One key to being financially successful like Robert Nico Martinelli is to be able to relate your entire financial picture to a single score. This article will explain how you can use the “magic” ratio of 4% (dividing by 25) as that single score to help you determine if you are on track for retirement. There is no way to tell exactly what your financial picture will look like 25 years from now. But the 4% rule is designed to ensure you have enough money available for at least 20 years of retirement, which is generally accepted as being adequate for most people. It also takes into consideration the effects of inflation over time on your costs.
Concepts You Will Need To Know To Understand The 4% Rule
The rule calls for you to withdraw 4% of your retirement account the first year of retirement and then adjust that dollar amount each subsequent year for inflation. For those who are unfamiliar with this, let’s review some basic concepts:
– Annual Percentage Rate (APR) is a multiplier used to find the equivalent interest rate for investing over a period of time which is longer than one year.
– The Federal Reserve Board’s Open Market Committee (FOMC) meets eight times a year to review economic trends and decide what level of interest rates it will set for the next six weeks. This six week treasury bill auction determines what the Fed Funds rate will be. The Fed Funds rate is the interest banks charge each other for overnight deposits. This rate directly impacts what long term interest rates will be, which in turn impact stock and bond prices.
– When you buy a treasury bill at auction, you are actually lending money to the Federal government for 13 weeks or so (depending upon when you purchased it). In return for your loan, the Federal government gives you a certificate stating that at a date in the future, they will repay this loan to you along with the interest it earned over that time period. Sometimes they call this a “bill,” but it’s really just another way of saying “treasury bill.”
– Over the past 40 years, treasury bills have averaged a 5.5% APR.
– Treasury bonds are debt securities issued by the Federal government and carry maturities of more than ten years. These securities pay interest at fixed rates for their entire life, which is why they are considered to be very low risk. Their yield is based upon the current level of long term interest rates.
– Mortgage rates are based upon the yield of treasury bonds with comparable maturities. So, when you have an opportunity to lock in a fixed rate mortgage (a topic we’ll discuss shortly), it’s like locking in interest rates on your mortgage for 30 years in many cases.
– At age 65, the average life expectancy is approximately 85 years.
– The 4% rule is designed to allow you to withdraw money from your retirement account for 20 years. Since this accounts for the possibility of someone living beyond their life expectancy, it could be considered to represent a “worst case” scenario.