Nestegg Cycle © How to Actually Engineer a "4% Rule" Retirement

Posting Date: May.10, 2022, updated: May.15, 2022

Although the much-discussed "4% Rule" has been around for decades, something I've never seen is an explanation of how to do this:

OK, I'm a 25-year-old worker just starting out and I'd like to build up a retirement nestegg that will comply with the "4% Rule"
(or any other X percent Rule)

Now ... Very specifically, given my particulars ...
WHAT do I need to contribute, and what does my money need to earn,
so that I'll save enough to make that work for me?

Here is some help.
You would need to enter your particulars into the calculator screen, but to illustrate,
start with this most basic report out of, taking all default inputs:

Min Yield required for Broad Range Salary Contribs:

  1 after contrib: yield is same PRE & POST Ret

contrib:     yield:  sav/sal: withdrw:
  2.50% 1   11.222%    8.42X    8.91%   
  5.00% 1    9.404%   10.20X    7.35%   
 10.00% 1    7.601%   12.69X    5.91%   
 20.00% 1    5.812%   16.28X    4.61%   
 40.00% 1    4.036%   21.61X    3.47%   
 80.00% 1    2.268%   29.80X    2.52%   

Multiplier of Salary & Prices during 42 working years:
Salary: 3.3599    Prices: 2.7522

Several salary contributions (2.50%, 5.00%, etc) appear in rows which also show for each:
-- yield: The required investment yield calculated to satisfy the specified retirement goal, for this contribution.
SO, every row is already a retirement solution!

-- sav/sal: The nestegg amount that will have accumulated as of retirement time, as a multiple of final year's salary.

-- withdrw: The initial retirement year's payout, as a percentage of that nestegg total.
Note that the dollar amount of the payout is the same for every solution, even if the nestegg amounts are not.
The payout in every case, will be the goal percentage of the final salary at retirement (here, 75%).

We're interested today, in a solution for which the initial year's withdrawal rate is 4%.
It will be somewhere between
  20% contributions (showing a withdrw rate of 4.61%)
  40% contributions (showing a withdrw rate of 3.47%)

A side calculation shows that the exact solution here is: 28.55% contribution at 4.9% yield.
BUT there are three important concerns here:

-- Almost no one will be willing to contribute 28.55% of their salary toward retirement.
  That would be a budget buster.

-- Besides, this solution shows an investment yield (4.9%) which is relatively tame for growing a nestegg.
  Note that these solutions require the same investment yield both before and after retirement,
  and this is indicated by the "1" to the right of each contribution%.

-- What we'd really want is a higher yield before retirement to grow it faster, and then to "dial it down" after we retire.

Enter the POST-retirement yield requirement.
This feature is initially OFF. To activate, click the checkbox to the right of the Retirement Age entry.
POST-retirement solutions are indicated by a "2" to the right of their contribution%

As seen above for the 28.55% contribution, this scenario requires a POST-retirement yield of 4.9%
in order to get a withdrawal rate of 4.0% that can last for 38 years (ages 67 - 105).

The general process for determining the right POST-retirement yield for the withdrawal rate you want, will be shown in Part2.
Here is that report with the 4.9% POST-retirement yield imposed.

Min Yield required for Broad Range Salary Contribs:

  1 after contrib: yield is same PRE & POST Ret
  2 after contrib: yield is PRE-ret, and 4.9% POST-ret

contrib:     yield:  sav/sal: withdrw:
  2.50% 2   14.014%   18.74X    4.00%   
  5.00% 2   11.602%   18.74X    4.00%   
 10.00% 2    9.087%   18.74X    4.00%   
 20.00% 2    6.393%   18.74X    4.00%   
 40.00% 1    4.036%   21.61X    3.47%   
 80.00% 1    2.268%   29.80X    2.52%   

Multiplier of Salary & Prices during 42 working years:
Salary: 3.3599    Prices: 2.7522

Now we have some more-palatable contribution/yield options that work with 4% withdrawals!
Any of these, and contribution amounts in between, is a solution which pays out exactly 4% of the nestegg in the first year
and adds a 2.5% COLA to that payout each year.
Note that the last two rows, contrib of 40% and 80%, work with yields that are already below the 4.9% POST-ret value
so these do NOT get "dialed down".
The "1" notation reminds us that the yield remains the same before and after retirement for these rows,
and because their balances (sav/sal) are higher at retirement, their withdrawal rates drop below 4% for the desired payout.

