Previously, I talked about how much certain expenses are costing you over each decade. In that article, I said that I would next cover the “4% Rule.” As always, let’s start with the definition. And these are always added to the Glossary page.

4% Rule: This is what is considered the “safe withdrawal rate” to draw down a portfolio averaging 7%, post inflation, so that it will last 30+ years. Modern analysis and early retirement (ER) conversations have moved this to 3.5% to cover longer withdrawal periods.

I’ll add some other useful terms to the bottom for reference as well.

Concepts like the “Rule of 72” and “4% Rule” can get confusing over time as everything seems to get labeled this way. The goal of the 4% rule is that it is considered the safe withdrawal rate to live off a portfolio and ideally bring it close to, but not below zero, before you die. Personally, I don’t really like the idea of bringing the portfolio to $0, which is why many people are advocating that 3.5% or lower is even “safer.”

Here’s the thing to remember: this rule was made to plan for retirement. Normal retirement at a normal retirement age. 65 with a 30-year plan. If you can meet all of your inflation-adjusted expenses off of $40,000 a year, you would only need $1,000,000. Now, if you follow the 7% average, that would mean you could end up with double your starting money, assuming the market doesn’t crash and you continue to only withdraw the $40,000; but in a scenario like the early 2000s with years of flat market, you would be concerned with the money not lasting.

This million dollar scenario assumes zero other income like a pension or social security.

If you retired on January 1, 2000, with $1,000,000 in the S&P 500 and withdrew 4% annually to live off of, it would deplete to zero by 2023. If you adjust for inflation, the last 3 years of withdrawals would have been over $70,000 instead of $40,000, and many people live off of significantly less than that. Which is why the 4% “rule” is a guideline that can survive 98% of scenarios. When the market was way down pulling out less would make more sense.

If the same person stuck to their $40,000 withdrawal exactly, never withdrew more for inflation, and only used the S&P 500 as their diversification, they would have been down to $425,000 in 2008 and back up to $1,500,000 by 2025. Keep in mind that $40,000 is almost double the average Social Security check.

How do you use the 4% rule most effectively? Like most things I talk about here, the first step is to budget correctly. You have to track all of your expenses and plan for emergencies. Once you have that number, you can calculate what the 4% would be. Let’s use my own budget as an example:

If I don’t change my lifestyle, but remove retirement contributions, and add a $10,000 buffer, I could probably safely budget for $60,000 a year (and I have fat to cut from my spending). Take my number and divide it by 0.04 (which is 4%), and we get $1,500,000. At this amount of expenses and that amount of a well-balanced portfolio (VOO, VTI), work becomes optional. That’s actually pretty cool because that means I’m 50% of the way to a FIRE number.

The thing that many people in the finance space don’t really explain is that while frugality can bring freedom faster, these numbers work with any level of spending. You want a $200,000 budget per year? The 4% rule says you need $5,000,000. This doesn’t seem crazy if you start planning as young as possible and meet that 50% savings rate.

Because I like math, let’s look at this: using the average S&P 500 historical return of 10%, an 18 year old with a savings rate of 50% from 18 to 59 would only need to make $20,000 a year to have a $5 million portfolio. Time in the market beats timing the market.

Safe Withdrawal Rate (SWR)	The percentage of your retirement portfolio you can withdraw each year without running out of money, assuming a specific time horizon (usually 30 years). It balances enjoying your savings with ensuring your money outlasts you.
Sequence of Returns Risk	The danger that poor investment returns occur during the early years of retirement. When you withdraw money from a declining portfolio, you are forced to sell more shares to maintain your standard of living, leaving permanently less capital to recover during subsequent market rebounds.
Portfolio	A basket of financial assets owned by an individual or an institution.
Diversification	Spreading investments across different types (stocks, bonds, etc.) to reduce risk—if one drops, others may hold steady.
Inflation Adjustment	Converting a past (or future) amount of money into its equivalent value in today’s money.
Nominal Return	The stated, unadjusted rate of return on your investment.
Real Return	The true return on the investment after removing the eroding effects of inflation. For example, if a stock portfolio grows by 10% in a year, and the inflation rate is 3%, the real (inflation-adjusted) return is roughly 7%.

~~Miniwing~~
Investor, Stoic, Parent