The day you reach financial independence will be an amazing day. However, will my nest egg be enough? It all comes down to you essentially. If you spend a higher percentage of your retirement fund then it is riskier. What shall we use to calculate this risk?
The 4% Rule
This is the generally accepted rule for drawing down your retirement savings so that they last you for your retirement period, which hopefully for most of use, will be 40 to 50 years.
Thankfully, financial experts, who are far more intelligent than I am, have researched this extensively. The Trinity Study simulated withdrawal rates of 3% through to 12% across all 30 year periods between 1926 – 1995 using historical stocks data.
What they found is:
- Early retirees who anticipate long payout periods should plan on lower withdrawal rates.
- The presence of bonds in the portfolio increases the success rate for low to mid-level withdrawal rates.
- For stock-dominated portfolios, withdrawal rates of 3% and 4% represent exceedingly conservative behavior. At these rates, retirees who wish to bequeath large estates to their heirs will likely be successful.
- One way to plan for the impact of inflation is to adopt a withdrawal rate smaller than the rate of return on the portfolio; that allows the portfolio value to grow annually.
In other words, invest your nest-egg in both stocks and bonds, use a low withdrawal rate (of initial portfolio at retirement), and keep your withdrawal rate less that the yearly growth most years, and you will not only outlast your retirement, but will likely have a much higher net worth than you even started with.
The updated years
*Trinity Study updated for 1926 – 2018 and including 40 year increments
Don’t forget, this 1926 – 2018 time period included the biggest market crashes in history:
- Crash of 1929 (Black Monday) – the Great Depression
- Crash of 1987 (Black Monday the 2nd) – the market lost 23% of it’s value
- The Dot Com Bust 1999/2000 – the market dropped 23% in a single day!!
- The Financial Crisis 2007/08 – the S&P index dropped 45% by the lowest point
The updated numbers are hugely re-assuring! There have been major market drops, 2 of them being in the last 20 years yet the 3% or 4% rate is holding up strong. A nest-egg tucked away in a 75/25 stock/bond portfolio has a 92% success rate over 40 years.
Obviously I enjoy this number because if my retirement begins at 45, I will get to 85 no problem! But guess what, by 85, I will have my pension and social welfare payments coming through. The warm and glowing embrace of FIRE is ever more enticing!