Jakarta, CNBC Indonesia – If you are planning for retirement and have started to build up funds for it, you should be familiar with a concept known as the 4% Rule. This concept is designed to guide the withdrawal of retirement funds so that you can finance your lifestyle without having to worry that the funds will run out quickly.
William P. Bengen introduced this mathematical concept through his article entitled “Determining Withdrawal Rates Using Historical Data.”
In simple terms, after successfully accumulating pension funds, you only need to withdraw 4% of the total funds in the first year of retirement to finance your life. The question now is, is this concept suitable for you? Let's discuss it.
How is the 4% Rule concept applied?
For example, you have a target of collecting IDR 5 billion in retirement funds by the age of 60. When you officially retire, in the first year, you only need to withdraw 4% of the total funds, namely IDR 200 million, to cover your living expenses for a year.
However, keep in mind that in the next few years, this 4% drawdown may become irrelevant due to inflation.
For example, if inflation rises by 2%, then the amount you withdraw will be IDR 200 million x 102% = IDR 204 million.
One common mistake in understanding the 4% Rule is when someone routinely withdraws 4% of their investments every year without paying attention to inflation and other factors.
Origins of the 4% Rule
Bengen previously conducted research and found that since 1993, stock investments generally provided a return of 10.3% per year, while bonds had a return of 5.2% per year.
By analogy with withdrawing funds, the results of your stock and bond investments will produce profits which will ultimately return the total value of your portfolio.
If someone successfully invests their pension funds according to target in both instruments, a first withdrawal of 4% and so on can keep the pension funds afloat for 50 years.
Suitability of the Concept for You
The 4% Rule concept is often considered more suitable for accumulating retirement funds in the long term, in contrast to people who wish to retire early, such as the FIRE generation.
It is important to remember that personal financial planning is personal. Every individual has different preferences and views regarding their finances. Apart from that, without having to withdraw your pension funds, you can also earn passive income by allocating your total pension funds in a lump sum to government debt instruments.
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