Is the 4% Rule outdated?

We are all told to save as much money as possible for retirement, but how much is enough? For years, experts have relied on the 4% rule to help determine how much savings someone needs.

The rule states that if you begin by withdrawing 4% of your nest egg's value during your first year of retirement, and then adjust subsequent withdrawals for inflation, you'll avoid running out of money for at least 30 years. Not only is the 4% rule a nice idea in theory, but it has been tested and proven successful time and time again.

But the 4% rule is far from perfect and here are three specific problems to watch out for.

1. It makes assumptions about your investment mix

The 4% rule is designed for portfolios with a relatively equal mix of stocks and bonds -- specifically, 60% stocks and 40% bonds. But maybe that mix is not what you desire or comfortable with. Over time, that could throw everything off.

2. It is outdated

We just learned that the 4% rule assumes a relatively healthy mix of stocks and bonds. But the rule was also developed during the mid-1990s, at which point bond interest rates were significantly higher than what they have been for the past number of years. In other words, bonds cannot generate the same sort of growth today that they could in years past, which calls the rule's formula into question. And given that the Federal Reserve raised interest rates three times last year alone, we might see bond values begin to drop even lower.

3. It might cause you to sell your retirement lifestyle short

The 4% rule is designed to make your retirement savings last for 30 years. But some of us may not need three full decades' worth of retirement income, especially given the number of people who are working longer these days. And while it is always nice to be optimistic, the fact of the matter is that only about 10% of seniors will end up living until 95. Another factor could be that we are in much better shape at the beginning of our retirement than later and want to do more things early on in retirement, like travelling.

A better way to use the 4% rule

But even if a yearly 4% withdrawal rate may not be ideal for you, it should give you a general ballpark of what to expect. It is a pretty good starting point to work with as far as retirement planning goes but that is all it should be, a starting point.

Most cannot get away with removing 10% of their savings year after year but sticking to a mere 2% withdrawal rate may not be necessary either. The beauty of the 4% rule is that despite its drawbacks, it gives us a benchmark to work with. And that is something most of us can use. I prefer for my clients to re-assess the withdrawal rate on a yearly basis since want’s, needs and market conditions change constantly. In the end it is your money and you should be in control of it, not some ‘experts’ determined average. We all know the problems with averages.