What is the “4% rule”? It helps me know roughly how much I can spend yearly in retirement?
The “4% rule” is a simplified “spending rule” methodology for roughly approximating how much one can spend each year during retirement without running out of money. For example, if you start retirement with $1 million, the 4% rule says you should be able to spend $40,000 (4% x $1,000,000) per year (or $3,333 per month, pre-tax) with a low chance of running out of money during retirement (Note: the 4% rule does not include Social Security income, if applicable). The traditional “4% rule” assumes that a person is in retirement for 30 years and utilizes a portfolio with a “balanced” mix of stocks and bonds (e.g. 60% stocks, 40% bonds). While you can decide when you retire, and the 4% rule can be helpful as a quick rule of thumb, it isn’t possible to know how long you will live or exactly what return investment markets will provide. As a result, and because some economists project that investment returns in the next 50 years may be somewhat lower than in the last 50 years, it may be appropriate and more conservative to utilize a rate lower than 4%, for example 3.5%. For projections that better fit your expected circumstances, it is advisable to consult a qualified, conflict-free, fee-only financial planner. There’s a chance that could lead you to spend less now and end up with extra money at the end of your life, but that may be a better alternative than spending more now and running out of money before you run out of years. The 4% rule can also be used to back-into an approximate “nest egg” amount that one would need in order to start retirement. For example, if you need to be able to spend $3,333 per month in retirement (on top of any Social Security payments, if applicable), the 4% rule says you would need $1 million on day 1 of retirement ($40,000 [i.e. $3,333 x 12], divided by 4%). See the WealthStep homepage for a basic 4% rule calculator, and use the WealthStep advice engine for somewhat more refined spending calculations. For additional information on the 4% rule, see this independent publication: http://www.vanguard.com/pdf/s325.pdf