Cutting Edge Insights
with Dr. Lee

Which 4% Rule Do You Follow?

Within financial discourse and economic verbosity, the number 4, specifically in the sense of 4%, seems to have a prominent role.  For example, I stumbled upon several “rules of thumb” during recent readings that all make 4% important as a metric of something:

  1. You should be able to withdraw 4% of your retirement fund balance annually during retirement without risk to principal.
  2. Out of 100 people starting their careers, by age 65, 4% will be financially stable.
  3. The average American family barely has 4% of the recommended emergency fund.
  4. A mere 4% of all stocks accounted for ALL the stock market gains from 1926 to 2016.

A deeper dive:

Rule #1:  You should be able to withdraw 4% of your retirement fund balance annually during retirement without risk to principal.

This guideline was developed by William Bengen in 1994.  It could be looked at as another way of saying, “You need to accumulate about 25 x what you plan to withdraw every year in retirement.”  Financial stalwarts more recently will tell you that based on your specific asset allocation, you may even be able to adjust this figure upward to 4.5%.

But I don’t like it.  It’s heavily dependent on current returns.  And it’s another way of saying, “Work really hard and accumulate a mountain worth of liquidity your entire life, then slowly plunder your supply of golden eggs.”

My preferred mechanism is, “Work and buy an asset, which is a goose that lays golden eggs.  Keep the asset performing (laying golden eggs).  Buy another goose when you can.  Don’t dismember the goose because you will then lose your supply of golden eggs.

Rule #2:  Out of 100 people starting their careers, by age 65, 4% will be financially stable.

This was part of the results from a study by the Social Security Administration.  The rest of the study said that 36 people would be dead, 54 dependents on the government or family, 5 still working, and 1 wealthy.

Interesting.  I wonder whether the results would be different, if financial education and literacy were taught in schools before young people started their career.

Rule #3:  The average American family barely has 4% of the recommended emergency fund.

This is a totally made-up rule.  In the spirit of full disclosure, I fabricated it.  But I did not fabricate the fact that the average American family is only $400 away from financial disaster (see references below).  I extrapolated this and in doing so, I assume that the ideal emergency fund is $10,000.  The reality is that your family’s emergency fund needs to be whatever allows you to sleep well at night.

This rule reminds me of Robert Kiyosaki’s definition of financial intelligence.  That is, “The size of the financial problem you are able to solve.”  For example, Robert can likely solve a problem worth 8 figures, Warren Buffet 9 or 10 figures (or more).  Unfortunately, according to the article, most Americans’ financial IQ is well under 4 figures.

Rule #4:  A mere 4% of all stocks accounted for ALL the stock market gains from 1926 to 2016.

I found this one remarkably interesting.  Again, raw data is below in references.  Further, in a period from 1998 through 2017, the median stock only had a 2% annualized return. {Median means half had greater, half had less.  Not to be confused with average or mean, which is weighted, and therefore skewed by outliers.}  The average return was 6.1% annually.

I’m not a financial advisor, but I feel this would underscore the need to diversify one’s portfolio of stocks if that were one’s investment vehicle of choice.  Historically, diversification has been positioned as a way of spreading risk of loss, but this article makes me feel like it’s also necessary to spread out the hope of gains.  Note the operative word, hope.

Of course, I’m biased toward real estate.  Big surprise.

As you think about that, remember that financial education is the first and most important step necessary to avoid becoming a statistic of American financial reality.

Until next time,

Dr. Lee Newton

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References

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Which 4% Rule Do You Follow?

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