Other Retirement Investment Strategies
Financial advisors recommend several retirement saving strategies. Each recommendation has pros and cons you should examine. To begin, let’s explore three common guidelines.
Percentage Of Your Salary
Some experts recommend saving at least 70% – 80% of your pre-retirement income. So, if you made $100,000 a year before retiring, you should plan on saving $70,000 – $80,000 for each year in retirement.
This investment strategy is easy to calculate and provides a good estimate of how much you need to save for retirement.
Accounting For Inflation
But there are disadvantages to only using a percentage of your salary to calculate how much you need to save to retire comfortably. A major downside is that it doesn’t account for inflation. You must adjust your salary forinflationto better estimate how much you’ll need to retire. You can use an inflation calculator or theRule of 72formula to adjust for inflation.
Divide 72 by the average inflation rate to calculate the number of years it takes to double your cost of living. For example, if inflation is at 3%, it’ll take 24 years for your cost of living to double.
The Rule of 72 is a good guideline, but you’ll get more accurate results with an inflation calculator.
Another downside to using a percentage-based strategy is that it’s hard to know how much money you’ll need because there’s no way to predict how long your retirement will last. However, you can still use the strategy as a guideline to help you determine what percentage of your income should be allocated to retirement and savings accounts.
The 4% Rule
The 4% Rule is a guideline for withdrawing money from yourretirement assetsso your funds can last at least 30 years. According to the rule, you make a 4% withdrawal from your accounts in the first year and adjust your withdrawal rate for inflation over the following years.
Let’s say you plan on living on $40,000 a year during retirement. According to the 4% rule, you’d need $1,000,000 to retire, or 25 times your annual expenses. And in your first year of retirement, you’d withdraw $40,000.
If inflation were 4% in year one, you’d withdraw $41,600 the second year ($40,000 X 0.04) + $40,000 = $41,600.
Concerns About The 4% Rule
You may have seen the 4% figure floating around, especially among members of theFIRE movement(Financial Independence, Retire Early). That’s because one of the biggest fears (and risks) for retirees is their funds running out.
The 4% Rule is easy to follow, but it has disadvantages. For example, withdrawing 4% each year when you don’t have enough saved may cause you to run out of money faster. And the rule doesn’t account for market fluctuations. Further, the 4% Rule assumes a 30-year retirement. Increase your life expectancy or plan to retire early, and you’ll need to have more saved for the 4% Rule to work.
