What Does the 4% Withdrawal Rule Mean?

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Wikipedia says “The 4% refers to the portion of the portfolio withdrawn during the first year (of retirement); it is assumed that the portion withdrawn in subsequent years will increase with the consumer price index (CPI) to keep pace with the cost of living.” 

Your investments will pay dividends and appreciate in price over time on average at 7% per year before inflation. The inflation rate typically should be around 3% at maximum. That leaves you with a 4% safety withdrawal rate.

Many people who aim at financial independence and early retirement (FIRE movement) calculate their yearly spending (budgeting is essential) and save up about 20-30 times of their annual spending budgets, before they retire to enjoy independent and financially free life to its fullest. For instance, if your yearly budget is £40000, you will need £1,000,000 to retire comfortably. (4% = 1/25 so you have to have 25x of your annual spending available, not to ever theoretically having to dig into your pool, just live off interests). The Trinity study has shown that you will never run out of money over the 30 years retirement period with a 4% withdrawal rate. So, check out that study if you want to see the hardcore numbers.

I know that anything can happen in the reality of early retirement. Pandemic, “unpredictable” climate behaviour, etc that may suddenly impact how the market behaves. However, being flexible with your budget while retired, especially for early retirees, is one of the most critical skills the FIRE movement encourages people to learn. If the markets go down, you can easily adjust your costs of living without feeling deprived. If people feel deprived in any way, it will be tough to make lifestyle adjustments.

So far, this part of the FIRE journey has been the most rewarding for me on a personal level. However, budget flexibility is just one way of sailing through rough seas. Creating passive income streams, looking for a part-time job have been done and explored successfully by many people who had to earn extra money, while retired. Also, once you reach the retirement age, that allows you to claim governmental/company pension that will add to your yearly budgeting.

If you are at the start of your journey to financial independence, calculating your number based on the 4% rule will help you figure out what your retirement number is, which will allow YOU to become financially free and independent. Knowing the number will also help you calculate how much you need to invest and how long it will take you before you can retire.

Financial calculator that will help you calculate how much money you need to retire

cFIRESIM will also help you run your financial calculations

This is what JLCollins has to say about the 4% rule.

For more information on 4% check out this article from Mr Money Mustache.

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