RFI vs the "4% Rule"


RFI vs the "4% Rule"


The "4% rule" is a common method used by financial advisors and retirees to determine "safe" spending during retirement.  The rule generally states that a retiree can withdraw 4% of their original financial asset balance each year, plus an annual inflation adjustment.  One problem with the 4% rule is that it involves a small but significant risk of running out of money in old age.  A major feature of RFI is to develop spending strategies that reduce or eliminate this risk.

To see how a retirement strategy based on the 4% rule compares to an RFI strategy, first click the "Display 4% Rule Scenarios" check-box in cell A42.  The box shown below will appear underneath the input table for the 6 RFI scenarios.

In this case we are using a materialized rate of return of 3.6%.  This rate is based on a 50/50 portfolio of stocks and bonds, and is the 2nd percentile return for historical 25 year holding periods (see RFI RISK Profiles and Historical Returns for more information on this topic).  The projected spendable funds for this 4% rule strategy (Scenario 1 above) is shown here:

There are a few things to note on the above chart:

The next step is to compare the 4% rule strategy to an RFI scenario as shown in the input tables below.  Note that in RFI Scenario 1 we are setting both the "Assumed Rate of Return" and the "Rate that Materializes" to be the same 3.6% rate of return used in the "4% Rule" Scenario 1. (For more information on how to define a basic RFI scenario see RFI Fundamentals).

After entering the input values, click the "Calculate" button for Scenario 1 (cell O45) to display the comparison chart:

Note that in this case RFI results in an initial monthly spendable funds amount that is approximately $460 higher than with the 4% rule.  Perhaps more importantly, the RFI strategy includes an annuity payment that continues for the life of the retiree.

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