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Say goodbye to the 4% rule

April 22, 2013

No matter what the specifics of your retirement planning and savings strategy, no matter what kind of investments you make and how much you decide to sock away, there is really only big question that needs to be answered: will it be enough? That’s what everyone fundamentally wants to know. Am I saving enough? Will this keep my family and I safe and comfortable once I retire?
 

For a some time now, one of the key pieces of information needed to answer this question was thought to have been fairly straightforward: the 4% rule. Developed and popularized by a California CFP named William Bengen in the 1990s, the 4% rule basically states that retirees can withdraw around about 4% of their savings every year and be reasonably confident that their hard-earned nest egg will last at least 30 years. Whether or not you believe 30 years is long “enough” these days, that 4% benchmark has long been considered a sound rule of thumb.
 

Here’s the problem, however: there are some very reputable people suggesting that the 4% rule may no longer apply. Some recent studies have suggested that the standard portfolio today, with a mix of approximately 60% stocks and 40% bonds, stands a very good chance of falling well short of that 30-year horizon. The Journal of Financial Planning predicted in 2011 that, instead of 4%, an annual withdrawal rate of just 1.8% would be required. That’s a big difference. Another study found that sticking to the 4% rule would generate a 57% chance of failure, and a much-discussed T. Rowe Price study in 2012 suggested that current savings had only a 29% chance of lasting the full three decades!
 

Think about it this way: if you went in for a routine surgical procedure (a minor knee surgery, for example), and among those medical disclaimers at the bottom of your consent form was a line explaining that your odds of walking out of there alive were less than 30%, you’d be out the door so fast the surgeon’s head would spin. The bottom line is be cautious, and don’t make the mistake of taking long-held financial and retirement assumptions for granted. Plan ahead and give yourself plenty of breathing room: There are more options out there than playing the market.

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