The primary theme of this blog is how to live off your retirement assets. But first one needs to accumulate enough assets to retire. So, for my inaugural post, I’ll address how to determine how much you need to retire. This can be quite a complex topic which I’ll come back to many times but lets start out with some generally accepted rules of thumb.
The 4% rule of thumb represents the maximum amount you can withdraw from your retirement portfolio for all expenses and have you portfolio last throughout retirement. First, calculate how much income you need to fund your desired lifestyle. Lets assume you need $40,000 per year to meet expenses. Then divide that number by 4%, in our example $40,000/0.04, and you arrive at the total amount of assets you need to begin your retirement. In our example, that works out to be $1 million dollars. Alternatively, you can take your annual desired income level and multiply it times 25 and arrive at the required level of assets.
The 4% number is known commonly as the safe withdrawal rate (SWR) and is calculated in a couple of different ways. One way is using long term historical returns of stocks and bonds using various allocations of stocks and bonds. Another way uses computer simulations (monte-carlo methods) to simulate potential future returns under different scenarios. The withdrawal rate is normally adjusted for inflation, using the historical CPI, and the retirement period is assumed to be approximately 30 years. While there is a lot of discussion to be had on the details here, and I love these details as you will see, that can push you to either higher or lower withdrawal rates, a 4% SWR is a good starting off point. A great summary of withdrawal rate from retirement portfolios can be found here.
A 4% SWR is what I used to determine my retirement needs and what drove my decision to finally take the leap in early 2010. But I do use it as a rule of thumb and a general planning tool. My plan is flexible and I’ll adjust to the reality of the situation if needed.