Manage Your Spending
To avoid running out of money during retirement, the standard rule has been to withdraw 4% from your nest egg in the first year of retirement and use the inflation rate as a guide to adjust withdrawals in subsequent years. For example, if you have $1 million, you can withdraw $40,000 in year one. If the inflation rate clocks in at 2% in year two, your withdrawal grows by 2%, to $40,800.
The 4% rule is based on historical market returns for a portfolio evenly split between stocks and bonds. But as the saying goes, past performance is no guarantee of future returns. Plus, the rule assumes you will live 30 years in retirement, so you might want to adjust the withdrawal rate up or down based on your life expectancy.
Still, you should do just fine if you use the rule as a starting point for withdrawals. In fact, T. Rowe Price tested the 4% rule for a worker who retired in 2000 with a $500,000 portfolio (60% stocks, 40% bonds) and experienced two bear markets—the 47% drop in Standard & Poor’s 500-stock index in 2000–02 and the 55% drop in 2007–09. Though the retiree’s balance shrunk to about $300,000 by 2009—a 40% decline—the subsequent bull market helped restore the balance to $414,000 by the end of 2016.
Like any rule of thumb, the 4% rule won’t work for every Amaya Colonia retiree or in every situation. You might need to reduce the withdrawal rate if you retire early or have a major expense, or if a market downdraft wipes out a chunk of your nest egg. Or you might increase it if your investments have appreciated more than expected, or you’ve spent less than you anticipated and have built up a sizable balance.