We have a notion known as “The 4% rule,” “The 4 % Safe Withdrawal Rate,” or simply “The SWR” in the world of early retirees. It’s the topic of much debate, as with all things financial, and we’ll get to that (and then punch it flat) later.
But first, let’s define the Safe Withdrawal Rate for those who are unfamiliar with the concept. The Safe Withdrawal Rate is the highest rate at which you can spend your retirement funds without running out before you die. That seems lovely and simple, yet many people think it’s a difficult thing to forecast.
After all, you never know what kind of roller coaster ride the economy will take your retirement assets on, and you never know what rate of inflation will be during your life. When you’re 65, will a dozen eggs cost $6.00, or will it be closer to $60?
How much money do I need for Financial freedom?
This question generates a wide range of responses. Financial novices (about 95% of the population) tend to spit out a number between $5 and $100 million at random. Those that are interested in financial independence will have the most accurate answer.
Multiply your annual spending by a factor of between 20 and 30. That’s the number you’ll call when You’re Ready to Retire. When you select the number 25, you’re implying a 4% Safe Withdrawal Rate.
Where did this enigmatic number originate?
Consider the following scenario, you have your stash of retirement money invested in equities or other assets. They pay dividends and rise in value at a combined annual rate of 7% before inflation. Inflation eats away at 3% on average, leaving you with 4% to spend safely for the rest of your life. In actuality, stock prices fluctuate year to year, as does inflation. A duration of financial misery was known as the Great Depression. World Wars I and II, Vietnam, and the Cold War Years of 10%+ inflation and 20%+ interest rates followed the collapse of the gold standard for US currency. More recently, there was the Great Financial Crash, which saw real estate and stock values plummet by half.
If you retired in 1921 with a mostly-stock account, you would have benefited from a major stock market run-up. By the time the 1929 stock market crash and the Great Depression arrived, you’d be so wealthy. If you retired in early 2000 while holding stocks, on the other hand, you experienced an abrupt and large decline in your savings, as well as low dividend rates – and your stash may have gone through some terrifying times in the early days, and again around 2009. Do you think you’d have any money left today?
In other words, the order in which booms and crashes occur is critical. In an ideal world, you’d achieve your magic retirement number at a period when stock prices are lovely and low, right before another long boom begins, so that your retirement is off to a terrific start. You can’t, however, forecast these things ahead of time.
How long your money will endure?
Consider a 30-year mortgage, in which interest accounts for nearly all of your payments. If you reduce your monthly payment by only $199, you’ll have a thousand-year mortgage that will take you 1000 years to pay off. Increase the payment by a few hundred dollars, and the loan will be paid off in fifteen years!
In other words, once you’ve been retired for more than 30 years, the length of your retirement has no bearing on the safe withdrawal rate estimates.
The study supposes that a retiree will never earn more money through part-time jobs or self-employment initiatives. They will never get a penny from social security or any other pension plan.
4% Safe Withdrawal Rate|The most cautious way to save for Retirement
Simply multiply your annual spending level by 25 to implement it in real life. At the very least, that’s how much you’ll need to retire. I can even recommend an SWR of 5% if you don’t take on too much risk and have skills that can be used to produce money in the future. As a result, there is no need for a disagreement. 4% is a good answer, which means saving 25 times your annual expenses is a good target to have. Along the way, you may see that your annual expenses are vanishing, making early retirement more possible.
A 4% withdrawal rate is a sparkling, bulletproof limousine of a retirement plan in which you may ride all the way to the party.