The question that I hear more than any other is, 'How much do I need to retire?' If I am sitting in front of my computer when posed with that question, I input some numbers into my favorite spreadsheet and generate a comprehensive Retirement Income Projection that accounts for the numerous expected variables that are relevant to the person posing this very important question. Unfortunately, a spreadsheet and your favorite financial advisor are not always sitting across the table when this question pops into your head.
In situations where a simplified ballpark amount is useful, a person can generally assume that they will need an investment portfolio large enough where the amount removed each year will not exceed 4% of the total portfolio. Based upon various historical analyses, it has been shown that a person will not likely exhaust their portfolio as long as they do not withdraw more than 4% of their investments each year. Therefore, if a person has an investment portfolio of $1,000,000, an investor can plan to withdraw $40,000 during the first year of retirement. The investor can then assess whether this ballpark estimate is sufficient to meet their needs in conjunction with any other potential sources of income such as Social Security, pensions, etc.
The asset amount against which the 4% withdrawal rate is applied includes only those assets which can be liquidated in order to obtain the cash required for withdrawal. Therefore, the value of your house, jewelry or car should not be included in the value of your investment portfolio. If you plan to sell any of these assets, you can use their value in the calculation. For example, if you plan to sell your house and move in with a friend or relative you should include the equity in your house in the calculation.
Every investor should have a comprehensive calculation that considers the variables of your unique situation. However, the 4% rule is useful when you are not sitting across the table from a financial advisor with a computer and need a quick and easy estimate.