The 4% rule is a common financial rule of thumb to help you with retirement planning. 

In short, the 4% percent rule states that you should be able to withdraw 4% of your total savings in year one of retirement. After year one, you should be able to again take out 4% of your total savings after adjusting for inflation every year. If you do this, then you should not run out of money for at least 30 years.

This is not a bulletproof rule, and does not apply in every country. However, it should be valid as a rule of thumb for the United States and Canada based on historical data.

If you want to play it safe while planning for retirement, then you can always drop the withdrawal rate down to a lower percentage – say 3%. The unexpected can always happen. Imagine if the first year of your retirement was in 2008, and you took out 4% of your beaten down portfolio. An event like that can significantly drag your retirement returns and disposable income.

How Did People Come up With the 4% rule?

So who came up with this anyway?

The 4% rule was first broadly popularized by a financial planner named Bill Bengen in 1994. He came up with this rule since so many of his clients asked about how much they should be withdrawing per year in retirement. Using historical data, Mr. Bengen made a determination that with a 50/50 portfolio split between stocks and bonds, a 4% withdrawal rate should provide enough cash flow for a 30 year retirement.

4 Percent Rule Assumptions

As with any rule of thumb, there are assumptions that go along with it. Here are the assumptions for the 4% rule.

  • Your portfolio is roughly 50% stocks and 50% bonds.
  • Your spending level stays steady during the 30 years of retirement.
  • You live in the United States or Canada.
  • You increase your spending every year in line with inflation.
  • You have a 30 year retirement.
  • The future market returns will be, on average, in line with historical market returns.

Putting the 4% Rule Into Practice

After doing a rough calculation with the 4% rule, you should try using a personalized spending rate, based on your lifestyle, risk tolerance (did you YOLO everything on GME?), and investments.

You should have an in-depth discussion with your financial advisor if you’re not sure how to apply this rule, and where you should have some flexibility. The biggest mistake people make with the 4% rule is thinking that it has to be followed to the letter. Rather, it should be used as a starting point on how much to save for retirement. 

How do you figure out what your personalized spending rate should be? A good first step is to ask yourself these questions:

1. How do you want to invest? Does a 50/50 portfolio split between stocks and bonds work for you, or do you want to adjust that?

2. How long are you planning for? People are living longer and longer. Is a 30 year retirement enough?

3. How sure do you want to be that your money will last? Taking only 3% out a year rather than 4% can add a lot of peace of mind if that’s important to you.

There are a lot of complexities with figuring this stuff out so we do recommend that you speak with your financial advisor to make sure that the numbers are calculated properly. You don’t want to be ten years into your retirement and find out that you messed up the calculations!

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