don’t want to make it seem all bad, I mean unless you retired early, after 30 years in retirement you’re probably in your 90s and don’t need the money to last very much longer and even in this example you still do end with $586,000. It could be worse right? However I do want to bring your attention to the difference that this made. This one purchase made your ending net worth that you could have left as inheritance to your children or grandchildren or even donated to charity go from $787,000 all the way down to $586,000, that’s a difference of over $200,000. And all that’s with just one splurge. But that’ll about do it for me I hope you enjoyed the video and if you did or if you learned something be sure to like And subscribe I’ve got a lot more of these Finance coming out in the near future as well as some more book summaries and other fun stuff.
But with that being said, thanks for watching and have a great day. .
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What Is The 4% Rule? How Much Money Do I Need To Retire?
Jason 0 Comments Tips for Retiree's
In this video, I want to explain the 4% rule. This is also known as the Safe Withdrawal Rate – or basically the rate at which you can spend your money without ever running out of money. An easy way to calculate what this means for you – and how much money you’ll need to retire is by flipping it around and multiplying your yearly expenses by 25. For example, if you and your family spend $40,000 per year, you’ll need to have 1,000,000 invested to not run out of money.
There must be some limit to how long you can withdraw 4% and still have money left over, right? The study that explains the 4% rule is called the Trinity Study, and it looked at how much money you’d need to retire for every year between 1926 and 2009. The study found that if you invest 50% of your money in stocks and 50% of your money in bonds, withdrawing 4% of your money will be fine for 25 years, 100% of the time. Doing it for 30 years – you’ll still have money left over 96% of the time. only if you retired in a very unlucky year and never made any money after retirement including pensions or social security – the 4% rule didn’t work. So to make sure we’re all clear – the 4% rule isn’t 100% foolproof.
But those odds are pretty darn good – and even while I hope to retire from regular work longer than 30 years – i know I’ll continue to make money doing things i love which will make sure that the 4% rule does succeed. For those of you that want to be 100% sure your money will never run out (especially for those of you who plan to retire longer than 30 years), use the 3% rule and only withdraw 3% of your investments per year.
Let’s get back to the 4% rule and dive a little deeper. As many of you are probably asking, why is 4% the safe number and not 10% or 2%. Very simply, investing money will pay you dividends and increase in value at an average rate of 7% per year. On average inflation is about 3%, basically decreasing the actual value of the money you have. Combine those two numbers, and you’re a 4% – your net income will increase by 4% each year.
And if you spend that 4% without going over, you’ll end the year with the same amount that you’ve started… in perpetuity. Okay okay – i know a lot of you say this is crazy – what about the recession – you can’t predict stocks – and lots more thoughts. But let’s look at those numbers even deeper. Since 1900… over one hundred years ago, the average return per year has been 7% including reinvested dividends (meaning you reinvest the dividends – or the money the companies pay your for investing – into your investment). For inflation – since 1913 – over one hundred years ago, the average yearly inflation is 3.22% Even through the great depression, world wars, crazy years of inflation, more wars, and the great recession the average return rate has been 7% and inflation has been just over 3% What does this tell us? It tells us that investing is more about being patient and investing early rather than trying to time the market.
Now this doesn’t mean that it can’t change. Investing is a risk. That’s why you do it and make money from it. But world war iii could happen. another even greater depression could happen. and we have to be prepared for something like that. because if you retired with 1,000,000 in 2007, assuming you’d be able to spend 4% of your net worth per year, you were in for a surprise – which might mean going back to work for a few years and waiting out the recession.
Hopefully, if you did that… and left your investments in the stock and bond market, you would be in good shape. The key takeaway is that throughout the history of modern america – you’ll be fine to retire using the 4% rule. So calculate your yearly expenses… include some emergency padding… and start investing to get to that goal of 25 times your expenses.
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