With our goal of being present parents to our new baby boy by avoiding the rat race established, let’s talk about a useful concept to understand how much money we actually need to do so: the 4% Rule.
The 4% Rule is a well-trodden path to financial independence, and its simplicity is truly a thing of beauty. It works like this: multiply your yearly spending by 25, and voilà! You’ve got your retirement number. That’s it. No need for fancy formulas or complex calculations.
The 4% rule is based on the seminal Trinity Study conducted by three professors in 1998, which aimed to determine safe withdrawal rates for retirement portfolios containing stocks and bonds. The professors used historical returns data for stocks and bonds from 1926 to 1995 to simulate a retiree’s portfolio performance for a retirement period of 30 years. They then tested different withdrawal rates ranging from 3% to 12% to see how the portfolio would perform under different scenarios. They found that a withdrawal rate of 4% (adjusted each year for inflation) resulted in the portfolio lasting 30 years in 95% of the scenarios. This means that in only 5% of the scenarios did the portfolio run out of money before the end of 30 years. Thus, the 4% rule is a conservative number, as it was largely successful even in the worst economic downturns.
If you’d like to mess around with when and how much you might need to leave the rat race, here is a fun calculator to play around with to see how adjustments to your income, expenses, and savings rate can impact your path to early retirement: FI calculator.
The secret sauce to achieving early financial independence lies in monitoring your yearly spending and, if possible, lowering it (more on this later). By keeping a close eye on your expenses and making mindful choices, you’ll not only reduce your retirement number but also reach financial independence more swiftly.
