Coffee heat rising

The Divide by 4 Percent Rule?

Frugal Scholar has been ruminating about an idea inspired by something Jacob of Early Retirement Extreme wrote to the effect that you can get a rough preview of how much you need to retire by dividing the annual cost of an item (or, by extension, a set of items) by 4 percent.

Jacob’s theory is that you can calculate the amount you’ll need to cover the cost of, say, your daily coffee habit by figuring the annual cost and multiplying by .04, the “canonical” 4 percent withdrawal rate. His idea is that you will figure out how much savings you’ll need to support each of your various expenses in retirement, and, because these will be smaller than the daunting total, you’ll feel a) more motivated to work toward each smaller goal and b) less inclined to diddle away money on unnecessary purchases. In his example, if you spend $50 a month on groceries, you’ll need $15,000 in savings ($50 x 12 ÷ .04) to sustain your eating habit through retirement. A more realistic $300 a month would require a stash of $90,000.

Holy mackerel! What fodder for the neurotic frugalist!

So naturally I had to whip out the calculator. Do I have enough to sustain me through the end of my life at a 4 percent drawdown?

We know expenses are, at most, $2,045 a month. This is the amount I budget, even though the truth is expenses go that high only during the pricey summer months, when utility bills hover near the stratosphere.

$2045 x 12 – $24,540
$24,450 ÷ .04 = $613,500

So the answer is hell, no, I most certainly do not have enough to sustain me through old age. When last seen, total cash holdings came to about $488,000. I’m doomed!

Or am I?

My actual maximum monthly out-of-pocket costs are not $2,045, because they’re defrayed by net income from Social Security. In reality, the amount I have to come up with to support myself in my present penurious splendor is “only” $1,070, or $12,840 a year.

$12,840 ÷ .04 = $321,000

In that light, retirement looks a lot more doable, even on my pretty modest savings.

The problem, of course, is that it doesn’t take into account the effect of inflation, at least not in any realistic way. To manage that $12,840 from a 4 percent drawdown without draining my savings over a 25- or 30-year period, I will have to keep most of my money fully invested in stocks and bonds. No CDs for this little chick! A CD doesn’t earn enough to allow a 4 percent drawdown—at that rate your savings would disappear pretty quickly. And CD rates do not track inflation effectively, mostly because they’re so low they don’t generate enough income to keep grand-baby in shoes.

And as we know, the market is highly unreliable. Lose $180,000, as I did in the late, great crash of the Bush economy, and your income drops dramatically. In that event, if you’re drawing down 4 percent, you’ll have no chance of building your nest egg back up to a point where it will support you. If today I lost $180,000 again, a 4 percent return on the remainder would be $12,320, less than I need to survive even with Social Security.

One thing is as certain as death and taxes: the market will go down again. Whatever goes up must come down; the market follows that fundamental rule of physics, if in a metaphorical way. And it’s safe to assume that inflation will return. It could return with a vengeance, given the overall sickness of the world’s economy.

What this means is that, unless you’re very wealthy, you’re left with only one course of action: keep working until you drop.

Right now I’m not pulling down any retirement fund money, because I’m scraping together enough by part-time teaching to cover my costs. I intend to keep teaching as long as I can dodder into the classroom, which I figure will be about another five years. After the age of 70, I probably won’t be able to do it any more. Then I’ll be forced to use savings to live on.

Well. I don’t feel too worried about my own future.

But I sure do worry about my son’s. Given that most Americans now earn low rates of pay and can expect, with competition from Third-World countries stealing jobs as fast as water can drizzle out of a half-open tap, to see pay continue to fall, and given that the Republicans have come as close as they dare to saying aloud that they intend to get rid of Social Security, what are our kids going to do in old age?

I fear most of our sons and daughters will not be able to look forward even to semiretirement: that they will have to plan on working—full-time, not at some part-time gig—until they are too infirm to work at all. Experience tells us that no matter how much you love your job (and most jobs available today are anything but lovable), after 15 or 20 years, you’re royally sick of it. After 20 or 30 years, you need to retire, for your health and your sanity’s sake. Without Social Security, that will not be possible for most Americans.

6 thoughts on “The Divide by 4 Percent Rule?”

  1. Au contraire. The 4% actually does take inflation into account. It comes from “safe withdrawal rate” simulations of market returns over 30 year periods using different periods in history and inflation. In other words, historically speaking, if you invested your money in the broad market and withdrew 4% each year ADJUSTING for inflation, the portfolio would always survive for 30 years.

    If you want to to survive longer, say 60 years, you can only withdraw 3%.

    The second course of action to meet these “impossible” numbers is of course to spend significantly less, typically by arranging one’s home and transportation differently.

  2. @ frugalscholar: Yeah, he did. But he got discouraged when he was turned down by the JET program and didn’t score high enough on the Civil Service exam to be considered for the state department. Now he’s past the age for grand tours–he feels he should be married and settling down by now.

    @ Early Retirement Extreme: Yes, I see how it does take that into account. It’s hard to imagine how, in my case, I could cut my living expenses much more, short of moving into a mobile home. I live on a third of what I used to earn, and what I earned was a very ordinary salary. To arrange my transportation differently, I would have to live someplace that has public transport, or in a small town that was small enough that residents could walk or bicycle to all of its infrastructure; my car is paid for and is 10 years old, so registration fees and insurance are rock-bottom.

    One point I meant to make in writing the post, actually, was that it should take a lot less than .04% of annual expenses to get by in retirement, because at least some of that retirement will be partially underwritten by Social Security benefits.

    But even if the .04% does track inflation, you still do face the risk of a bear market. Because few retirees are in a position to contribute more savings to help revive a depleted fund, when a chunk of the nest egg is lost to a market crash, all or most of it is just…lost.

  3. The 4% accounts for bear markets insofar that the next one is not worse than what has been seen historically. Check out to get a better idea of how these studies work. In fact, if you withdraw 4% you’re probably more likely to end up with a lot of money than you are of running out. 4% is the maximum you can withdraw while avoiding the WORST case [so far].

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