The 4% rule for retirement spending comes from a 1994 paper by financial planner William Bengen called Determining Withdrawal Rates Using Historical Data . Bengen showed that portfolios with 50% to 75% U.S. stocks and the rest in intermediate-term treasuries would last for 30+ years with yearly inflation-adjusted withdrawals of 4% of the starting portfolio value. However, Bengen assumed that you don’t pay any investment fees. Here I replicate Bengen’s study and look at how fees affect the results. The retirement spending plan tested by Bengen differs from my ideas on Cushioned Retirement Investing in two main ways. With cushioning, you adapt your spending somewhat if investment returns severely disappoint, and the cushion leads to your portfolio volatility dropping through retirement. Bengen tested a strategy where you choose the withdrawal amount based on your portfolio size at the start of retirement. Once the withdrawal amount is set, you only adjust it for inflation. Benge...

Most of us believe that we should reduce the riskiness of our portfolios when we retire. However, there is little agreement on exactly how to do this. One common rule of thumb is to use your age as your percentage in bonds. However, such fixed rules just don’t take into account people’s unique circumstances. I prefer a technique I call Cushioned Retirement Investing to reduce risk. This technique is based on the simple principle that you shouldn’t invest money you’ll need in the next 5 years in risky investments. There is nothing magical about the 5-year threshold. More daring types may choose 3 years, and more conservative types may prefer 7 years. I’ll stick to the 5-year figure for this discussion. The main idea is that you keep any money you’ll need in the next 5 years out of the main part of your portfolio. Because the main part of your portfolio only holds funds that will be there for 5+ years, it can stick to your preferred asset allocation for your entire life. If...

I had another full week of posts. How much longer will I keep this up? Working Out Your Retirement Magic Number How Often Should You Buy Stocks with New Savings? It’s Still Not Rocket Science Abusing the 4% Rule You can follow me on Twitter now ( @MJonMoney ). Here are some short takes and some weekend reading: Freakonomics discusses a study on the effects of long work hours. Just about every high-tech company I’ve worked for celebrates employees who work long hours. I’ve long known that my own performance drops off badly if I try to work too many hours. It’s not just that I’m inefficient in hours 9 through 12 of a given day – I’m likely to be inefficient the entire next day as well. Adequate exercise, rest, and mental relaxation give me the time to reflect and “work smarter.” If I work too many hours, I’m very unlikely to see a better way of getting things done. However, any discussion of these facts at work just sounds to management ears like a lack of commitment...

The 4% rule says that it’s safe to start retirement drawing 4% of your portfolio in the first year and increasing the withdrawal amount by inflation each year. There are important caveats that come with this rule, but they seem to get lost in the retelling. The 4% rule originated with an excellent and very accessible 1994 paper by financial planner William Bengen called Determining Withdrawal Rates Using Historical Data . Bengen showed that portfolios with 50% to 75% U.S. stocks and the rest in intermediate-term treasuries would survive well with yearly withdrawals of 4% of the starting portfolio value. The idea is that once the withdrawal amount is set, you only adjust it for inflation; Bengen assumes that you don’t adjust your spending based on your portfolio’s returns.  This inflexible approach is how he calculated his safe initial spending percentage, but he was clear that a real retiree may choose to increase or decrease spending in the face of a portfolio that is decli...

In a follow-up to It’s Not Rocket Science , Tom Bradley at Steadyhand has another investment book out called It’s Still Not Rocket Science . Like the first book, this one is a collection of a few years of Bradley’s essays explaining investment topics clearly. Bradley’s style contrasts sharply with the usual message from the investment industry that investing is very difficult and that you’d better hand over your money before it blows up. Disclaimer: I did not receive any compensation from Steadyhand to write this review other than a free copy of the book. My relationship with them is limited to having met a few times and liking how they treat their clients. I’m a DIY indexer myself, but for those seeking advice, Steadyhand offers lower fees than most other options. Further, Steadyhand is actually trying to beat the index rather than charging high fees for just hugging the index. Here are a few ideas from the book that jumped out at me. Measuring Personal Returns Most do-i...

My son recently set up his first TFSA and has $450 per month flowing into it. His plan is to buy Vanguard Canada’s exchange-traded fund VCN with this money. Once his portfolio grows, he’ll consider adding other stock indexes and other asset classes. After the first deposit, he asked me a good question: “how often should I buy VCN?” He was clever enough to figure out that making a trade every month might be too expensive, but if he waits too many months between trades, he’s giving up potential growth. There must be some optimum number of months between trades. The following factors affect the optimum interval between trades: m – yearly new savings r – excess yearly return of stocks vs. cash c – stock-trading commission Bid-ask spreads are a real cost, but they don’t enter into consideration because they are the same over the course of time no matter how often you trade. From these values we can calculate T – threshold cash balance when you should trade to minimize ...

How much money do you need to save to retire? This is an important question that gets a lot of debate but few useful answers. We hear arguments over whether a million dollars is enough, as though there is a single number that applies to everyone. Here I offer an answer based on a proposed retirement spending strategy that takes into account your unique circumstances. Lately, I’ve been writing a fair bit about a proposed strategy for retirement spending in retirement ( first description , adding income smoothing , yearly spending percentages , experimental results using 100 years of investment returns ). The focus was on turning a lump-sum portfolio into an income stream for retirement. But we can turn this around and calculate how much you need to save to retire using this spending strategy. I added another page to the spreadsheet that computes the percentage of a portfolio that you can spend each year in retirement based on a set of inputs you supply. (To edit this spreadsh...