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Money Monday: 4% rule is alive and well

Four percent is actually a fairly conservative figure, based on the worst historical conditions, rather than the average ones.
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Photo by Max Harlynking on Unsplash

This column is intended for informational and educational purposes only and should not be construed as professional financial advice for your individual situation. Please consult with a financial professional before making any serious financial decisions.

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Hello Longmont! 

I am a dad, carpenter, writer, and retired software engineer who has been living in Longmont since 2005. I used a few simple but powerful life principles to become wealthy enough to retire at age 30, and went on to start a blog called Mr. Money Mustache that has now reached over 30 million people in the past nine years. Now it’s time to take these ideas to the streets of Longmont, so send in your questions about money and life!

Recently another financial blogger, the "Financial Samurai" claimed that the 4% rule is now outdated (apparently it was developed in 1998) and that now we should all be going by the .5% rule instead. I think much of this thinking is due to low bond rates of return, but anyways, it would be great to get feedback on this.--Mack 

Not to get into the financial blogger equivalent of a rap battle here, but you should definitely not listen to much of what that particular writer has to say - he is notorious for prioritizing clickbait over content. (For example, he also frequently writes about how hard it is to get by in San Francisco on only $300,000 per year, while many of my own readers are doing it on under $40k!)

Now let’s get into that 4% rule - I am happy to report that it is still alive and well.

According to the Charles Schwab website, the 4% rule is when you add "up all of your investments, and withdraw 4% of that total during your first year of retirement. In subsequent years, you adjust the dollar amount you withdraw to account for inflation. By following this formula, you should have a very high probability of not outliving your money during a 30-year retirement according to the rule."

Four percent is actually a fairly conservative figure, based on the worst historical conditions, rather than the average ones. Right now, we could indeed be in one of the riskier times, because stocks are more expensive than average (the price-to-earnings ratio smoothed over the past ten years) is about 30, whereas the average since the 1880s is about 17. This suggests that stocks are 75% more expensive than average, and if they gradually revert closer to that average, you would expect some down years (or at least slow returns) are in store for us.

But, interest rates also play a big part in this: when interest rates are lower, stocks are worth more, and interest rates are the lowest they have ever been. On top of that, the U.S. stock index as a whole still pays a dividend of 1.6%. 

When you wrap all of this up together, you can calculate something called the “price adjusted safe withdrawal rate”, which in today’s conditions is right at 3.5% according to my friend The Mad Fientist’s calculator. What that means is that if you want to retire with a fairly reliable annual income of $30,000, you would need ($30,000 / 0.035) = about $857,000. 

And of course, you can do even better if you have supplementary income like a pension, social security, a side or hobby income, or if you get some of your money from things with higher yields like owning a rental house.

It’s still not chump change, but it’s a lot better than the totally preposterous $6 million implied by certain online personalities. 

You can learn more on this subject from these two articles:

https://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

https://www.gurufocus.com/shiller-PE.php



About the Author: Pete Adeney

Pete Adeney, Mr. Money Mustache, is a fifteen year Longmont resident.
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