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Retirement planning is hard. Beyond the math, there’s a psychological hurdle that trips people up: shifting from decades of saving money and earning income to suddenly needing those savings to last a lifetime.
How do you convert your career earnings into a big enough nest egg? And once you get there, how much can you safely take out?
These questions keep people up at night. Let’s tackle them head-on.
The Longevity Challenge
Here’s a stat that should reframe how you think about retirement: a couple aged 65 has a 25% chance of at least one person living to age 96. That’s potentially 30+ years of retirement, as long as your entire professional career.
Studies show that individuals consistently underestimate their life expectancy. They believe it’s more strongly linked to genetics and their parents’ experience than it actually is. At the same time, they overestimate market volatility during retirement. This combination leads to poor planning decisions.
You can’t save your way to enough money without getting growth on those career earnings. I’ve run the numbers using a 30-year accumulation phase: money in the bank earning 2.5% versus a portfolio of stocks and bonds earning 6% (which is actually below historical averages). Investing cuts your savings burden by close to half.
The takeaway? You need growth. Sitting in cash won’t get you there.
The 4% Rule: Your Starting Point
If you don’t have a detailed financial plan yet, the 4% rule is a great starting point for figuring out your number.William Bengen created this rule in 1994. He was a young financial advisor who wanted to figure out the retirement math for his older clients. He looked at historical returns for a 60/40 portfolio and inflation history and concluded that 4% of your initial portfolio value is a safe retirement withdrawal rate that you can increase annually for inflation over 30 years.
Here’s how it works: if you have $1 million, you’re taking out $40,000 that first year. Every year thereafter, you increase that amount by roughly 3% for inflation. It’s not 4% per year. It’s 4% as your baseline, adjusted upward over time.
The rule has been poked, prodded, and revisited over three decades, including by Bengen himself. It’s stood the test of time. There’s actually a strong argument you can withdraw more than 4% since Bengen calculated the rate that would never fail, and he had a less diversified portfolio than what investors can access today.
If you’re close to retirement, 4% of your portfolio value is a healthy gauge. If you’re further out, multiply what you want to spend annually from your portfolio (not including Social Security or other income) by 25. That’s your target in today’s dollars.
The Retirement Smile
Understanding how spending flows through retirement matters more than most people realize.
Research on retiree spending patterns reveals what’s called the “retirement smile.” Early retirement tends to be active and expensive, filled with travel, hobbies, and that bucket list. Spending often dips in the middle years. But don’t assume you’ll coast into your later years spending less, because health and long-term care costs increase dramatically and round out that smile.
One way to improve your plan outcomes: consider long-term care insurance. Not enough people do. Women in particular are strong candidates. They’re twice as likely to be widowed and more likely to be a caregiver for an elderly family member, which can derail retirement savings.
When planning your 4%, don’t anchor to the lowest spending years. Plan for the higher numbers, knowing later-life costs will likely bring you back there.
Investing Well Is Simple, But Not Easy
During the early days of COVID, I put on some weight. Not the full “COVID-19,” but close. By fall, I’d lost the extra pounds. A friend asked how I did it, looking at me with great anticipation for the secret I was about to reveal.
The answer? Moving a lot more and eating a lot less. Simple, right? But not easy.
Investing is the same. Buy a diversified basket of low-cost funds or ETFs. Hold them. Don’t sell. Whenever you have new money, buy more. Look out 20 or 30 years, and you’ll have a great nest egg. Simple, but definitely not proven to be easy.
Morningstar has done a 10-year study five times showing how investors performed in the funds they owned compared to how those funds actually performed. Through bad market timing, investors underperformed their own investments by 1.1% per year. Every category, including index funds, showed this gap.
The Mistakes That Derail Retirement
Not knowing market history. Over one-year periods, stocks can be down 37% or up 52%. Over 20 years? There’s no historical period of losing money in stocks, bonds, or a blend. The long game is undefeated. Stay in the market.
Impatience. The stock market transfers money from the impatient to the patient. I see people with solid diversified returns develop fear of missing out because a subset of AI-driven tech stocks is outperforming. Remember: you’re investing to fund your retirement, not to brag at the golf course.
Misunderstanding “never lose money.” Warren Buffett’s rule isn’t about short-term volatility. It’s about permanent loss of capital. A stock going to zero is permanent. The market dropping 30% while you stay invested? That’s temporary. You recover. Too many people fight the wrong battle trying to avoid volatility instead of avoiding speculation, concentrated portfolios, and market timing mistakes.
Holding too much cash. In the long run, cash is not king. After taxes and inflation, you’re losing money compared to stocks and bonds. Figure out your rainy day fund (three to six months of expenses) and put the rest to work.
Relying on income-only strategies. People don’t want to touch principal, so they chase yield. This leads to longer-term bonds with more interest rate risk (30-year Treasuries lost 39% in 2022), lower-quality bonds that correlate with stock market stress, or dividend-focused portfolios that sacrifice diversification. A total return approach, investing for the best long-term returns given your risk tolerance, is more effective.
The Tax Piece
Charlie Munger said that when you buy and hold, the government’s tax system gives you an extra one to three percentage points per year with compound effects. He was talking about lower portfolio turnover, but I’d expand it to include asset location and tax-loss harvesting.
Target lower turnover investment strategies. Look for funds turning over every few years at most. Use asset location to shelter less tax-efficient investments in retirement accounts. And in down markets, selectively harvest losses in your brokerage account to offset future gains.
Finally, grow your tax-free bucket. Roth contributions grow tax-free and come out tax-free. Even if you make too much to contribute directly, backdoor Roth contributions are available to almost everyone. Most people miss this, even those getting good financial planning advice.
Putting It Together
Target a modest withdrawal rate around 4%. Accept that growth is necessary and invest accordingly. Avoid the mistakes that keep you from earning your fair share of returns. Don’t rely on target date funds or high-income strategies. Start smart tax planning now.
Simple, right? But not easy. Your retirement is too important to use as a way of finding out if you’re a good do-it-yourself investor.
Want the full breakdown? This article is based on my 30-minute retirement planning presentation where I walk through these concepts with charts, real examples, and additional strategies. Watch the full presentation here.
Frequently Asked Questions
What is the 4% rule in retirement planning?
The 4% rule states that you can withdraw 4% of your portfolio in year one of retirement, then increase that amount annually for inflation. Created by William Bengen in 1994, it’s designed to make your money last 30 years based on historical market returns.
How much money do I need to retire comfortably?
Multiply your desired annual spending from investments (excluding Social Security) by 25. If you need $60,000 per year from your portfolio, you’ll need $1.5 million. This calculation is based on the 4% withdrawal rule and assumes a 30-year retirement horizon.
Why is holding too much cash bad for retirement?
Cash loses purchasing power after taxes and inflation. While a rainy day fund covering three to six months of expenses is smart, excess cash should be invested in diversified stocks and bonds. You need growth to build a nest egg that lasts 30+ years.
What is the retirement spending smile?
The retirement smile describes how spending patterns change over time. Spending is high early in retirement (travel, hobbies), dips in middle years, then rises again due to healthcare and long-term care costs. Plan for both ends, not just the low middle years.
How can I reduce taxes on my retirement savings?
Use three strategies: keep portfolio turnover low to minimize capital gains, use asset location to shelter tax-inefficient investments in retirement accounts, and grow your Roth bucket through backdoor contributions. Converting to Roth during low-income years also helps reduce future taxes.
