Updated: Sep 11, 2019
As with everything in the financial world, this too can definitely be argued, the 4 percent withdrawal rate is the maximum safe rate at which you can spend your retirement savings. Yes this can definitely be argued, and most often is, but at this conservative safe rate, there's a good chance that you won't run out of money in your lifetime. Obviously, all this is contingent on what you've invested over your lifetime of course and how long you live.
All of this also sounds super simple, and you wish it were so, however, nailing this concept down is more unpredictable than simple. After all, neither one of us can predict the future of the stock market or the economy or the rate of inflation during your lifetime. Neither you nor I have any idea if a loaf of bread will cost $7 or $70 dollars in the future. How in the wide world of sports will we have a clue on how much money we'll need to live on for the rest of our life.
One way to try to calculate what it may take is to: take your annual spending number and multiply it by somewhere between 20 and 50. That's your retirement number. If you use the number 25, you're essentially saying that 4% would be good. Or your saying that 25 times your annual expenses is a good goal to save for.
Where does this random number 4 come from? This may be the easiest way to think about it, at least it is for me. Let's say that you have a stack of retirement money that is invested in stocks and other assets. They pay dividends and appreciate at a rate of 7% per year, before inflation. Inflation steals about 3% on average, leaving you with 4%. That's about the simplest way of getting to the number 4.
So here's the other side of this argument. How can you know? Over just our American history we've had "The Great Depression", World Wars, Real Estate busts and booms, "Black Fridays" in the stock market, how do we know what is held in the future? The true answer is, we don't. However, lucky for us, wherever there is money involved there are people trying to save, invest and maximize it. Modern analytics have produced calculations that show what would happen to a hypothetical person who spent 30 years in retirement spending an ever-increasing amount of his portfolio each year. This whole study was named the Trinity Study, it has since been updated and reworked by a guy named Wade Pfau.
As with anything and everything though, there are skeptics and naysayers, this holds true in this case too. While this Trinity Study is interesting it also assumes that the retiree will:
* Never earn any more money through part-time work or self-employment side jobs.
*Never collect from social security
*Never adjust spending to account for any economic realities, good or bad.
*Never do what most people do as they age, spend less.
So for the sake of further argument, apply this concept to your life right now. What do you spend per year, $25,000? Multiply $25k by 25 (25 times your spending) = $625,000. You will need $625K in your retirement account(s) to make this work. If you were to spend $30K/year, you will need $750,000. You can do the math from here. But as you see the less you spend, the less you'll need or the more comfortable you'll be. Or on the other hand, which was mentioned above, if you add a few life hacks and or some additional streams of income on top or your "Nest Egg", you can live quite comfortably.
We can go on and on and debate whether 4% is good for you or not, you will need to decide whether 4% is the right amount for your own retirement and personal situation. But as for now, you are informed a bit more and have another weapon to calculate your future with, go and be excited that you can do this. Make all you can, invest all you can and give all you can, but most importantly don't spend away your future, invest in your future.