Saving for retirement is not an easy thing to do. But finding the money for retirement savings is only half the battle. You’ll also need to invest your money so it grows into a larger amount over time. And to that end, you’ll generally hear that it’s best to invest in the stock market, despite the risks involved.
Of course, once you manage to build up your retirement nest egg, you’ll need to manage that money strategically. And that can be a tough thing. You’ll need to strike a balance between having access to an annual income that lets you live comfortably while minimizing risk in your portfolio.
For years, financial experts were quick to recommend the 4% rule for managing a retirement portfolio. The rule states that if you withdraw 4% of your portfolio’s value your first year of retirement and adjust future withdrawals as needed for inflation, your savings have a strong chance of lasting 30 years. If you retire at a fairly traditional age, there’s a low likelihood of running out of money with the 4% rule.
Financial guru Dave Ramsey, however, has a different suggestion for managing a retirement portfolio — the 8% rule. However, you should know that his strategy carries a lot of risk.
How does the 8% retirement rule work?
The 8% retirement rule is similar to the 4% rule, only it allows you to take withdrawals that are twice as large. With Ramsey’s strategy, you withdraw 8% of your portfolio’s value your first year of retirement and adjust future withdrawals for inflation.
To allow for that larger withdrawal rate, though, Ramsey recommends investing 100% of your retirement portfolio in stocks. And there lies the problem.
The 4% rule is based on the assumption that your portfolio has a fairly even mix of stocks and bonds. And many financial experts agree that a mix of that nature is appropriate for this stage of life.
It’s one thing to invest heavily in stocks when you’re in the process of building up a nest egg and retirement is many years away. If you’re not anywhere close to taking withdrawals from your savings, then you can ride out a stock market downturn and allow your portfolio to recover.
But if you’re already retired and are therefore living off of your portfolio, Ramsey’s guidance is very risky. If the stock market were to crash and the value of your portfolio were to shrink at a time when you’re using it for income, you may be forced to lock in losses. That could, in turn, put you at risk of running out of money later on.
How to use the 8% retirement rule
The 8% retirement rule allows for a more generous income than the 4% rule. If you’re willing to accept the risks involved, it could make for a more fulfilling retirement.
If you’re going to take Ramsey’s advice, though, then one thing you absolutely want to do is make sure to have two years of living expenses or more in cash. That way, if the market experiences a downturn, you’ll have some leeway to leave your portfolio alone for a good amount of time, allowing the value of your investments to recover.
Without adequate cash reserves, the 8% rule is very risky. Even if you’re okay with risk, you don’t want to put your long-term financial security on the line. Playing it safe with a cash backup plan could make this strategy work for you.
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