Many financial planners commonly refer to something called the “four percent rule”. It’s frequently used by near-retirees looking to determine their savings withdrawal rate. It’s supposed to be a simple answer to the common retiree fear: running out of money.
David Mendels of Creative Financial Concepts explains the four percent rule’s roots stating:
“Back in 1994 a financial planner named Bill Bengen read an article in a popular financial magazine claiming that the “safe withdrawal rate” for a retiree was 6 percent.
What Bengen discovered was that the 6 percent withdrawal rate he had read about failed around 20 percent of the time, but 4.5 percent survived for every one of those periods—even those starting just before the onset of the Great Depression.”
The four percent rule suggests that retirees can withdraw 4% of their portfolio the first year they retire. Each subsequent year, they take out the same dollar amount plus an additional amount to cover inflation. This method projects that with a diversified portfolio, retirees will not run out of money for 30 years or more.
Matthew Sadowsky of TD Ameritrade makes a critical point about the four percent rule saying:
“It is a rule of thumb, not a law. It is often misunderstood. In its purest form, if you withdraw 4% and grow with inflation, your portfolio should not run out for 30 years. It does not mean you will not run out of money.”
Here’s the problem with things like the four percent rule: they’re more like general truths than ironclad rules. Calling the four percent rule a rule is, in fact, a misnomer. We’d be better off referring to it as the four percent axiom or the four percent adage.
If we’re speaking generally, the four percent rule is a good place to begin a conversation about retirement withdrawals. However, taking the four percent rule as doctrine is a mistake. Every investor has a different set of circumstances, and those circumstances can alter their financial situation drastically.
I don’t advocate leaving your future financial well-being up to a general truth. Before you accept any adage about financial planning, I recommend you discuss your situation with a professional.
Sources:
http://archive.pnj.com/usatoday/article/20774021
http://www.schwab.com/public/schwab/nn/articles/Is-the-4-Percent-Rule-Still-Appropriate
http://www.cnbc.com/id/102165628#.
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