I thought I should make a one stop shop for all of the retirement needs. Be it a traditional or early retirement. In this first entry we’ll define some of the individual parts that we’ll talk about in later additions to this post. The goal will be to provide a in-depth answer to this question: “what do I need to do to retire?” As well as any questions that could stem from that initial question and adding more to that answer to arrive at the specifics of what someone will need to do to retire. The goal is to have this cover all of the information I’ve looked at since I started really becoming interested in retirement saving, both early or traditional. I hope to mostly focus on items that have been relevant to me in my own experience and where I am in my journey at the time of writing. Throughout, I will try to present as unbiased a position as possible, but I’m sure that I will not be perfect.
Obviously, I’m not retired yet. But I’ve done a lot of research on the subject and will try to keep it to the steps that I’m currently working through myself or have completed in the past.
If I had to break down the answer to that question into a handful of items that need to be checked off, iit would be the following:
- Determine when to retire.
- Determine the amount needed to retire.
- Save that amount.
- Prepare to transition from working to retirement.
For the most part step 1 is a personal choice and I won’t touch on it too much throughout this series. I plan to write this guide such that someone could use it whether they plan to retire at 30 or at 80. Although I think that it is probably the most important in determining what you need to do in steps 2 and 3. I reserve the right to extend and add optional steps to this list at any time.
Before we launch into the first of these topics, I want to talk about two last things of note. If down the road I make small changes to these posts such as adding steps to the above or new subtopics I’ll maintain a log of each of these changes at the bottom of each post. Larger changes will probably become new posts that replace older ones.
Finally, throughout this series we may discuss investing. I am not a professional and nothing I say should be taken as advice. While I try to make sure my information is the most accurate that it can be, any investment decisions should be discussed with your financial advisor with consideration to your specific situation and circumstances.
To start though, we’ll start with the considerations used to determine the amount needed to retire. The topics that will make up these considerations are, at current, the following:
- The 4% rule of thumb
- Other withdrawal rates
- Other withdrawal strategies
- Length of retirement (and sequence of return risk)
- Asset Allocation
- Different types of investment strategies (rentals, stocks, ect.)
- Other expenses
- Visualizing retirement
The 4% Rule of Thumb
From what I’ve seen the most common way to determine how much you need is the 4% rule. To put it simply. When my retirement savings are large enough such that I can withdraw 4% of them a year to cover my retirement expenses minus other cash flows I have saved enough money to have a high probability of survival over a 30 year retirement. Mathematically, if you divide the amount you want to spend every year (minus income from other sources like pensions) by 0.04 (4%) you’ll find out the amount of money that you need to save. Often this equation is simplified to multiplying by 25 which is equivalent.
For instance if you estimate that your retirement savings are going to be $40,000 then you’ll need $1,000,000 (40,000/0.04 = $40,000*25). Between each year you then adjust your spending upwards by the amount of inflation for that year to allow you to preserve your buying power year to year.
The 4% rule does have a lot of considerations that will be important to anyone planning for their retirement; it considers how long the retirement is to be, inflation, historical averages, and stability of buying power.
I think that the 4% rule is a great place to start especially if you’re greater than 5 years from retirement. However I also think that there are some major problems with the 4% rule that need to be considered. I’m probably also biased against it, my current plan includes a lower withdrawal rate than the 4% rule, after all.
I call it a rule of thumb rather than a set in stone rule because I don’t think there truly is a rule that can be used to perfectly determine retirement for every individual, but they can be used to help those people start figuring out what they need for their situation.
Problems with the 4% Rule
As pointed out by others who have done much more comprehensive studies, one of the largest problems with the 4% rule that is often overlooked is that it looks at survival over a 30 year retirement, $0 is a surviving portfolio. If you’re retiring at 70 then you’ve got a decent chance of being fine over that period, however for early retirees you’ll need to provide this part greater consideration, if you’re planning for a 60 year retirement, running out of money after 30 years could be a major problem. We’ll talk more about how this consideration should be used in a future post. Personally, I find the rate at which the chance of success drops as the time until retirement increases to be one of the larger problems with the 4% rule.
On the flip side of this, it has been noted repeatedly that the 4% rule in the past has a high chance to significantly increase the amount of money you have after a 30 year period rather than running out. Albeit past returns are no indication of future results.
It suffers from the sequence of return risk (prolonged downturns early in retirement can affect if the amount you saved was actually enough). Although there are some modified strategies that have been suggested to try and offset this risk, it is essentially an omnipresent risk with every strategy that I’ve seen. Many things can be done to help offset this specific risk as we’ll talk about in the future.
It does not include tax considerations, something we’ll talk about in the future. This is a simple consideration to deal with under any standard withdraw x amount of initial portfolio value adjusted for inflation model.
If you want to leave money to heirs or charity, some cases for survival may not include this. Although, this problem can be offset by saving a little bit more to annualize how much you want to give to charity or your heirs in the worst case scenarios of having $0 at the end.
While we’ll talk about this more in future posts on how to determine the amount you need to retire and other ways to arrive at that number, I think the 4% rule works really well if the plan is to have a retirement lasting about 30 years or less. I also think if someone with a longer retirement length is just starting to estimate what those numbers will be.
That being said I do believe that there is a decent probability that those who do take the 4% rule for longer time horizons will avoid capital depletion, for a variety of reasons that we’ll touch on in future posts, if an individual wants to take that risk they’ll have to consider their own situation and assumptions for the future.
I think that overall the 4% rule is a good ballpark that makes important considerations that any withdrawal strategy for retirement needs such as inflation, the length of retirement, and preservation of buying power. As more posts are added to this series I believe that it will become more clear that there are things that can be done to make the 4% rule work, or other similar rules. It’s an imperfect solution but has a good foundation.
Update 9/24/2023 – Fixed typos.