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

James · October 26, 2021 · Leave a Comment

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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      • Jon believes 5.2% – 5.5% can be safely withdrawn from your portfolio when executed properly.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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