In my post yesterday I mentioned how the “safe withdrawal rate” is 4% and I’m living on less than 2% of my investments. I got some questions about it, so here’s the answer!
Once you have enough money invested, you can live off of those investments forever without needing any new income! When you’ve done that, you’ve reached “financial independence”! So how much can you take out?
The 4% number actually comes from “The Trinity Study” where they looked at a reasonable portfolio of stocks and bonds over every 30 year period of the modern economy and concluded if you withdraw 4% per year of the starting amount, adjusted for inflation every year, in only the two worst years would your portfolio hit zero.
The “4% rule” passes the common sense test too. The market has returned an average of 10% per year over the last 100+ years, but there’s volatility baked into that 10%. If there’s a bad 5 year run, and you’re taking 10% of the starting amount out each year you’re likely to go broke. That means 10% is too high. But on the flip side, if you only take out 1%, you could just leave that money in a savings account and live off it for 100 years, and no one reading this is going to live for 100 years (except maybe a few ambitious babies) so 1% is too low. 4% is about in the middle!
In real life though, this is never performed in a vacuum. For example, if you start doing 4% for a few years and then the next great depression happens, you could decide to dial it back a bit. On the flip side if you do it for a few years and your portfolio doubles, crank it up a bit! I’m currently doing less than 2% to make sure my portfolio keeps growing since I’m still young!
As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.