This post and episode is a compilation of a few financial rules of thumb. I hope these are helpful for you.
4% Rule for Retirement Spending
In this podcast I will answer the question: What are the benefits and limitations to the 4% withdrawal rule for retirement planning?
The rule, or guideline, came out in the 1990s. It states that if a retiree withdrew 4% of their initial retirement savings per year, their savings would last them for 30 years. The withdrawals would increase over time to adjust for inflation.
This was based on a very aggressive 70% stock portfolio at a time of fairly high stock returns. Most retirees I know would not have held this aggressive of a portfolio during the last 10 years.
This 4% rule has been used as a rule of thumb for many people to estimate how much savings they need at retirement given their current spending. However, it is just that, a rule of thumb, a rough guide to achieve a target amount.
I like this guideline for a quick estimate – for a very rough estimate. If someone would like to have about $80k/yr from their investments, they would need to have about $2M saved up. At 3% $2M will provide $60k/yr. This is useful to know, it is a good starting point and a good double check to other retirement projections.
Of course, there are many limitations to this simple estimation, including the following.
• One of the primary limitations is that a flat withdrawal rate does not take into account any changes in cash flow needs for health, travel, vehicles, inheritance, pension, social security or other future cash flows. Some of these needs are unforeseen but many are not. There are many people who need more of their savings upfront and less as other cash sources begin. Some would like to travel or spend more in the beginning of retirement and reduce spending with time.
• The tax results of your withdrawals could impact the effective return. If your investments are primarily in IRAs or accounts where you will need to pay income taxes on the amount you withdraw, that will reduce the amount you have to spend. If there are large capital gains to pay that will also impact the net amount (alter taxes) that you have to use.
• How conservative (or aggressive) is your portfolio is another factor and how accepting you are if the market goes down significantly. People can underperform the market significantly by selling when things to not look good and the market goes down and buying when everything is positive, and the market is up.
The rule does not provide flexibility to change withdrawals and projects based on actual investment performance.
In conclusion, the 4% rule provides a nice easy estimate, but a more detailed plan should be used and updated regularly to project how your long term spending and retirement will work out.
5 Tips to Building Wealth
1. Save Early and Often
The earlier you start saving the better
Let your money work for you
Compound interest over time will help your investments grow
Spend less than you earn
2. Eliminate debt (and don’t take on more)
Especially expensive debt like credit cards
Interest is working against you
Minimize the amount of ongoing debt you have
3. Pay yourself first
Auto-deposit part of your earnings into tax advantaged accounts for retirement
Through work or on your own
By dollar cost averaging (steadily contributing each pay period) you will take advantage of markets when they are down
401k, IRA, Roth, 403b, SEP
4. Negotiate everything – do research
Do not just pay because your being charged
Shop around for insurance
Investigate what insurances you actually need
Negotiate your salary, interest you pay, fees, bills
5. Seek support
Finances are a sensitive
It may help to have a fee-only financial advisor
Join an investment/savings group
Check in with someone regularly
The 50-30-20 rule for budgeting
• 50% of your income toward necessities (housing and bills)
• 20% financial goals (paying off debt or saving for retirement)
• 30% of your income can be allocated to wants (entertainment, hobbies, donations)
This can be a helpful guide just to get started with budgeting with broad categories. It can help you start to create a balance between obligations, goals and splurges.
You can further break this down.
• 10-15% of your income (necessities category) on food.
• 2-10% of your income (wants category) on personal items (haircuts, clothing, entertainment)
• No more than 30-35% towards debt (including mortgage) and monthly rent
• Pay off highest interest debt first
Cost in Hours
When you’re evaluating a purchase, think of the cost in terms of how many hours of work it costs not just the cost in dollars.
For example, a concert costs $100 plus parking, gas and dinner, $150 total. $300 to go with a date.
If you earn $30/hour at work. If you consider taxes and expenses for work (transportation expense, clothing) you can easily subtract 20%. So you take home about $24/hour after expenses.
The concert with a date will cost 12.5 hours of work. Plus you have commute time, time to get ready for work, and unwind after work. Add another 20%.
So the cost of the concert costs 15 hours of work – almost 2 days of work.
It may be worth it to you – it’s just another way to look at expenses.
Expat Planning
1 Taxes
2 Underestimating the cost of living
3 Banking and money transfers
4 Investment products and small businesses
5 Health and life insurance
6 Investment accounts
7 Estate Planning
Sustainable Responsible Impact Investing
Sustainable responsible impact investing is an investment strategy seeking to maximize financial return and social good. This is done three ways:
1. Screening – positive and negative – including or excluding investments based on their industry, governance, environmental record
2. Shareholder advocacy – as a shareholder you have the right to engage with companies on Environmental Social and Governance issues
3. Community investing – providing capital to individuals and organizations that otherwise would not have access
Fee-Only Financial Advisors
Financial planners can be very helpful. They can keep you on track to meet your financial goals, conduct long term planning evaluations, incorporate tax planning, estate planning, cash flow into your investment decisions.
However, it’s critical to know how your financial advisor is being compensated. They may be fee-only and be compensated solely by their client. Fee-only advisors may be paid a lump-sum fee, by the hour or based on the amount of assets that they manage.
They do not receive any compensation that is contingent on the purchase or sale of a financial product. This keeps fee-only advisors unbiased.
A fee only planner may not receive commissions, rebates, awards, finder’s fees, bonuses, or any form of compensation from others as a result of a client’s implementation of the individual’s financial planning recommendations.
Because AIO is only compensated by our clients, we can address a diverse array of financial issues that do not involve selling investment products.
However, the great majority of financial advisors are commission-based or fee-based. Which means they are receiving commissions on the products they sell their clients. This creates a conflict of interest. They may not be recommending the best investment for their clients because there are different commissions and incentives for this type of advisor.
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