Thursday, July 10, 2008

Retiring Using 8%, 4% Rule

In trying to figure out how to handle retirement, I came across the 8%, 4% rule.

There are three main risks to retirees. They are longevity risk, inflation risk and market risk. This is from Jonathan Chevreau column of June 14th, 2008. He was talking about Dr. Moshe Milevsky’s book Annuities are Personal Pensions. See and
and Note that Dr. Milevsky does not talk about the 8%, 4% rule, but I think that the longevity risk, inflation risk and market risk are important to this discussion.

The 8%, 4% rule means that you should count on making 8% a year on your investments and you should count on spending 4% a year from your investments. The 8% return is not too difficult, especially if you have some good dividend paying stocks in your portfolio. You can usually count on making 2% extra on dividend paying stocks. It is a good idea if you use stocks that increase their dividends at least at the long term background inflation ration rate of 3%.

To get an idea on what your pensions are worth, say a pension like the CPP, multiply your annual pension amount by 20. CPP is indexed to inflation so the 20 factor is about right. However, if you have a pension that is not indexed to inflation, the factor to use would be 5 or 10.

So, roughly, if you say have saved in an investment or other accounts $1,000,000, you can spend $40,000 and you would hope to make $80,000. The next year you will start with $1,040,000 and can take out $41,600 and expect to earn $83,200. If you are receiving the top CPP amount for 2008 of $884.58 and you have the in an investment or other accounts of $1,000,000, you can spend $48,491 the first year. Your CPP would be worth $884.58 x 12 x 20 or $212,299.29 so you will start with $1,212,299.29 and 4% of this is $48,491.

No one knows how long he or she will live, so with the 8%, 4% rule, you will have money until you die. Yes, you might leave an estate, but you also might have high expenses the last few years of life. This plan basically plans on 4% increase in income per year to help with inflation. The long term background inflation maybe 3%, but it can very greatly. There is also the market risk. With the higher than inflation increase per year, you will have some flexibility to decrease the amount you spent each year.

For a list of the stocks for which I have put up spreadsheets, see my web site at

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