This rule was advertised by the finance industry since mid-90s, when a paper had been circulated stating that withdrawing 4 per cent from your portfolio a year will make it last for at least thirty years.
Before we look into the background and underlying assumptions lets have look at the 30 years of retirement. This is particularly important to note that healthy working life expectancy at the age of 50 years is on average 9.5 years for men and 8.5 years for women. This means that the healthy working life expectancy at age 50 years in the USA and the UK is below the remaining years to State Pension age. So out of the average life expectancy of 80 years old, last twenty are in poor health, where people are unable to enjoy the life.
Interesting that the four percent a year withdrawal underlying
assumptions are largely omitted by the finance bloggers and the mainstream
media.
There are three main ones:
#1 Firstly, after you spent four percent in the first year,
you need to increase that amount by inflation each year.
#2 Secondly, your withdrawal rate is four percent of the
initial portfolio. Whatever happens you need to keep it that way, for the
calculations remain true. Imagine,
even if your portfolio would increase substantially due to the stock market
growth, you should keep your initial withdrawal rate constant.
#3 Thirdly, you need to keep your nest egg invested in a
50/50 mix of equities and fixed income, re-balancing it back to 50/50 each year as
the market moves. The imaginary portfolio
that was used for calculations, was also consisting of intermediate term
Treasure notes. The long-term average for them was 4.41%, while current rate is
0.81%. In the most recent years, it is 1.8%. The government policy in the USA
is to keep them that way for the next five years or more. The UK is even worse,
where the long-term gilt yields are at their lowest level in 300 years,
depressing prospective investment returns.
