Figuring out how much money you need to save for retirement can be a huge challenge. Trying to anticipate what returns you’ll receive, and what unpredictable expenses you’ll face,by necessity requires some guesswork and simplification. As a result, many have turned to a simple guideline known as the “4% retirement rule” to help them figure out where to start.
Using the rule, retirees take 4% of their initial retirement portfolio balance, and then withdraw that amount each year, adjusting for inflation each year thereafter, to create a “series of paychecks” that last for 30 years. Yet even though it has value, the 4% rule also some shortcomings, especially in the current economic environment. Let’s look at three serious problems with this rule:
1. The 4% retirement rule aims to be your worst-case scenario aid.
At first glance, the idea that the 4% rule gives you a worst-case scenario solution might seem like a good thing. After all, if the worst possible outcome is to run out of money in retirement, then a rule that’s tailored toward eliminating that possibility sounds exactly like the kind of guideline you’re looking for.
The problem, however, is that the worst-case scenario almost never happens, and so the 4% rule is needlessly conservative in the minds of many retirement planners. Specifically, unless the markets behave in exactly the worst possible way, then the amount you can withdraw from your portfolio generally can exceed 4% without running out of money. Every dollar left at the time of your passing, is one that you didn’t get to enjoy during your lifetime. For those with heirs to whom they wish to leave a legacy, that shortcoming isn’t necessarily as important, but it can nevertheless produce stress that exaggerates the true risks involved.
Original article by Dan Caplinger via The Motley Fool March 4, 2016
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