Money Management

Throwing a bit of water on the FIRE

By  Ben Le Fort

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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 $1.25 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 “traditionalretirement planning, those pursuing FIRE must be aware of the limitations of the 4% rule when modeling a retirement beyond 30 years.

Ben Le Fort

About the Author

Ben Le Fort

Hi, my name is Ben. I am the founder of Making of a Millionaire. I have been obsessed with personal finance and learning how to manage money, ever since my parents declared bankruptcy and lost the family home to foreclosure in 2010.

I spent the next 10 years continuing my journey of educating myself about money. This education was both formal and informal.  

On formal education, I earned a Bachelor’s and a Master’s degree in Finance & Economics. 

On the informal side, I consumed every book, video, blog post, and podcast that discussed personal finance.

Education was nice, but it wasn’t until I began implementing what I learned that I began feeling more hopeful about the future. 

Before long, I had paid off my first loan. Then the next. By 2015 I was debt-free. By 2016 my wife and I bought our first house. Then we started investing. We bought another house and began building real wealth.  

As our wealth grew, the memories of that family bankruptcy seemed further and further in the rear-view mirror. My stress and anxiety began to melt away and I was able to sleep at night without my mind racing and problem-solving.

By 2018 I knew it was time to start sharing what I learned about managing money and Making of a Millionaire was born.

I hope you find the articles, videos, and courses created by Making of a Millionaire to be of value to you. Please feel free to reach out to me directly if you ever have feedback or questions.

You can read all of my articles on my personal site, or on Medium. If you’re interested in video-based personal finance tutorials and education, you can Subscribe to my YouTube channel or check out my in-depth personal finance course.

Disclaimer: In order to make Wealthtender free for our readers, we earn money from advertisers including financial professionals who pay to be featured on our platform. This creates a natural conflict of interest when we favor promotion of our clients over other professionals not featured on Wealthtender. Learn how we operate with integrity to earn your trust.

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