Americans think you need $1.25-million to retire. Canadians think you need $1.7-million. U.S. author and TV host Suze Orman thinks $5-million is barely enough - since private islands don’t buy themselves.
Where do these numbers come from? Well, some people take their yearly expenses and multiply it by their life expectancy. Others assume you’ll need 70 per cent of your pretax income in retirement.
The problem is that these methods don’t consider investment growth or customize for different spending levels. Some people are perfectly happy living in Thailand, spending $30,000 a year, while others want a lavish retirement income of $200,000 a year.
As former engineers, we prefer to make decisions with math, not feelings. So, we calculated our retirement number using the 4-per-cent rule.
So, what is the 4-per-cent rule? Basically, it’s how much you can withdraw annually in retirement to avoid portfolio depletion.
The history of this rule goes back to 1994, when it was created by a financial adviser named Bill Bengen. He simulated what would happen to a portfolio if you were to withdraw at different rates (3 per cent to 6 per cent) over different time periods, spanning the Great Depression, a World War and stagflation in the 1970s. He discovered that 4 per cent was the maximum you could safely withdraw, after accounting for inflation.
In other words, if you retire with $1-million, you could withdraw $40,000 a year and have a 95-per-cent chance of having your portfolio be worth $1-million or more at the end of 30 years.
You can also use the rule to reverse engineer how much you need to retire. Since 4 per cent is 1/25, you simply multiply however much income you need by 25.
This means that if you’re spending $40,000 a year, like we were, you would need $1-million to retire ($40,000 x 25).
Of course, no rule is perfect and comes with caveats. For example, Mr. Bengen devised this rule using an asset mix of 50-per-cent bonds and 50-per-cent stocks, which consisted of large-cap stocks held in index-tracking funds, and intermediate-term government bonds. If you have a different asset allocation, the rule may not apply. Also, the world has changed significantly since 1994 – the biggest companies in the S&P 500 are mostly tech companies, for example.
So does the 4-per-cent rule still hold? Or do we need a different rule?
The good news is that Mr. Bengen recently updated his research, using scenarios like the 2020 pandemic and the 2008 financial crisis, and found that a higher withdrawal rate is possible. He’s revised the 4-per-cent rule up to 4.7 per cent - if you are well-diversified and flexible.
By being flexible about where we live and adding international diversification to our portfolio, we could easily raise our 4-per-cent withdrawal rate to 5 per cent, or $50,000, without depleting our portfolio.
Now, you might argue that while international diversification is achievable by picking the right assets in your portfolio, flexibility is a lot harder to achieve when you have a family.
We agree with that — to some extent. It depends on your job, your child’s age and your lifestyle preferences.
If your job requires you to go into a physical office, it’s much harder to be flexible.
If your children are school-aged, it’ll be harder for on them to move schools.
If you don’t like travelling and prefer to settle in one place, it’ll be harder to take advantage of geographic arbitrage (moving to a low-cost area to spend money you earned in a high-cost area).
In these cases, 4 per cent or less might be the safer option for you.
However, if you can do your job remotely from anywhere, have younger kids, or are willing to consider “world schooling” – schooling abroad, home-schooling while travelling, correspondence schools or other approaches – you may consider withdrawing 5 per cent.
Our son is currently too young for school, so 5 per cent can work well for us. However, once he’s older and if we decide to settle in one place and put him in a traditional school, we’ll go back to our tried-and-true 4-per-cent safe withdraw rate.
At the end of the day, arguing over withdrawal rates is a waste of time. Mr. Bengen‘s research shows that not only does the 4-per-cent rule still apply today, diversification and flexibility enable you to withdraw even more.
It’s better to work on lifestyle design, so that you can be as flexible as possible, and as a result, not be hurt by market fluctuations or inflation. You might even be able to retire earlier than you thought. As long as you don’t need a private island.
Kristy Shen and Bryce Leung retired in their 30s and are authors of the bestselling book Quit Like a Millionaire.
