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"I frequently see advice that if you invest in stocks you can safely withdraw 4% of your investments each year for retirement."

You will also see a rule of thumb that indicates you can use 5% safely. Like all rules of thumb they are guidelines - not guarantees.

What this rule of thumb is trying to do is to make certain that the investment pool is large enough so that as inflation increase, the actual dollars drawn can increase without the jeopardy of running out of investment before running out of life.

Let's take an example. Assume you are making $50,000
the year you retire and you decide you need or want $50,000 a year to come from investments. The 5% rule of thumb (4% rule of thumb) would mean that you would need $50,000/5.0% = $1,000,000 invested ($50,000/4.0% =

Most Fools know that in retirement a person could live easily another 15 - 20 years (and for us Fools who want to retire early it might be closer to 30) Well,
$50,000 in 15 years with only a 3% inflation rate will buy $32,093 worth. Thus in 15 years with a 3% inflation in order to have the same buying power, a Fool would need to withdraw $77,898.

This can still be accomplished with investments getting anything more than 8% return. (5% draw and 3% inflation). An 8% return averaged over 15 years is not too hard to hit with a mix of equity,CD, bonds funds.

There was one stretch of 10 years when S&P 500 did not return 5%. In this case, drawing 5% with inflationary increases would reduce the investment principle and so would a 4% draw.

Rule of thumbs are only a good stating point.

BTW, your bond scenario regardless of the calculation will not make up for inflation.

I hope this explains why 4 or 5% draw is used - so that your actual amount of the draw can increase to keep up with inflation.

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