How Should You Invest to Take Advantage of The 4% Rule?

Our topic on this episode of the Ready for Retirement podcast is about understanding how you should invest to take advantage of the 4% Rule.

Questions answered: What is the 4% rule and how does it impact my ability to retire? What are the best strategies when it comes to investing to take advantage of the 4% rule? What is the best approach for my individual situation? 

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Key Points

• Research 
  • How does the research suggest you should invest in order to ensure you don’t run out of money?
  • What is the highest sustainable withdrawal rate that one can safely begin to draw from their portfolio?
• 4% Rule – Bill Bengen
  • Bengen’s 4% rule has a very simple analysis when it comes to determining the portfolio allocation:
    • 50% Large Caps
    • 50% in Intermediate Term U.S. Treasury Bonds
      • No alternative asset classes, small companies, international companies, etc.
  • Bengen has adjusted this to:
    • 30% Large Caps
    • 20% Small Companies
    • 50% Intermediate Term U.S. Treasury Bonds
      • This would allow you to withdraw 4.5% as opposed to 4% in the previous example. 
• Guyton’s Guadrails – Jon Guyton
  • Jon Guyton – Decision Rules and Maximum Initial Withdrawal Rates
  • How do we define a safe withdrawal rate that allows for dynamic changes along the way?
    • This allows you to take more out of your portfolio along the way, but there is more work involved.
    • Jon believes 5.2% – 5.5% can be safely withdrawn from your portfolio when executed properly.
    • Check out Episode 26 for more information on this: How Much Can I Safely Spend In Retirement?
      • Once you have a starting portfolio value, what tweaks need to be made so you can continue to generate income throughout retirement?
  • Guyton looked at three different portfolios
    • 50% Stocks / 50% Bonds
    • 65% Stocks / 35% Bonds
    • 80% Stocks / 20% Bonds
  • Example: If we’re looking at the 65% stocks / 35% bonds, here’s how he view the allocation:
    • Cash: 10%
    • Bonds: 25%
    • Large Cap Value: 13%
    • Large Cap Growth: 13%
    • US Small Cap Value: 9%
    • US Small Cap Growth 9%
    • International Stocks: 15%
    • Real Estate: 6%
      • A more diversified portfolio can sustain higher withdrawal rates as you have more options to choose from when withdrawing.
    • So, where do I take money from in retirement?
• Additional Expenses
  • There’s often one-off expenses that can cause you to withdraw additional expenses that aren’t initially accounted for.
    • These withdrawal percentages don’t take into account sending children to college, legacy goals, travel, etc.
    • If you’re able to live on a portfolio that generates 4%/year, that’s great. 
      • These withdrawal rates act as a ceiling for what you can expect to spend to have a secure retirement.
  • Taxes
    • Example: Let’s assume you have a portfolio of $1,000,000 and you determine 4.8% portfolio is the right for you. 
      • Once you’ve determined you need $48,000/year ($4,000/month), that’s the first step.
        • However, this $4,000/month is pre-tax.
        • This is the most a portfolio can generate, but the research doesn’t take into consideration where these dollars are coming from (401(k), IRA, Roth IRA, Roth 401(k), etc.).
        • You may have to withdraw $5,000/month in order to end up with $4,000/month after-taxes.
          • $5,000/month ($60,000/year) would result in a 6% withdrawal rate (assuming the $1,000,000 example).
  • Retirement Income
    • Assume you have $2,000,000 in your retirement portfolio.
      • How much do I need to create $40,000/year of income?
        • A portfolio of $1,000,000 can create $40,000/year.
      • How should your other $1,000,00 be invested?
        • Do you invest it all the same and take 2%/year to have an additional $20,000/year?
    • Determine what portion of your portfolio is needed and invest differently in your portfolio that may not be needed to simply maintain your living expenses.
• Additional Considerations
  • What if you want to retire early? What if you want additional travel? What are your specific legacy goals?
    • Create a portfolio and a strategy that aligns your money with what you care about most. 

Timestamps

1:00 – Introductory Question

4:31 – Bengen’s 4% Rule

5:47 – Guyton’s Guardrails

7:54 – Sample Allocation

10:45 – Where Should I Pull Funds From?

15:35 – Tax Planning

17:19 – Additional Considerations

19:40 – Aligning Your Investments With Your Financial Goals

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