The 4 percent retirement rule has been used by financial planners since the 1990s to calculate how retirement funds should be distributed. Times have changed and the question today is, will this rule still work for you?
What is the 4 percent retirement planning rule?
The premise of this rule is that your retirement funds should last 30 years provided you take 4 percent of your savings out the first year you retire and adjust that amount with inflation in the following years. At the time of its inception, this strategy depended on portfolios being invested in both fixed-income assets (bonds) as well as long-term assets (stocks). The plan was built around the idea of retirees taking withdrawals on the interest and dividends of these investments and on the basis that remaining assets would continue to grow in retirement accounts providing sustainable income for years to come. Sounds like a solid plan, right?
The potential problem is that this calculation method was initiated back in the good old days, when interest rates on bond index mutual funds were nearly double (or more) what those rates are now. And, even though the stock market has always been risky—it seems even more so today. Economic climates across the globe are struggling, despite recent rebounds in some markets. In fact, according to an article published in Financial Review in April of this year: Stephen Roach, a former chairman of Morgan Stanley Asia, says the world economy is “dangerously close to stall speed” and lacks resilience. “We’re a shock away from the next global recession,” he says.
So, back to our question.
Does the 4 percent retirement planning rule still work for you?
The answer is: it’s hard to tell and depends on many factors. No one can predict the future. But, there are a few reasons the 4 percent rule may not work for you.
- There is solid evidence that people are living longer. Great news, for sure, but it also means you might just need a few extra dollars stashed away for retirement.
- The longer you live, the more potential health problems you may incur—and we all know how expensive quality health care is these days. (Hint: you may need a few more of those extra retirement funds…)
- Interest rates are not what they once were and this has a definite impact on your portfolio’s earning potential over time.
If you started saving for retirement early, you may have quite the healthy nest egg and no worries in the world. But, if you’re like many Americans, you may not have saved enough. As far as the 4 percent rule goes, we suggest you do a bit of strategic planning and number crunching with your financial advisor.
While this rule may have had its place for some time—several big names in the financial planning industry are recommending a more fluid strategy for retirement planning and distribution of funds.
Experts suggest different percentages may work within certain scenarios. Depending on your life circumstances, some say planning to allocate 3 percent of your funds upon retirement may be a good place to start; others think 4 percent may be too low. Of course, all agree it depends on the diversity and success of your investments and that flexibility is key. Frequent review of portfolios is critical in determining what adjustments you should make to achieve successful retirement income.
When reviewing your retirement portfolio with diversity in mind, consider alternatives to stocks, bonds, and mutual funds. Alternative investments include real estate, private mortgages and notes, private equity and stock, crowdfunding options, gold, futures and forex trading…and much more. Many individuals are using self-directed IRAs and other plans to acquire these assets, which have the potential to produce greater returns—over less time—than more traditional investments.
At the end of the day, we can’t tell you if the 4 percent rule is for you or against you. It’s a numbers game. Your numbers game. The key is to determine what your magic number is to comfortably retire and work towards it as diligently as you can, using various investing methods to help you reach your goal.
If you have questions regarding this article or would like to learn more about self-directed plans, please contact us.