Don't bother with the 4% rule: Why it isn't as desirable in 2020 as it once was

What is the 4% rule? Why does it matter? Let's dive deep!

We'll split this article into 3 sections:

1. What is the 4% rule

2. Our current situation with the pandemic

3. How this affects its popularity

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1. What is the 4% rule?

A 'rule of thumb' for living within your means after retiring.

Let's say you retire at 60, your 'nest egg' has $1 million. Now you have set yourself a life expectancy of around 85 years of age- that's 25 years in retirement.

Now, you're one of the many Mama Birds, and as Mama Birds, it is to your best interest to preserve that $1 million in whatever way you can. Now, most Mama Birds choose to put this million in a bank, with very low interest rates and redraw from it whenever they need it.

This means, living up to 25 years in retirement, every year the Mama Birds have to have a set amount of money for expenses ready to spend.

This set amount of money = nest egg ($1 million) ÷ number of years in retirement (25 years)

Each year, the Mama Birds will have $40,000 to spend. And when they do reach that predicted life expectancy of 85, they will have $0 in their accounts. (Assuming that every year the Mama Birds spend the exact figure of $40,000 and stays loyal to that amount)

We will use this figure throughout the article:

Principle: $1 million

Retirement period: 25 years

Maximum amount to be spent per year: $40,000

The percentage here is 4%

Now, what if the Mama Birds live over 85? They will not have enough to sustain their lifestyle. Their principle of $1 million is gone.

But you're not most Mama Birds, no, you're the Mama Bird, so you decide, heck no, I'll not eat into my principle of $1 million, I'll flap my last flap of wings still having that $1 million, whilst living comfortably for those 25 years. That's where the 4% rule comes in.

P.s. I feel that this is a good time to add that birds, Mama Birds or otherwise, do not usually live up to 85 years of age. Sorry to kill your dream, kid.

Now Mama Bird here decides to use the 4% rule, meaning she will invest that $1 million, that earns her more than 4% interest per year. (4% is the number Mama Bird settles for, in reality, this can be any percentage, depending on your spending appetite). So Mama Bird invests in stocks, bonds, shares, whatever earns that 4% or more for her every year.

Mama Bird also has 25 years of retirement to go, with $1 million in her account. But, by earning the equal or more than the amount she requires for spending each year, she does not eat into her principle, her nest egg, that $1 million.

The main idea is that you earn that 4% from your investment of that $1 million each year, and use this for your expenses through the year.

Photo credits: alice-in-wonderland.net

The sad thing is, that's a fantasy only the Mama Bird gets to live. We humans do not have that idealistic retirement life. Sorry to kill your second dream, kid.

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2. Our current situation with the pandemic

With the pandemic slapping our faces, the fantasy of that 4% retirement life cannot be further from reach.

Here's the thing about the pandemic:

When the economy isn't doing well, we have to cut the interest rates. Cutting interest rates allows a spur in the economy by encouraging businesses to continue doing business activity e.g. borrowing with low interest rates to keep their business alive.

But this works in the other way as well where most bonds' interest rates also plummet, not giving that 4% or more per year anymore. This means that you would have to take a cut in the return on your principle, since you wouldn't be earning that 4% anymore.

If anything, most countries have negative interest rates, meaning instead of earning something from your investment, you have to pay that negative interest rate.

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3. How this affects its popularity

With the general economy and hence those interest rates going down, down, down, down, the 4% rule cannot be realistically applied anymore. There is a consensus that a 2% rule (or really, anything lower than 4%) would be more feasible and achievable than the 4% rule. With 2% per year rather than 4%, that means your expenses will also have to take a cut.

With interest rates being low, a new '% rule' benchmark needs to be set. Mama Bird may not be too safe with that nest egg anymore.

Photo credits: disney.fandom.com

Or, Mama Bird could go wild in Vegas and gamble for higher risk, higher reward-

Article coming soon!