Everyone has the same goal in retirement: Don’t run out of money!
But there are numerous different strategies that are used to ensure your money will last.
Here are 3 of the most popular strategies.
Sacred Principle
The first strategy is the simplest.
It is simply to only spend your growth/interest and never touch your principle.
So if you retire with 800k then you never spend the core 800k. You only spend the growth/interest that the 800k produces.
So if your 800k grows to 830k one year then you can spend the 30k in growth.
But if your 800k goes down in value or just doesn’t grow then you don’t spend anything.
Pros: It is simple and easy to understand.
Cons: This strategy doesn’t produce a steady income stream every year. Some years you will have lots to spend and other years you won’t have any.
The 4% Rule
The 4% rule is a strategy to produce a steady income stream from your investments for the rest of your life.
This is how it works. You multiply the amount of investments you have at retirement by 4%.
So if you have 500k then 4% would be 20k.
The 4% rule says you can spend 20k (4%) in the first year of retirement. And in the following years you simply take the previous year’s withdrawal amount and increase it by what inflation was that year.
So if you withdrew 20k the first year and inflation was 5% then in year two you could withdraw $21,000 (5% more). In year 3 you increase $21,000 by whatever inflation was, etc…
If you follow the 4% rule then the odds of you running out of money is very small.
Pros: It is relatively simple and produces a steady inflation adjusted income stream for the rest of your life.
Cons: If your investments have good growth in retirement then the 4% rule may be too conservative and you’d be leaving retirement income on the table.
Dynamic Distribution
This strategy is designed to solve some of the problems with the 4% rule.
It is similar to the 4% rule in that it starts out with a percentage you can spend per year like 5%.
But it is ‘dynamic’ because the withdrawal amount may go up or down depending on how your investments perform over time.
For example, if you retire with 500k then a 5% withdrawal rate would give you 25k per year in income. But if your investments were to rise or fall to predetermined levels then you would adjust your withdrawal up or down.
For example, if your investments grew to 600k then you would adjust your withdrawals up and if your investments fell to 400k then you would adjust your investments down.
Pros: This strategy allows for a larger initial withdrawal rate (larger than 4%) and potential for increases if your investments do well.
Cons: It is a more complicated strategy to implement and you’d have to be okay with adjusting your withdrawals down when your investments don’t do well.
Note: The devil is in the details for this strategy. The examples above were just simple examples of how this could work but you’ll want to do your own research.
Your Best Strategy
So which is the best strategy?
There is no perfect answer as it depends on your money goals and which one you are comfortable implementing over time.
The most important thing is that you have a strategy that you understand and that works well with your retirement plans.
