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THE 4% RULE:
All of this begins in 1994, when the 4% rule was first “invented,” and used as a method of calculation to make sure you NEVER run out of money in retirement. The premise was that you could spend 4% of your portfolio every year for 30 years.
However, Vanguard recently cautioned AGAINST this metric for these reasons:
1. Spending 4% relies on historical returns, that might not work for today’s investments.
As Vanguard calculated, historically….the markets have a REAL RETURN of 7.5% for US Stocks, and 2.43% for Bonds, adjusted for inflation, between January 1926 and March of 2021. BUT…over the NEXT 10 YEARS…they’re forecasting SIGNIFICANTLY lower returns…like, 2.44% for US Stocks, and 0.27% for US Bonds, adjusted for inflation.
2. 30 Years Might Not Be Long Enough
The 4% rule was originally crafted to fit a 30-year time horizon…not someone who wanted to retire early. Because of that, the “standard 30-year retirement calculation” is LESS LIKELY to work for someone who wants to STAY RETIRED for a longer period of time.
3. The 4% Rule Doesn't Take Into Account FEES
For example, your retirement accounts could have annual costs that eat away from your profit…almost every index or mutual fund has an expense ratio that needs to be factored in…and, as a result…your overall return begins to decline.
4. You need diversification
See, when the 4% rule was first calculated – it ONLY considered the US Stock Market…but, Vanguard’s analysts believe that, over the next 10 years…INTERNATIONAL STOCKS could actually wind up OUTPERFORMING…which means, if you diversify throughout the entire world…you could increase your chance of having enough money from 36%…all the way up to 56%.
And FINALLY…FIFTH…they said there’s risk in simply just spending 4%…and that’s it.
Even though the 4% rule was meant to be SUSTAINED throughout a time where the stock market crashes out of nowhere, for no reason, even though Jim Cramer told us to buy….in reality, Vanguard says that…if the market drops…it’s probably a better idea to cut back on your spending until things recover, JUST to give yourself a greater chance that you can make your money last as long as possible…PLUS, that kind of dynamic spending could increase your chances of success by nearly DOUBLE.
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