For those who are not familiar with the “four percent rule”, it is the guideline that retirees should live off of four percent of their portfolio’s value in their first year of retirement [I.E. $20,000 on a $500,000 portfolio] and adjust it upwards with inflation each year. Going by the rule, if inflation was 5% the over your first year you would adjust your withdrawal from $20,000 to $21,000 for year 2. Many people wrongly believe that the four percent rule states that you should withdrawal 4% of your portfolio’s value each year to live on, this would cause your living expenses to rise and fall drastically from year to year depending on how the stock market and your other investments are doing.
The four percent rule is a great guideline for people nearing retirement as to how much they should have saved. If a couple needs $50,000 yearly to live on and they will get $30,000 from social security they should have at least $400,000 saved for retirement [$20,000/.04]. The four percent rule is designed to conservatively last retirees for at least 30 years, age 60 to 90 for example.
Now that we know what the four percent rule is let’s look at some of its downfalls:
1. Living expenses vary from year to year. Some years you will need to make major purchases such as buying a new car, furniture, or a vacation you have planned for, for years. Other years will be relatively “quiet” financially [during retirement this is a good thing!] and you will need less money to live on. In your 60’s you will likely not need to dip into your portfolio for medical expenses but once you get into your 80’s and 90’s medical bills and possibly nursing home expenses will eat your retirement account up. You do not want to burden your children with 5-10 thousand dollar a month nursing home bills for several years.
2. You could end up with far too much money! Even if you invest in a conservative portfolio comprised of mostly bonds [Think 70/30 bonds to stocks] your portfolio should return 4 percent or so annually over the course of several decades. The 10 year treasury rate will not stay at 2% forever! If your retirement accounts are growing more than you are withdrawing then you will end up with more money than you started with when you first retired. This is obviously much better than the alternative of running out of money late in your retirement stages but you do not want your hard earned money to go unused after you bite the dust. Leaving an inheritance is great for your kids and an admirable thing to want to do, but with estate taxes and all the hassle involved in an inheritance the average person should plan on saving up enough money to last themselves only.
3.You do not know when you are going to die! 30 years is a reasonable time plan to assume you will be retired, but some will go for 15 while others can go for 45+. It is simply foolish to assume that everyone should plan for 30 years of retirement when some retire earlier than others and some retirees are in better health than others.
Your end goal should not be to end up with the greatest amount of money possible. If this was the case retirees and older workers would still be fully invested, or even over leveraged in stocks which will generate a higher rate of return over long periods of time. Your goal should be to give yourself the best percentage chance of having enough money to retire on, while still maintaining whatever lifestyle you want to live. Let’s use an example to help illustrate what I am trying to say. We have two retired gentlemen, retiree A and retiree B. Retiree A uses the 4% rule and spends more money than he needs to in good times. In bad times [think medical bills, any unplanned major expenses] this causes him to have to dip into his portfolio greater than 4%. Retiree B simply saves as much money as he possibly can and spends his money frugally whether or not he hits 4%. Retiree B has no problem spending only 2 or 3 percent of his nest egg if he can still maintain his desired lifestyle. Retiree A’s money will not last him as long as Retiree B’s.
The 4 percent rule is a nice guideline to go by, but it is anything but a fool proof, flawless method.
Written by Forexpipster.com. For more information on Forex Strategies and Forex trading system reviews, be sure to check them out.