In retirement, how much can you safely withdraw from your investments?
When it comes to retirement, the amount you spend is often more important than how you invest. And the amount you withdraw from your nest egg each year will directly impact how long your savings might last, regardless of the market performance you experience after your working years. One common rule of thumb employed by financial advisors is the so-called "4% rule."
According to this strategy, you initially withdraw 4% of your portfolio, and then increase that amount annually to account for inflation. In recent studies, experts have demonstrated that investors who expect to live 35 or 40 years in retirement should set their initial withdrawal rate at only 3% to 3.5% of their assets. On a $1M portfolio, the 4% rule would suggest an initial withdrawal of $40,000 in the first year of retirement. But if you expect to live 35 or 40 years in retirement, statistics and historical returns suggest constraining your withdrawals to $33,000 or $35,0000 is a more prudent approach.
Of course, the actual levels of inflation and market returns an investor experiences is beyond their ability to control. Investors can control, however, how much they spend, how they save and invest, and when they decide to retire. Setting a realistic budget and comparing it to your current assets is a necessary first step in determining your readiness for retirement.
Sources: “Determining Withdrawal Rates Using Historical Data,” William Bengen, 1994; “The 4 Percent Rule Is Not Safe in a Low-Yield World,” Journal of Financial Planning, Michael Finke, Wafe Pfau and David M. Blanchett, 2013.