“Will I be OK?”
The Rule of 20 is a simple tool that answers two related questions, 1) “How much should I be saving/investing?” and 2) “How much can I safely withdraw from my investment accounts?”
The answers to these two questions are:
- You need $20 of investments to allow for withdrawals of $1 each year, and
- You can withdraw $1 each year for every $20 of investments
You may have noticed that the Rule of 20 can also be thought of as the Rule of 5%. Here are some examples of what this looks like:
| Investments* | Withdrawals (5%) |
| $2,000,000 | $100,000 |
| $3,000,000 | $150,000 |
| $5,000,000 | $250,000 |
But why 5%? We assume that investors will be invested in US stocks and bonds—approximately 65% in stocks, 30% in bonds, and the rest in cash. Since World War II stocks have returned 10% per year, including dividends, US Treasury bonds have earned 4% per year, and we will assume no income from cash. This balanced portfolio will produce an average annual return of just under 8%.
*Keep in mind that how the cash withdrawn is earned is not important. There will be stock dividends and bond interest earned, but also capital gains will be realized. It is also unimportant where the cash comes from—401K, IRAs, etc. Added all together those events make up “total return” on the investments held. Withdrawals are funded by all of these. |
So why not spend 8%?—one reason: inflation. The investor with a balanced portfolio will enjoy growth over time. The goal is to steadily increase income over time as the portfolio grows in value. Investors should feel just as comfortable spending 5% of the total—after inflation—as they do today.
Spending 5% or less than that will produce more portfolio growth, while spending more than 5% runs the risk of lower investment totals in the future and, therefore, lower income.
Projecting investment outcomes over long periods of time might feel risky when most financial market commentary is short-term focused. Investing in above-average companies in the stock portfolio and taking very little risk in the bond portfolio (US Treasuries) increases the odds of a favorable outcome for investors. That’s what we call Investment Planning at Dock Street.
Best regards,
Daniel A. Ogden
Dock Street Asset Management, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. You should not assume that any discussion or information contained in this letter serves as the receipt of, or as a substitute for, personalized investment advice from Dock Street Asset Management, Inc.
It is published solely for informational purposes and is not to be construed as a solicitation nor does it constitute advice, investment or otherwise.
To the extent that a reader has questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult with the professional advisor of their choosing.
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Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Past performance is no guarantee of future returns.
