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We're all looking forward to retirement, and if we're smart, we've been saving and investing for it, too. Here are three easy moves to help make your money last your lifetime.
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1. Consider the 4% rule
Selena Maranjian: One way to make your money last your lifetime is not to withdraw too much from year to year. There's a long-standing guidelinefor this -- the "4% rule" -- that says you can withdraw 4% of your nest egg in your first year of retirement and then adjust future withdrawals for inflation. This withdrawal strategy assumesa portfolio with 60% in stocks and 40% in bonds, and it's designed to make your money last through 30 years of retirement.
Here's how it would work: Imagine that you've socked away $500,000 by the time you retire. In your first year of retirement, you can withdraw 4%, or $20,000. In year two, you'll need to adjust that rate by inflation. Let's say that inflation over the past year was at its long-term historic rate of 3%. You'll now multiply your $20,000 withdrawal by 1.03 and you'll get your second year's withdrawal amount: $20,600. The following year, if inflation is still around 3%, you'll multiply that by 1.03 and get your next withdrawal amount, $21,218.
It's all reassuringly simple, but it's not foolproof and it does have some problems. For starters, we're living longer and longer and some of us are retiring rather early. If you retire at 60 and live to be 96, your retirement will be 36 years, not 30. The unpredictability of the stock market is another issue. If the first few years of your retirement are in a bear market, with your nest egg shrinking, you'll hobble it more with your withdrawals. Some suggest taking out less than 4% in bear markets and more than 4% in bull markets. To be more conservative, especially considering that we're in a period of low interest rates and, thus, low bond income, you might even start your withdrawals at 3.5% or less -- if you can.
The 4% rule is a fine place to start, but don't just use it blindly without periodically checking to see how you're doing.
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2. Use a bond ladder to cover your near-term spending needs
Chuck Saletta: Once you start spending money from your portfolio, it is vitally important that you have a portion of that portfolio where you can take those withdrawals no matter what the stock market does. That's where a bond ladder can be incredibly handy. A bond ladder is simply a collection of high quality bonds (such as U.S. Treasuries) that mature on a regular drumbeat schedule and that you intend to hold to maturity.
As part of a withdrawal strategy that uses a bond ladder, you'd be able to keep the rest of your money invested in stocks for their higher potential long-term returns. Say you need your portfolio to provide you $10,000 of income to cover your expenses and you expect inflation to run 3% per year. You could set up a bond ladder that looks something like this:
Each year, your bonds get one year closer to maturity, and as those bonds mature, you get your $10,000 of income, adjusted for your expectation of inflation. To keep your bond ladder around that initial seven-year length, you'd use the interest from your bonds, dividends from your stocks, and potentially some sales proceeds from your stocks to buy longer-term bonds in following years.
If the stock market performs well, you could sell more stocks to replenish or even extend the bond ladder. If the stock market performs poorly, you could slow down your stock sales and let the bond ladder shrink a bit. With a seven-year starting point in the bond ladder, you've got time to let the market work its magic with your long-term money while protecting your near-term ability to spend what you need.
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3. Flexibility is key
:Learning how to shift from being a wage-earner to someone who lives off of his or her nest egg can be a big challenge.When the markets are heading higher, it can be relatively easy to live within your means and stick to your plan. However, when the markets take a turn for the worse, the challenge can become a whole lot harder, and you could find yourself forced into selling assets at depressed prices just to pay for life's necessities.
Being forced into the latter scenario can quickly cause your assets to dwindle. That's why you need to build as much financial flexibility into your lifestyle as you can. Doing so will help to ensure that you can face any challenge that is thrown at you. You want tobe able to increase your spending when times are good and pull back when times are tough. Here are a fewstrategiesyou can use to increase your financial flexibility:
- Pay off all of your debts, including your mortgage, before you retire.
- Keep a six-month emergency fund in cash.
- Take expensive vacations when the markets are doing well, and stay local when they are not.
- Stay in touch with former co-workers. If times get really bad, it might not be a bad idea to pick up a part-time job, so having contacts that are still in the work force can be helpful.
The more financial flexibility you can build into your lifestyle, the better. Doing so will go a long way to ensuring that your money lasts a lifetime.
The article 3 Easy Moves to Make Your Money Last Your Lifetime originally appeared on Fool.com.
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