A retirement savings plan can seem overwhelming, especially when you don’t know where to start.
Using the 4% rule, a popular guideline for determining how much money you’ll need to retire, you can actually figure out how much money you’ll need and how to get there.
The 4% rule means you can withdraw up to 4% of your retirement savings in your first year of retirement. In the following years, you adjust for inflation and do it again.
In this example, assume inflation is at 2%.
If you have $1 million, you will withdraw $40,000 during your first year of retirement. In the second year, you would take out $40,800 (the original amount plus 2%).
In the third year, you would withdraw $41,616 (the previous year’s amount, plus 2%), and so on.
Developed by William Bengen in 1994, the 4% rule was tested using historical market performance data from 1926 to 1992.
Because it was successful during that time period, some investors assumed it would also be successful in the future.
The advantage of this strategy is that it’s simple and gives you a predictable amount of income each year.
Disadvantages
The 4% you decide to withdraw is unlikely to equal the same amount of constant income each year. Your portfolio may adjust based on market swings.
While many maintain a 50% fixed income/50% equity asset allocation within this approach, it would be advantageous to be more tactical and diversified.
It’s not easy to predict the future. Strategic asset allocation sets the foundation for your achieving your goals and objectives and diversification is the cornerstone for creating efficient and optimal portfolios.
Work with a certified financial planner (CFP) to help figure out how much money you need to save before you can retire.
First, you will need to determine how much money you will spend each year in retirement. As a starting point, consider the following costs:
- Rent or mortgage
- Healthcare and long-term care costs
- Annual cost of groceries
- Annual cost of medication
- Costs associated with transportation (such as car payments, maintenance, and public transportation)
- Amount you plan to spend on travel each year
- Pet expenses
