Recently, there was a story on television that talked about a couple who tried desperately to buy a home. Each time they applied, they were denied because they simply could not meet the qualification requirement. There personal finances were not enough to cover the down payment of their dream home. What was interesting was the strategy they used to finally get their dream home. After each rejection, they managed their finances to equal the down payment, saved and invested it. They did this consistently over a period of 5 years.
At the end of 5 years, they had realized that their yearly investments grew to over $1MM. The one simple strategy they incorporated was the 4% Rule, also known as the Safe Withdrawal Rule. Never withdrawing more than 4% of their invested amount to live and not jeopardizing their investment growth.
The 4% Rule is not widely used because, well, most people don’t even know it exists. And maybe another reason is most people feel they simply don’t have the discipline to implement it.
However, those who do are more likely to retire wealthy than those who do not.
Let’s face it, if we are lucky we will live well beyond our 60’s, and the question is: Will you have enough money to sustain your livelihood?
This post will give you an easy way to calculate the 4% rule and demonstrate how much money you’ll need to retire is by flipping it around and multiplying your yearly expenses by 25.
For example, if you and your family spend $50,000 per year, you’ll need to have 1,250,000 invested to not run out of money.
There must be some limit to how long you can withdraw 4% and still have money left over, right? The study that explains the 4% rule is called the Trinity Study, and it looked at how much money you’d need to retire for every year between 1926 and 2009.
The study found that if you invest 50% of your money in stocks and 50% of your money in bonds, withdrawing 4% of your money will be fine for 25 years, 100% of the time. Doing it for 30 years – you’ll still have money left over 96% of the time. only if you retired in a very unlucky year and never made any money after retirement including pensions or social security – the 4% rule didn’t work. [Resource: Video Online School, What Is The 4% Rule? How Much Money Do I Need To Retire? https://www.youtube.com/watch?v=0GpC8U0tF0M]
While the 4% Rule is not foolproof, it is a great way to help you reach your financial goals, even before retirement.
For those of you that want to be 100% sure your money will never run out (especially for those of you who plan to retire longer than 30 years), use the 3% rule and only withdraw 3% of your investments per year.
So, why is 4% the safe number and not 5% or 10%.
Here is a simple explanation. Investing money in today’s market will pay you dividends and increase in value at an average rate of 7% per year. On average inflation is about 3%, basically decreasing the actual value of the money you have. Combine those two numbers, and you’re a 4% – your net income will increase by 4% each year. And if you spend that 4% without going over, you’ll end the year with the same amount that you’ve started…forever.
How can this theory be tested?
Well, since 1900, the average rate of return per annum has been 7% including reinvested dividends (meaning you reinvest the dividends – or the money the companies pay your for investing – into your investment).
Since 1913, the average yearly inflation is 3.22% Even during the great depression, world wars, insane years of inflation, even more wars, and let’s not forget the great recession, the average return rate has maintained average of 7% return, and inflation has been just over 3%.
What does this tell us? It tells us that investing is more about being patient and investing early rather than trying to time the market.
Make no mistake, investing is a risk.
The key takeaway is that throughout the history of modern America the 4% rule will work for you. Just calculate your yearly expenses with some emergency padding, and start investing to get to that goal of 25 times your expenses.
Here’s to Your Remarkable Life & Legacy!
Kim Harris, The Legacy Creator
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