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4% Rule for retirement
I came across this tidbit in an article on my real estate investing forum (Bigger Pockets). However, this portion of the article is specifically about retirement in regards to William Bengen's 4% Rule. Which is basically, if you withdraw 4% or less from your retirement during your first year of retirement, you have a 96-100% chance of having enough money to last 30 years or more. I thought some of you might find it interesting:
The 4% Rule
In 1994, William Bengen released a study that had some pretty astonishing revelations. If you withdraw 4% or less from your retirement account during your first year of retirement, then re-adjust your withdrawals for inflation, you have a 96%-100% chance of having enough money to last you 30 years or more.
Bengen took historical data from the stock markets and ran his theory in varying amounts, from 3% to 6%. He found that withdrawal rates of 3.5% or less returned a 100% chance of having enough money, while withdrawal rates of 6% only had a success rate of 40%.
He also came up with the ideal mix of investments as 50-75% stocks and the remainder in bonds. But here’s one interesting fact: Bengen’s study assumes zero additional income once you retire. His study was meant for the traditional retire-at-65 crowd. What do you think would happen to your investment account if you included the income from even one rental?
Let’s do some easy math. Let’s say you need $50,000 a year to live comfortably.
$50,000 x 25 = $1,250,000
According to Bengen’s study, which was tested to basically the same conclusion in 1998 by The Trinity Group (they used a different bond type and concluded only a 95% success rate versus Bengen’s 96% rate), you can comfortably live for at least 30 years by saving and investing $1.25 million.
That’s really not a lot of money. Remember when Dr. Evil demanded $1 million in Austin Powers? He was laughed at by the entire world.
Bengen’s study shows a significant percentage of accounts end up lasting far longer than 30 years — with many scenarios ending the 30 years with a balance larger than what they started out with.
Let’s go back to your $50,000 annual withdrawals. Let’s say you have a rental property that brings in $12,000 a year. It’s paid off, and you have a healthy capex reserve fund. Now you only need to withdraw $38,000 a year. That’s a 3% withdrawal, and Bengen put a 100% success rate at 3.5%.
Bengen’s study did use historical stock market data, and past performance is not indicative of future gains. So while this isn’t a guarantee, it’s still a great place to start.
Re: 4% Rule for retirement
One thing people lose track of is the fees tied to their accounts. If your account has a 1% annual fee, now you have to live off of 3% in order to stay under the 4% rule. That 1% fee - which seems small when you frame it that way - would account for 25% of your annual expenses.
Unfortunately a lot of people forget to include the fees in their withdrawal rate, so they pull out more than 4% per year. People also forget to account for taxes when figuring out how much they need to save. It's kind of crazy because taxes and admin fees work out to be some of the highest expenses you will have in retirement, and yet people tend to think "I need $50K to live on" when calculating their magic retirement number. Realistically, if you need $50K to live on, your investments might have to generate $70K or $80K to offset what you pay in taxes and fees each year.
Yes, that's what our planner had told us and I think it's a good general idea of what to follow.
Good point about the annual fees @hoffse!
When does a higher fee (in your opinion) justify itself?
Here's a good article about it with a list of low-expense funds at the bottom:
http://money.usnews.com/money/personal-finance/mutual-funds/articles/2015/04/06/great-index-funds-for-a-dirt-cheap-portfolio