Imagine you had a crystal ball that could tell you your financial future. A magical orb that knew all your spending and investment returns over the next several decades. With such a device, we could perfectly plan out when you could retire to match your spending needs with your retirement income over time.
Unfortunately, no such object exists. While we might be able to estimate your future spending based on your expected lifestyle in retirement, we have no idea what investment returns you will get nor how long you will live.
This is why the Nobel Laureate William Sharpe called retirement the “nastiest, hardest problem in finance.”If it were easy, there wouldn’t be an entire industry dedicated to helping people navigate this period of their lives.
Despite the difficulty of the problem, there are some simple rules you can use to determine when you can retire. One of the simplest is called The 4% Rule.
The 4% Rule
William Bengen was trying to figure out how much money retirees could withdraw from their portfolios each year without running out of money. In 1994 he published research that would revolutionize the financial planning world.
Bengen found that retirees throughout history could have withdrawn 4% of a 50/50 (stock/bond) portfolio annually for at least 30 years without running out of money. This was true despite the fact that the withdrawal amount grew by 3% each year to keep up with inflation.
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