I am currently taking a personal finance class at UC San Diego’s Rady School of Management, where I have had the opportunity to learn more about how to manage value, assets, liabilities, net worth, budgets, stocks, bonds, a 401k, and saving through a Roth IRA. With all of these tools available, I always kept asking myself, why do I keep hearing about the 4% rule? What is the 4% rule? There are many percentages being thrown around such as the 20% rule, the pay yourself first rule, and the do everything 100% to the best you can. Yet, what does the 4% rule mean exactly?
You might be wondering the same question, so let me help you understand a little bit more about the rule and why the 4% rule exists today. As we have learned in class, retirement is often going through some people’s minds, and although it may sound good in theory, it can be a whole different story in practice. You might be wondering what is the best approach to withdraw from your retirement account, so let’s start by diving deep into the numbers. The first thing we have to consider is that you should have a portfolio of around 60% stocks and 40% bonds. The second thing is to assume you will continue spending through your retirement. Once both conditions are met, then the 4% rule can be considered. The key, essential part to remember is that this doesn’t guarantee you will have unlimited funds with this 4% rule and is only a framework that may or may not work for you.
So, the 4% rule is a strategy for how much you should withdraw after you turn 72 years old. To be honest, there are various cons to this rule, especially when there is a recession, so it makes sense to look for alternatives. One alternate approach to the 4% rule is to forget about a common rule and instead talk with a financial advisor that can evaluate your situation and help you with your personalized retirement withdrawals. Make sure you have a fee-only advisor. Avoid a commission advisor, because they can make recommendations that are in their best interest instead of yours.
The 4% rule does not apply when there is a recession, so instead have the virtue of waiting patiently until the market is well. Patience and timing in life are everything, especially when it comes to things you value. Therefore, you have to evaluate your own situation to see what you will get in return for your investment. Always seek advice from those with more experience, but do your work and research who you are getting your advice from. Disclaimer that this article is in no way written by a financial professional.