What is the 4% Rule in Retirement?

November 17, 20237 min read
What is the 4% Rule in Retirement?
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Key Takeaways 

  • The 4% rule is a rule of thumb regarding the amount retirees should withdraw annually from their retirement savings to ensure that funds last.
  • The 4% rule assumes a person will live 30 years after the start of their retirement, but some retirees will live longer.
  • Because the 4% rule is based on stocks and bonds, it is subject to what is a constantly fluctuating market.

Advice abounds regarding how much one should save for their retirement. That is less the case when it comes to how much money one must withdraw each year of their retirement. After all, everyone wants to ensure that their funds last throughout their non-working years.

Enter the 4% rule. Exactly what is the 4% rule in retirement? That and more are explained below.

What is the 4% Retirement Rule?

The 4% rule is a withdrawal strategy regarding the amount retirees should withdraw annually from their retirement savings. The goal here is to make certain one’s funds last throughout their Golden Years.

The rule applies regardless of how much one begins with. It can help with planning, whether retirement is nigh or a number of years down the line.

The idea is to pull out just 4% of overall funds annually and enable the balance to keep growing. That way, one can ensure sufficient funds for at least 30 years.

What is the 4% Rule Calculation?

For the 4% rule, begin by adding up all one’s retirement accounts, investments, and other income. Four percent of that amount is the budget for the initial retirement year. Following each year, adjust for inflation.

For example, say a person has $1 million total for retirement. Their first-year budget will be $40,000. The following year, that $40,000 will be multiplied by the inflation rate. If the rate is 2.3%, the equation is $40,000 x 1.023. That means the second-year budget is $40,920. This process is repeated annually.

What is the History of the 4% Rule?

Financial advisor William Bengen came up with the rule in 1994. He wanted to provide a strategy for ensuring that people have enough funds throughout retirement.

To devise the strategy, he examined data on stocks and bonds from 1926 to 1976. Bengen’s rule of thumb is based on a 60% stocks, 40% bonds portfolio model.

What Does the 4% Rule Not Consider?

There are some factors that the 4% rule does not consider, including:

  • Medical expenses. It is difficult to predict what one’s healthcare expenses will be in the future.
  • Inflation. One never knows what the Inflation rate will be. That is why some financial planners recommend a flat annual 2% increase.
  • Market changes. Because the 4% rule is based on stocks and bonds, it is subject to what is a constantly fluctuating market. A downward turn could significantly affect one’s savings.
  • Personal tax rate. Everyone has their own tax rate, which is affected by factors including account types and sizes.

What are the Pros of the 4% Rule?

The primary benefits of the 4% rule include:

  • Easy guidelines. The annual calculation is relatively simple to follow.
  • Should last 30 years. The 4-percent-rule-in-retirement assumes a person will live 30 years after the start of their retirement. Still, one could live longer than that.

What are the Cons of the 4% Rule?

As with anything else in the retirement planning space, there are also potential drawbacks to the 4% rule:

  • Possibly insufficient savings. The 4-percent-rule-in-retirement rule assumes a 30-year retirement. Some people want to retire early or continue working well into their 70s. Health conditions may also alter the length of time savings will be needed.
  • Market could change. The 4% rule also hinges on historical market data, which may not be predictive of possible market changes.
  • Outmoded investment model. The 4% rule is based on an investment portfolio of 50% stocks and 50% bonds. However, more investors nowadays have more diversified holdings with varying growth potential. This could render the rule inaccurate.

What Should You Put Toward Retirement?

How much one should allocate for retirement depends on a variety of factors. Such variables include one’s lifestyle, retirement goals, and even where one resides.

Yieldstreet, the leading alternative investment platform, offers a retirement calculator that considers one’s personal retirement goals and anticipated income needs. The tool can help one establish the right time to retire and, thus, how much savings will be needed.

Is the 4% Rule Right for You?

Whether the 4% rule is a good fit will depend on one’s financial and investment goals. There is no single correct answer for everyone. It is important to consider one’s needs, wishes, and prospective disruptions such as healthcare costs or new grandchildren.

Further, whether the 4% rule is personally applicable hinges on where one’s assets are invested. If it is mostly stocks and bonds, such application is less appropriate.

How Can Yieldstreet Help Your Retirement?

Depending on one’s retirement goals, investing in alternatives can potentially help fund one’s hard-earned Golden Years.

Private-market alternatives, which include asset classes such as art, private debt, and real estate, are increasingly popular. Due to their low correlation to the stock market, alternatives can reduce overall portfolio volatility. They can also shield against inflation and provide tax favorability.

Historically, private markets have performed better than stocks in every economic downturn of the last 16 years. In addition to individual accounts, Yieldstreet offers investors opportunities to add private markets to their IRA or solo 401(k). In fact, more than 85% of the platform’s wide-ranging investments are available to retirement accounts.

It is not always necessary to realize income or capital gains whenever a private-market investment matures. Instead, one can let the funds compound in a tax-friendly retirement account.

Another benefit of investing in private markets is diversification. Creating a portfolio with a mix of asset types can reduce overall portfolio volatility. It can also potentially improve returns. In fact, diversification is key to long-term investing success.

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Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

While it has shortcomings, the 4% rule is a relatively simple guide for planning one’s retirement budget. It is not for everyone, however, including those with a more diversified investment portfolio.

Remember, to mitigate the effect of volatility on retirement funds, private markets may be a sound alternative.

Disclaimer: All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. Diversification does not ensure a profit or protect against a loss in a declining market.

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