The 4% rule is a key facet of
. The rule says that if you limit annual withdrawals from your
nest egg to 4% -- or some similar rate -- your balance should
survive 30 years.
That way, your money is likely to outlast you in
The 4% formula was arrived at using historical returns,
inflation and life expectancy. The strategy works if withdrawing
4% a year plus the rate of inflation equals an amount that's less
than your nest egg investment's rate of return.
How close would an investment in theS&P 500 ETF (
) have come in recent years? Despite historic downturns in 2000
and 2007, the ETF's average annual gain was 5% over the 15 years
ended Aug. 5. It was 8.06% over the 10 years ended then.
The average moderate balanced fund -- typically 60% stocks,
40% bonds -- was up 5.6% and 6.7% a year in those two
Some big, prominent funds have done even better. The $23
billion Fidelity Balanced Fund averaged 7.46% and 8.31% a year in
those periods. The $20 billion Vanguard Balanced Index averaged
5.94% and 7.47%.
"The 4% rule is a good starting point," said Sharon
Oberlander, managing director, wealth management, Merrill Lynch.
"It depends on your age when you retire, your asset allocation
and what degree of confidence you want that your portfolio will
It is less likely to succeed for a 50-year-old who has a 100%
bond portfolio, said Brian Layton, senior vice president, wealth
management, Neuberger Berman .
Stick To Your Plan
One key to succeeding with the 4% rule is to stay the course,
Layton says. In addition to a 4% withdrawal rate, select a
stock-bond ratio that you are comfortable with.
You'll want a mix whose volatility you can live with, given
the market's inevitable ups and downs. You want enough stocks for
Changing your asset allocation every time the market zigs or
zags can be counterproductive. On the other hand, a strategic
asset-mix shift based on age and circumstances, not daily market
moves, is OK. "When you reach age 85, it's all right to focus
more on preservation of principal," Oberlander said.
And how should you cope with inflation?
Michael Bilotta, senior adviser and CIO of JNBA Financial
Advisors in Bloomington, Minn., says one option is to add an
annual cost-of-living adjustment. A 2% COLA in the second year
means a 4.08% withdrawal.
Changing Your Withdrawal
A second option is to change your withdrawal by half the rate
at which the market changes. If the market rises 10%, give
yourself a 5% raise, which equals a 4.2% payout.
A third option: when the market declines, cut your withdrawal
by the same percentage, Oberlander says. When the market rises,
don't change your withdrawal. Just let the extra earnings build
Fourth: calculate the dollar amount you need for annual living
expenses. Adjust that by a COLA each year.
Fifth: Pick a portfolio, such as a 60-40 balanced fund or
individual securities, whose annual return is likely to top your
withdrawal rate. As your principal grows yearly, your payout of
4% or whatever gets a built-in COLA in dollars.