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.
- Bengen’s 4% rule has a very simple analysis when it comes to determining the portfolio allocation:
- 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- Jon believes 5.2% – 5.5% can be safely withdrawn from your portfolio when executed properly.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).
- Once you’ve determined you need $48,000/year ($4,000/month), that’s the first step.
- Example: Let’s assume you have a portfolio of $1,000,000 and you determine 4.8% portfolio is the right for you.
- 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?
- How much do I need to create $40,000/year of income?
- 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.
- Assume you have $2,000,000 in your retirement portfolio.
- There’s often one-off expenses that can cause you to withdraw additional expenses that aren’t initially accounted for.
- 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.
- What if you want to retire early? What if you want additional travel? What are your specific legacy goals?
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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