Throwing a bit of water on the FIRE

Reevaluating the 4% Rule

The 4% rule is a rule of thumb for the safe withdrawal rate during retirement. A safe withdrawal rate refers to how much of your retirement portfolio you can withdraw under normal market conditions, each year without running out of money during retirement

The 4% withdrawal rate refers to how much of your retirement portfolio you liquidate in the first year of retirement, this acts as your base year. 

In your second year, you withdraw the same dollar amount you did in the first year plus inflation and from there your annual withdrawals increase by the level of inflation.

The 4% rule is a way of answering the question, how much of my portfolio can I live off during retirement?  

This still leaves the question, how much money do I need to retire?

The 25 times rule 

The 25 times rule is the inverse of the 4% rule (4%=1/25) and answers the question of how much money do I need to retire? According to this rule of thumb, you would need at least 25 times your annual spending before you can retire. At which point you can begin using the 4% rule to fund your retirement.

Let’s say your expected cost of living in retirement was $50,000. 

• According to the 25 times rule, you would need at least .25 million ($50,000 X 25) before you could retire, 
• Using the 4% rule you could withdraw $50,000 ($1.25 million X 0.04) in your first year of retirement.
• In subsequent years, you would increase the amount of your withdrawal by the rate of inflation to maintain your lifestyle. 

Origins of the 4% rule 

The origins of the 4% rule can be traced back to a 1994 paper in the Journal of Financial Planning by William Bengen. In his study, Bengen used U.S data and built a hypothetical portfolio of 50% stocks-50% bonds to find the highest sustainable withdrawal rate for a 30-year retirement. To do this he modeled the returns of this portfolio for every 30-year period from 1926 to 1992. He found that a 4% withdrawal rate was the maximum safe withdrawal rate for a 30-year retirement.  

In 1998, a second study known as “the trinity study” (named after Trinity University where the study was done) found similar results as Bengen. The Trinity study found that a 4% withdrawal allowed retirees a 95% chance of not running out of money. 

Throwing a bit of water on the FIRE

I am a big fan of the Financial Independence Retire Early (FIRE) movement. I know full well that most people perusing FIRE are much more focused on “Financial Independence” (not having to worry about money) than “Early Retirement” (never working again). 

That being said, it’s important for anyone who is considering to stop working altogether in their 30’s or 40’s to remember that the 4% rule was designed under the assumption of a 30-year retirement. 

If you retire at 40 and live to be 100, you are looking at a 60-year retirement, twice the length that the 4% rule is based on. 

The safe withdrawal rate for a 60-year retirement would be closer to 2% rather than 4%. 

That being said 

Even a little bit of income in retirement can make those numbers look much better. 

Let’s return to our example of someone who has achieved Financial Independence at the age of 40 and expects to live to 100. 

They expect $50,000 per year would be enough to cover their lifestyle. With a 2% withdrawal rate, this person would need to save 50 times their expected spending if they wanted to truly “retire” at 40. This means they would need to save $2.5 million ($50,000 X 50) to live off their portfolio.

However, what if instead of “retiring” this 40-year old simply finds work that they have passion for but pays less money than they were previously making, say $30,000. 

They would need to fund $20,000 per year through their investments, which at a 2% withdrawal rate means they would need to save at least $1 million ($20,000 X 50). 

Bottom line

While the 4% rule is handy to approximate wealth accumulation goals under “traditional” retirement planning, those pursuing FIRE must be aware of the limitations of the 4% rule when modeling a retirement beyond 30 years.

About the Author

Ben Le Fort

Ben Le Fort is a personal finance writer and creator of the online publication “Making of a Millionaire.” He has been passionate about personal finance ever since graduating University with $50,000+ in debt.

In the eight years following graduation, he paid off all of the debt and built a seven-figure net worth. Ben holds a Bachelor’s degree in economics from Acadia University and a Master’s degree in Economics & Finance from The University of Guelph.

Ben lives in Waterloo, Ontario, with his wife, son, and cat named Trixie.