In this video, I want to explain the 4% rule. This is also known as the Safe Withdrawal Rate – or basically the rate at which you can spend your money without ever running out of money during retirement.
An easy way to calculate what this means for you – and how much money you’ll need to retire is by flipping it around and multiplying your yearly expenses by 25.
For example, if you and your family spend $40,000 per year, you’ll need to have 1,000,000 invested to not run out of money.
But there must be some limit to how long you can withdraw 4% and still have money left over, right? The study that explains the 4% rule is called the Trinity Study, and it looked at how much money you’d need to retire for every year between 1926 and 2009.
The study found that if you invest 50% of your money in stocks and 50% of your money in bonds, withdrawing 4% of your money will be fine for 25 years, 100% of the time. Doing it for 30 years – you’ll still have money left over 96% of the time. only if you retired in a very unlucky year and never made any money after retirement including pensions or social security – the 4% rule didn’t work.
So to make sure we’re all clear – the 4% rule isn’t 100% foolproof. But those odds are pretty darn good – and even while I hope to retire from regular work longer than 30 years – i know I’ll continue to make money doing things i love which will make sure that the 4% rule does succeed.
For those of you that want to be 100% sure your money will never run out (especially for those of you who plan to retire longer than 30 years), use the 3% rule and only withdraw 3% of your investments per year.
Let’s get back to the 4% rule and dive a little deeper.
As many of you are probably asking, why is 4% the safe number and not 10% or 2%.
Very simply, investing money will pay you dividends and increase in value at an average rate of 7% per year. On average inflation is about 3%, basically decreasing the actual value of the money you have. Combine those two numbers, and you’re a 4% – your net income will increase by 4% each year. And if you spend that 4% without going over, you’ll end the year with the same amount that you’ve started… in perpetuity.
Okay okay – i know a lot of you say this is crazy – what about the recession – you can’t predict stocks – and lots more thoughts.
But let’s look at those numbers even deeper.
Since 1900… over one hundred years ago, the average return per year has been 7% including reinvested dividends (meaning you reinvest the dividends – or the money the companies pay your for investing – into your investment).
For inflation – since 1913 – over one hundred years ago, the average yearly inflation is 3.22%
Even through the great depression, world wars, crazy years of inflation, more wars, and the great recession the average return rate has been 7% and inflation has been just over 3%
What does this tell us? It tells us that investing is more about being patient and investing early rather than trying to time the market.
Now this doesn’t mean that it can’t change. Investing is a risk. That’s why you do it and make money from it. But world war iii could happen. another even greater depression could happen. and we have to be prepared for something like that. because if you retired with 1,000,000 in 2007, assuming you’d be able to spend 4% of your net worth per year, you were in for a surprise – which might mean going back to work for a few years and waiting out the recession. hopefully, if you did that… and left your investments in the stock and bond market, you would be in good shape.
The key takeaway is that throughout the history of modern america – you’ll be fine to retire using the 4% rule. So calculate your yearly expenses… include some emergency padding… and start investing to get to that goal of 25 times your expenses.
Let me know if you have any questions or comments below! Is this crazy? Or am I onto something?
Again, thank you to mr money mustache and the mad feintist for the inspiration!