A peaceful and prosperous old age is certainly the dream of many people. But to achieve this, careful financial planning is key. One strategy that is often discussed in retirement planning is the 4% rule. This method is simple but effective in determining how much funds need to be prepared in old age.

The 4% rule concept is very popular among financial planners, especially for those who want to retire early or achieve financial freedom. You can design a realistic and sustainable investment and lifestyle strategy without fear of running out of money in old age by understanding how the 4% rule works.

But what is the 4% rule? To understand this financial strategy and how to apply it, Treasury has summarized it for you in the article below.

What is the 4% Rule?

The 4% rule is a retirement strategy that suggests you withdraw a maximum of 4% of the total investment value in the first year of retirement, then adjust it for inflation in the following years. This rule is based on William Bengen’s research.

In 1994 he showed that with a balanced investment portfolio, you can live off your investments for 30 years without running out of money. For example, if you have a retirement fund of IDR2 billion, then 4% of that amount is IDR80 million.

That is the recommended amount to withdraw in the first year of retirement. In the following years, the amount can be adjusted with inflation. This strategy allows you to maintain a stable lifestyle without having to worry about touching your principal significantly.

However, keep in mind that the 4% rule assumes your portfolio is already diversified, as well as favorable economic conditions. Therefore, it is important not to apply this rule rigidly without considering other factors such as lifestyle, health conditions, and other sudden needs.

How to Calculate Retirement Fund Requirements?

One of the main benefits of the 4% rule is that it makes it easy to calculate the total retirement fund required. The formula is simple:

Annual needs × 25 = Total pension fund

Why 25? Because 1 ÷ 0.04 (4%) = 25. So, if you need Rp120 million per year when you retire, the total funds needed are:

Rp120 million × 25 = Rp3 billion

Through this formula, you can start calculating how much savings you need to collect from now on. Of course, this figure can change depending on inflation, lifestyle, and investment strategies implemented during retirement.

Also Read: 7 Financial Strategies to Retire Early with Comfort – Treasury

Pros and Cons of the 4% Rule

Here are some of the main advantages of the 4% rule:

• Simple and easy to apply
• You don’t need complicated financial formulas. The 4% rule allows you to immediately know how much money you can withdraw per year and how much you need to save before retirement.
• Helps create clear financial targets
• The 4% rule makes calculations more practical so that you can develop a more targeted and realistic financial plan. You don’t just save randomly, but have a measurable target fund.
• Can be an early guide to early retirement
• For those of you who are interested in the FIRE (Financial Independence, Retire Early) lifestyle, the 4% rule can be a starting point in determining when you can stop working and still live comfortably from investment returns.

Despite its advantages, the 4% rule is also not free from disadvantages, among others:

• Does not take into account extreme economic conditions
• This rule is based on data from the US stock market during stable periods. If there is a major crisis or inflation spikes, this strategy may no longer be effective.
• Fixed spending assumptions
• In reality, your spending needs may increase as you get older, especially for health needs. The 4% rule is not fully flexible to such dynamics.
• Not suitable for all investment portfolios
• If you invest in more conservative or high-risk instruments, the returns could be very different from those assumed by the 4% rule.

How to Apply the 4% Rule

• Determine annual spending needs at retirement
• Evaluate the lifestyle you want in retirement. Calculate the cost of living, health, hobbies, and other needs. For example, if you need Rp10 million per month, then a year you need to withdraw Rp120 million in pension funds.
• Calculate the target pension fund with the formula 25 × annual needs
• If your needs are Rp120 million per year, then the target pension fund = 25 × Rp120 million = Rp3 billion. This is the minimum fund that must be collected.
• Build a long-term investment portfolio
• Invest retirement savings into investment instruments that tend to be safe against inflation, such as gold, because retirement funds are long-term needs. Gold is also suitable as an investment to prepare funds
• Start saving and investing as early as possible
• The earlier you start, the lighter the investment burden. By utilizing compound interest, you can reach your retirement fund target faster.
• Do regular reviews and adjustments
• The financial world is not static. Check your portfolio regularly and adjust your strategy if market conditions change or life needs increase.

The 4% rule is a simple yet very useful guide to help you design a peaceful and prosperous retirement. By understanding how to calculate it, its advantages and disadvantages, and applying it in a disciplined and flexible manner, you can achieve financial freedom without having to worry about finances in old age.

Although not perfect, the 4% rule is still a solid starting point for retirement planning. Don’t wait until it’s too late. Start strategizing now, and use the 4% rule as a compass to navigate a more secure financial future.

The 4% rule is not a magic formula that guarantees instant wealth, but it can be a strong guideline to ensure that you can live comfortably and prosperously in old age. By understanding the basic concepts, how to calculate retirement needs, and applying it flexibly, you can take control of your financial future.

You don’t need to be confused or guess how much retirement funds should be collected. Just use the 4% rule as a foothold, then adjust it to your lifestyle and personal needs. Remember, retirement planning is not just about numbers, but also about peace of mind in the future.

So, are you ready to start your journey to financial freedom? Make the 4% rule the first step towards a safe, comfortable, and smiling old age.