my favorite charts, part 3
the 4% rule
When it comes time to determine your retirement number, i.e. the amount of money you need to have saved before you can retire, you’ll have to make some assumptions. And while that can be somewhat scary, you can take solace in the fact that there is some science behind the process.
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In 1998, Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz published a paper in the American Association of Individual Investors Journal entitled “Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable”. (The sixpage journal article became known as the Trinity Study, owing to the fact that the three authors were professors of finance at Trinity University in San Antonio, Texas.) In the article, the authors conclude:
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“For stockdominated portfolios, withdrawal rates of 3% and 4% represent exceedingly conservative behavior. At these rates, retirees who wish to bequeath large estates to their heirs will likely be successful.”
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For those who have no interest in leaving behind a huge nest egg for their heirs, the 34% figure may seem way too conservative. In fact, the authors also conclude that “for short payout periods (15 years or less), withdrawal rates of 8% or 9% from stockdominated portfolios appear to be sustainable.” The issue with that statement is that many retirees will live more than 15 years after they retire. Would you rather have a little left over at the time or your death, or run out of money with time left on the clock? Seems like a nobrainer to me.
Of course, risk tolerance is varies greatly from investor to investor. Some may be willing to roll the dice with a 67% withdrawal rate every year. Others, like myself, may find comfort in the 45% range. The Trinity Study lays out all the scenarios and shows you the success rate of each. (Success is basically defined as not running out of money at the end of the time period.)
How to Read the Data
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The leftmost column breaks down five different portfolio types: 100% stocks, 75% stocks/25% bonds, 50% of each, 25% stocks/75% bonds, and 100% bonds. Each portfolio type is then broken down into four time periods: 15 years, 20 years, 25 years and 30 years. Across the top of the table, you’ll see that the column headers are percentages ranging from 3% to 12%. These are withdrawal rates as a percentage of the portfolio’s initial value. Finally, the numbers in the body of the table are percent success rates, ranging from zero to 100.
Ok, that’s a lot of info for such a small table. Let’s use an example to make things easier.
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A 62yearold retiree has a portfolio consisting of 50% stocks and 50% bonds. She has family members who live well into their 80s and being healthy herself, wants to ensure that she doesn’t run out of money if she lives into her early 90s. For her, this means that she’d like her retirement nest egg to last for 30 years. Using the table, she moves down the leftmost column and finds the portfolio that consists of 50% bonds and 50% stocks. She then chooses the ‘30 years’ row and evaluates each withdrawal rate.
She notes that she can likely withdrawal 3, 4, or even 5% of her nest egg each year and not run out of money at the end of the 30 year time period. She also notes that she could roll the dice a bit and spend 6% of her nest egg annually and still have a 98% chance of not running out of money. As a conservative person, she decides that a 4% withdrawal rate is best for her.
Let’s take this example even further. Suppose the retiree multiplies her retirement nest egg by 4% and decides that she can’t live off of that dollar amount each year. She has two options: reduce her spending in retirement or go back to work!
Take Home Points
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Determining a target retirement “number” can seem daunting, scary even. For the average investor, the Trinity Study should remove some of that fear from the process. Here’s how the Trinity Study’s 4% rule is put into action:
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Determine the amount of money you’ll need each year in retirement. Let’s say that number is $70,000.

Multiply that number by 25. (Why 25? 4% expressed as a fraction is 1/25. So the dollar amount from step 1 is simply onetwentyfifth of the total retirement nest egg.) $70,000 x 25 = $1,750,000.
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Voilà, that's it. Based on the 4% rule, an investor who saves $1,750,000 can safely spend $70,000 per year in retirement without running out of money.
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Use the 4% rule to determine your “number”—it’ll help your retirement plan take shape!