4% spending rule no longer valid due to inflation


Bill Bengen first devised the 4% retirement rule in 1994. Since then, retirees have relied on the rule to help determine how much they should spend in retirement. The rules are relatively simple. You add up all your investments and withdraw 4% of them in the first year of retirement. In later years, you adjust how much you withdraw to account for inflation. –

So if you saved $1 million for retirement, you would spend $40,000 in the first year, and if inflation were 2% in the second year, you would spend $40,800 that year. The 4% rule assumes that when you retire, your portfolio will be 50% stocks and 50% bonds.

Even accounting for the Great Depression, the tech bubble, and the 2008 financial crisis, this approach protects retirees from running out of money every 30 years since 1926, according to Bengen’s original paper.However, due to a combination of high inflation and high stock and bond market valuations, Fundamental believes retirees need to make some adjust their spending.

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Cut spending now

Bengen, who retired in 2013, said retirees will need to cut expenses and reduce withdrawal rates given today’s unprecedented economic situation. A recent study by Morningstar showed that a 4% dropout rate is too aggressive. Its research recommends a starting withdrawal rate of 3.3%.

This assumes a 50/50 stock and bond portfolio with 90% certainty that it will not run out of money over a 30-year time horizon. The key thing it found was that the more flexible retirees were with their spending, the better chance they had of raising their withdrawal rates over time.

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The impact of high inflation and high stock valuations

average value US inflation rate It has been 3.1% since 1913. With inflation now at 8.3%, withdrawals under the 4% rule have increased significantly. This means that the portfolio will need to earn higher returns, or the portfolio will be more likely to be depleted.

Another issue Bengen raised was that stock valuations are at record highs. The stock now trades at about 36 times the company’s earnings over the past decade. “That’s double the historical average,” Bengen said. “While lower interest rates have partly justified higher equity valuations, I think the market is expensive.”

When stock valuations are high, a bear market usually occurs to bring prices back to the average. So if we’re not in a recession right now, there’s a good chance there’s a recession or a bear market in the near future. During this period, retirees need to be more careful when withdrawing money to ensure they don’t run out of money.

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After reducing spending, Bengen advised retirees to reduce their exposure to stocks and bonds. This reduces their risk in the event of a recession or bear market. By having more cash or other assets, such as income-generating real estate, when the market falls, there may be an opportunity to buy stocks when they are cheap. Retirees need to be careful, though. It’s important not to try to time the market, as this could lead to bigger problems.

With today’s economy, retirees will need to rethink the popular 4% rule. Experts, including the creators of this popular retirement income strategy, believe it’s outdated and retirees should evaluate their financial plans and spending to manage the risk of running out of money.The key is to be flexible your finances And maintain a long-term financial view.

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