And I’ll second the thoughts on dividend paying stocks. That’s a class of investments that I can’t emphasize enough. It’s pretty easy to assemble a diversified portfolio of stocks with a yield of 3.5-4.5% if you choose carefully.

Dan @ Casual Kitchen

Now, if you only need your money to last 20 years or less, such as you’ve waited until age 80 to retire, or you’re 65 and everyone in your family has died by age 80 of the same diseases and you have all the same risk factors, or you’ve been diagnosed with something incurable, then it would be silly to try to preserve your capital forever.

For me, the hardest thing about retirement planning is remembering that I’ll probably be quite old during part of it. I probably won’t be able to have the same lifestyle if I get really bad arthritis, start forgetting important things on a regular basis, etc. What will I be doing instead? Will that cost more or less than what I’m doing now? Will it probably be okay to start spending capital by the time I’m having expensive health problems?

They have their roots in an older 5% rule that is used by charitable foundations. There the rule of thumb is that you can spend 5% of your capital every year and still grow your endowment. The catch is that you have to be willing to cut your spending in years when your endowment is down.

If your household spending is very flexible–if you could react to a 40% drop in the markets with a 40% drop in household spending, you could probably spend 5% of your capital every year and still grow your capital (on average). But most people’s household cost structure isn’t so flexible as that. Hence the 4% rule.

Most versions of the 4% rule allow you to grow your spending with inflation even when your portfolio is down. That’s what (on average) leads you to depleting your capital in a few decades. The real solution (no matter what rule you follow) is to do what I suggest in the main post–pay attention to your capital levels and reinvest enough income that you’re preserving the value of your capital.

(By the way, I had another response up above, but it’s being held for moderation, probably because it had links in it. I suppose it’ll show up eventually.)

As for the “need to preserve capital forever”, while it might be nice to predict the exact date and die with a zero balance, that ain’t going to happen.

In my grandfather’s time, he was told to save enough to last him till he was 72. He is now 93 years old and still with us. Thank goodness, he saved more than the average guy and only semi-retired at 65, working part-time until he was 89. He lived a great retired life as well – winters spent in Florida golfing. In the last few years he has started to feel a little pinched financially, but still has enough to support him and my grandmother (87) in the style they are accustomed to. There may not be very much left over for their kids, but they are happy to have made that trade.

Anyway, my point is that you have to save more just in case you live longer than expected.

Great article, by the way. A nice change from the usual “use one less toilet-paper square and save $50 over 10 years” stuff.

In other words, if I die early, they get their goods, and if I live long they get their inheritance over time with a warm hand rather than a cold one.

Regardless, I’d like to see some articles on reasonable life planning, not living forever planning. I think the differences could be eye opening for some who are often borderline when considering the gargantuan amounts of capital it takes to maintain income indefinitely.

For those off us not yet there, I think it is important to understnad the concept of getting our “extra” income to do something for us financially. Big or small, get it to do something.

If you do want to get there, you have to save substantially more than the 15% that is generally recommended. 30% will not cut it either. These numbers have been computed to maximize your lifetime consumption; not your financial independence. It’s a trade off.

If you save 50%, we’re getting there and you could become wealthy in around a decade, certainly less than two. This means that if you start early, you could live off your capital starting from your late 30s or early 40s. If you save 75% you can make it in half a decade. That may sound unbelievable, but if you run the numbers, it bears out: 5-6 years is enough.

Naturally, to reach these numbers some “stuff” must be sacrificed and only a few people are willing to give up their stuff. Yet for those who are, it can be done.

I didn’t word my original comment very well.

I liked this guest post if for nothing else it introduced the concept of living off something else than “earned income”. I would bet 50% of people (or more) don’t even realize that is an option.

@ABCs of Investing: You’re right that you have to be very clear about how much of the money that you’re getting is really “income” and how much is simply a return of your own capital. With TIPS it’s quite clear, but with most other investments you have to look pretty closely before you can just assume that the dividends that you’re getting are being paid without invading your capital. In the end, you have to take the responsibility to reinvest enough to keep your capital intact against not just inflation, but also sneaky fund managers that are trying to make themselves look good by paying you dividends out of your own capital.

I’ve read some people talk about “living off the dividends” and not withdrawing anything from their investments which is an illusion.

Another factor is that you can invest in very low-income investments (treasury bills). Living off that income might mean withdrawing only 1-2% of the portfolio each year. On the other hand you can invest in securities (REITs come to mind) that have very high dividend yields – partly due to riskiness of the underlying business and partly because some of the dividend is probably return of capital). Living off that income might mean you are using a withdrawal rate of 10%+ each year which is quite dangerous.