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Can YOU Afford to Retire? | 4% Rule Explained | Safe Withdrawal Rate - YouTube
Channel: Next Level Life
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How much money do you think you would need
to be able to retire?
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It's a question that a lot of people have
asked their financial advisers and it's one
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that seems to have a different answer for
just about every time it's asked.
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And the reason for that is simple the amount
of money that you need to be able to retire
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depends entirely on how much money you think
you can earn in retirement through interest
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and dividends and maybe even a part-time job
if that's your thing, and perhaps even more
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importantly how much money you're actually
going to need to survive in retirement.
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And that number seems to change each and every
time you ask as well because projections of
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things like medical expenses change as time
goes on.
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And I'm sure those of you who are nearing
retirement watching this video know medical
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expenses just seem to be going through the
roof, particularly for retirees.
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But that doesn't really help us it doesn't
give us a goal to strive for as we're going
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through our working careers.
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We may not be able to come up with an exact
number that we'll need but can we come up
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with something that's at least going to be
close?
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Well today I'm going to talk about something
called the 4% rule and how it gives us that
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goal to shoot for.
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I'm also going to be talking about some other
factors to keep in mind when you're using
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this rule of thumb as well as some situations
where you're going to want to avoid the 4%
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rule in entirely.
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Let's get started.
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So what is the 4% rule?
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It's a rule of thumb that's used to determine
the amount of funds that you will withdraw
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from a retirement account each year.
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It's also sometimes called the safe withdrawal
rate because the money you take out usually
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consists mostly of interest and dividends,
and thus your principal either stays the same
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or goes down a little bit but not too much.
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In fact in 1994 a financial advisor named
William Bengan did an exhaustive study of
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historical returns in the market focusing
heavily on the severe Market crashes of the
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great Depression and the early 1970s and concluded
that even during those hard Times no historical
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case existed where the safe withdrawal rate
exhausted a retirement portfolio in less than
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33 years.
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And for most of us 33 years would easily cover
our retirement.
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The idea behind the rule is that once you
have approximately 25 times your annual expenses
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saved for retirement you should be able to
retire with reasonable certainty that you
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could survive until death on your savings.
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Because at that point the amount that you
take out for your annual expenses would be
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approximately 4% of your retirement savings.
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And when I say 4% of your retirement savings
I mean your entire retirement savings anything
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that's been earmarked to use only in retirement
this includes 401ks IRAs and any other ways
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you've saved a nest egg for retirement.
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For example if you had $450,000 in your 401k
and $50,000 personal IRA then you would have
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$500,000 in all of your retirement accounts
and your initial withdrawal on the first year
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retirement would be 4% of that $500,000 or
$20,000.
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So some other factors that you're going to
want to keep in mind when using the 4% rule
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in addition to keeping an eye on your expenses,
is to account for inflation.
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The 4% rule believe it or not actually allows
you to increase the amount you withdraw to
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keep Pace with inflation.
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You can account for this either by just setting
a flat 2% increase to your withdrawals each
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year which is the target inflation rate by
the Federal Reserve or by just looking to
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see what the inflation rate was for the current
year and adjusting based off of that.
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Now you might be wondering how this could
possibly be I mean if you increase how much
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you would withdraw to keep up with inflation
won't you eventually run out of money?
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It's a legitimate question but as it turns
out no.
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And it's because over the long term the market
goes up.
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Now there are a lot of numbers that are thrown
around by financial advisors about how much
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the market actually goes up I've heard anything
from 6 to 10% a year on average.
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I'm going to be conservative here and go with
the 6% end of the scale.
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So let's go back to the example I've been
using in the video you start off retirement
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with $500,000 in savings, and in the first
year of retirement you withdraw $20,000 or
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4% of your savings.
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And I'm also using a compound interest calculator
here, and it assumes that whatever you withdraw
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is withdrawn right at the start of the year.
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So the $20,000 is going to be withdrawn on
January 1st of every year.
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I'm only noting that because it makes it a
worst case scenario you were to say withdraw
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$20,000 over the course of an entire year
but you did it in installments of $1,600 each
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month you would be able to earn interest on
the rest of the money that you hadn't yet
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withdrawn throughout the rest of the year
and thus you're ending net worth would end
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up being a little bit higher than it will
be in this example.
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So on January 1st you withdraw $20,000, meaning
you only have $480,000 left in your nest egg.
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But over the course of the year the market
goes up by 6% which means the value of your
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portfolio at December 31st would be $508,800.
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Now in year two of retirement you increase
your withdrawal by 2%.
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So on January 1st of the second year of your
retirement you withdraw $20,400.
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That brings your portfolio value down from
$508,800 to $488,400.
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But again the market goes up 6%, which by
December 31st brings the total value of your
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portfolio up to $517,704.
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If you were to continue to calculate this
out for 30 years you're ending net worth would
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be $787,716.90, almost $300,000 dollars more
than what you started with in retirement!
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But of course this is just a rule of thumb
so there are situations where you're going
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to want to avoid using this all together.
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One of those situations would be if your portfolio
consists of a lot more higher risk Investments
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then say your typical index funds and bonds
that are usually in a retirement portfolio.
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This is because obviously a higher risk investment
can go down a lot faster than your typical
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retirement portfolios, which can be extremely
devastating especially early on in retirement.
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Also this rule of thumb only really works
if you stick to it year in and year out.
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And if you're not going to be able to do that
then you don't want to use this as your retirement
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goal, because even violating the rule for
one year to splurge on a major purchase can
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have a severe effect on your retirement savings
down the road because the principal from which
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the interest and dividends that you get to
survive is compounded from gets reduced.
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Let me give you an example of how this works:
Say that in addition to taking out the $20,000
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your first year in retirement, you decide
to treat yourself with a new car and figuring
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that you'll be traveling a lot during retirement
you want to get one that's good, big, and
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comfortable as well as reliable.
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So for this example let's say you get a new
Toyota 4Runner for about $35,000.
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Now I know that you could probably find it
for cheaper used, but not everybody likes
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to buy cars used I know my dad didn't and
besides this is just an example.
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So you drop $35,000 on a new car and you still
have to have money to live so the $20,000
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still does come out of your retirement, meaning
that you only have $445,000 leftover.
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Now admittedly the market still does go up
about 6% leaving you with a nest egg of $471,700
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at the end of the year.
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And even if you were to stick to the 4% withdrawal
rate for the rest of retirement which, would
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be 30 years in this example, by the 27th year
you would be taking out more than you earned
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an interest and dividends as well as how much
the market went up.
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And by the 30th year of retirement you would
withdraw $35,516, but with interest, dividends,
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and Market appreciation your portfolio would
have only gained $33,209 in value.
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And that could put you in a pretty dangerous
position should the market go down for a couple
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years, or if you have some kind of medical
emergency.
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Now I don't want to make it seem all bad,
I mean unless you retired early, after 30
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years in retirement you're probably in your
90s and don't need the money to last very
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much longer and even in this example you still
do end with $586,000.
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It could be worse right?
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However I do want to bring your attention
to the difference that this made.
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This one purchase made your ending net worth
that you could have left as inheritance to
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your children or grandchildren or even donated
to charity go from $787,000 all the way down
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to $586,000, that's a difference of over $200,000.
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And all that's with just one splurge.
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But that'll about do it for me I hope you
enjoyed the video and if you did or if you
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learned something be sure to like And subscribe
I've got a lot more of these Finance coming
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out in the near future as well as some more
book summaries and other fun stuff.
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But with that being said, thanks for watching
and have a great day.
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