There is never a free lunch in any of this, of course.
Since the nestegg needs to be built up to a larger amount by retirement time, to support the dialed-down POST-retirement yield,
the money has to grow faster. Any given contribution requires a higher investment yield this way, than before.
For example, a 10% contribution here, requires a yield of 9.087%, compared with only 7.601% before.

Achieving a yield of 9.087% is a bit scary and uncertain to most people,
and this next adjustment needs to be seasoned to taste.

This author would consider it reasonable to try to grow the money at 7.0% PRE-retirement.
You may have a different number in mind, and you are encouraged to work through this with your numbers.

Working with my 7.0% preference to illustrate the process,
and with the next row showing a 20% contribution requiring a yield of 6.393%,
we refine the contribution which will do the job at 7.0%.

We need to interpolate between the 10% and 20% contributions.
To do this, we recalculate specifying a CUSTOM contribution range centered on 18% (as a guess)
and in steps of 0.5% above and below.
(See the HELP topic, "WHAT Else to ENTER", and look for discussion of "Contribution Range")
There may be some trial and error here.
Had the 18% center missed the mark, I could have re-run again with a different center value and/or different step size, until I find what I'm looking for.

This report shows me eleven rows -- I've eliminated some outliers for brevity -- and added the dashed lines to show the closest bracketting around 7.00% yield:

Min Yield required for Custom_18_0.5 Range Salary Contribs:

contrib:     yield:  sav/sal: withdrw:
 16.00% 2    7.287%   18.74X    4.00%   
 16.50% 2    7.165%   18.74X    4.00%   
 17.00% 2    7.047%   18.74X    4.00%   
 17.50% 2    6.931%   18.74X    4.00%   
 18.00% 2    6.818%   18.74X    4.00%   
 18.50% 2    6.708%   18.74X    4.00%   
We have now bracketted the contribution amount, as between 17.00% and 17.50% of salary,
since one requires just over 7.0% yield, and the other requires just under 7.0% yield.
We could home in even closer with a second custom range re-calculation,
say centered on 17.25% with steps of 0.10%,
but I think this is close enough to illustrate the power and process of using the website.

It is also worth noting that the salary contribution is proportional to the goal, all else being equal.
So if a 75% goal breaks the budget, consider a 50% goal, which can be achieved with 11.50% contributions that earn 7.00%.
That is, 2/3 of the contribution, gets you to 2/3 of the payout.

A "4% Rule" retirement which provides a 75% salary replacement for 38 years,
and given the other defaulted starting conditions,
will require this worker to contribute about 17.25% of salary every year during 42 working years,
into an account that earns 7.00% as a long term average,
and then at retirement (age 67) move the money into a "dialed down" lower risk investment mix earning 4.9%.
Note, the post-retirement rate of 4.9% is required to support the payouts for the years from ages 67 - 105.
(See Part 2, coming soon).

Some other "4% Rule" solutions that satisfy this retirement
with lower contributions in exchange for higher yield requirements are, approximately:
	15.25% contrib with 7.5% yield
	13.25% contrib with 8.0% yield
In Part 2
we'll discuss some further considerations about constructing any "X percent Rule" retirement,
including the reason I noted that the 4.0% withdrawal rate was for the first year, and ways to deal with what happens afterward.

This is the math only, but it can serve as a strong reality-check
for the much-less-exact art of selecting suitable investments that attempt to match these numbers.