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.
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 2013 of $ $1,012.50 and you have the in an investment or other accounts of $1,000,000, you can spend $49,806.40 the first year. Your CPP would be worth $1,012.50x 12 x 20 or $ $245,160.00 so you will start with $1,245,160.00 and 4% of this is $49,806.40
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 vary 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.
I stopped working and have been living on my dividend income from 1999. I started off using this 8%, 4% rule, but changed my mind after the 2000 stock crash. I now only take out what I earn in dividends each year. In 2000 I was taking out 4% and earning 3% in dividends. I changed this to 3.5% withdrawals and 3.5% dividend income. Currently I am earnings still around 3.5% income and I expect to take out just under 3% this year.
On my other blog I am today writing about High Liner Foods (TSX-HLF, OTC-HLNFF)...continue...
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