The 4% rule has been a tried and true rule within the early retirement community for some years now. It might be known to you as the Safe Withdrawal Rate or simply SWR. If it is not known to you quite yet, let’s define it before we dive further into this opening bid of how much money you need to retire comfortably!
The Safe Withdrawal Rate is the % of your investments available to you for withdrawal to cover living expenses without running out of money!
Clear as mud, isn’t it?
Let’s try explaining this again without the usual jargon which at times tends to confuse more than explain. Here is a simple breakdown I wish I would have had a few years back 🙂
The opening bid of how much money you need to retire comfortably!
- Assume your post-retirement expenses will be $40,000.
- Multiple that $40,000 by 25 (or divide by 0.04) to calculate your retirement goal.
- $1,000,000 is your retirement goal to be saved up during the accumulation/save up phase.
- Once reached, you will be able to withdraw 4% every year without depleting your $1,000,000.
The idea is that your retirement savings are invested in stocks and other assets. These assets not only pay dividends but also appreciate in value. All at a rate of 7% per year. Adjusted for 3% inflation, you are left with 4% of dividend income and cumulative gains to withdraw to live off of. If you think this sounds too simple, you are correct. This is the “perfect world” scenario of retirement planning.
Who can guarantee 4% returns year after year? No one! For one, the economy and the stock market might as well be dubbed Six Flags going forward, as they can be quite the roller coaster ride. And we have to consider inflation as well. The dollar in your pocket today will not buy you the same goods in ten, twenty, thirty years from now. So how can “we” possibly lay claim to fame for having early retirement all figured out?
Three professors of finance at Trinity University crunched the numbers and analyzed retirement “what if” scenarios ranging from 1925 through the 1980s. This study has since been updated by another finance genius named Wade Pfau, who came up with the below helpful chart. Over a 55 year period only once, around 1965, did the stock market dip enough for the 4% withdrawal rate to deplete your retirement base.
Trinity Study Updates
This establishes the 4% rule as a very conservative bet! Being the safety nut I am, I like to err on the side of caution. Hence, I would like to guard all of us against depleting our retirement savings all throughout retirement. There are many ways to go about that by adjusting the opening bid 4% rule by considering the following, all of which were not variables in the Trinity study:
- By ditching your stressful 9-5, you are free to pick up enjoyable part-time work or be self-employed. A few bucks earned here and there will allow you to draw down less of your retirement savings.
- Starting at age 62 (up to 67), you will be receiving social security checks. How much is up for debate, but it will be extra income propping up your retirement cash vault.
- If the economy and stock market take a nose dive, you can adjust your living expenses accordingly. Additionally, you could pick up a side hustle. Or live in a foreign country for some time where living costs are much lower.
The math is undeniable. The 4% rule is far from a risky approach. To the contrary, it is the conservative method of evaluating what your retirement goal should be. I utilize this rule to determine my retirement savings goals. If you want to play around with your own numbers, the calculator on the FIREcalc website will let you adjust the variables.
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