He suggests that retirees consider allocations of between 45% and 55% in stocks, 35% to 45% in bonds and approximately 10% in cash. The 4% rule is designed to limit the odds of a retiree running out of money over periods of 30 years when holding a portfolio of stocks and bonds.īengen used a portfolio of 35% large-cap stocks, 20% small-cap stocks and 45% intermediate-term bonds in his later research. If Laura and Allison experience a good sequence of returns in retirement-especially early in retirement-their withdrawals may prove to be conservative. Notice how the withdrawal rate is independent from the portfolio each year. The withdrawal amount in the third year would be the second-year withdrawal rate ($40,800) increased by the current rate of inflation, and so on. So, the second-year withdrawal would be $40,800. If the inflation rate was 2% during their first year of retirement, the couple would increase their withdrawal amount by 2%. Laura and Allison’s withdrawal amount for their second year of retirement would be influenced by the rate of inflation. For the sake of simplicity, we’ll use the lower 4% figure.) (Bengen later revised the initial withdrawal rate to 4.5% for those with a diversified stock portfolio. It suggests Laura and Allison withdraw $40,000 during their first year of retirement. They estimate that their annual living expenses will require a withdrawal of $40,000 during the first year of retirement after accounting for their guaranteed sources of income (Social Security, pensions, etc.). They have $1 million in savings as of their retirement date. To make the comparison between the two approaches easier, we will apply some simple numbers to a hypothetical retired couple, Laura and Allison. Both have been shown to work over a long period of time. It is known as the Level3 withdrawal strategy. The second was developed by AAII founder James Cloonan. It is commonly referred to as the Bengen 4% rule or simply the 4% rule. The first strategy was developed by former financial planner William Bengen. Investors then alternate taking withdrawals from the growth assets and from the safe assets depending on market conditions. The remainder of the portfolio is allocated for growth, primarily in stocks. It calls for allocating up to four years’ worth of living expenses into safe assets. It enables retirees to withdraw as much as 5% of their portfolio each year. The second is the Level3 withdrawal approach. Each year thereafter, the initial withdrawal amount is adjusted upward for inflation. This strategy calls for withdrawing 4% of savings during the first year of retirement. There are two primary withdrawal strategies individual investors can use. Even a period of above-average returns will not protect you if your withdrawal rate is too high. Withdraw too much and you will greatly increase the risk of outliving your money. Once in retirement, how much you withdraw is as important as how you invest.
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