Is the 4%-Rule Too Conservative? If You Accept Some Risk You Could Retire From The 9-5 Much Earlier!

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What I think about rather often is how much I need to retire from the 9-5.

Do I really need 25 x my yearly expenses to live well (4%-rule)?

Or would 15-20 x my yearly expenses be safe enough? Let’s look at the data.

This table presents the portfolio success rates for withdrawal rates inflation-adjusted on an annual basis.

The results in the table indicate that maintaining a relatively constant “real” withdrawal amount over time significantly diminishes portfolio success rates.

For example, a portfolio with 100 % stocks supported a 30-year retirement period with a 4 % withdrawal rate, adjusted for inflation, for  98 % of the sample overlapping periods.

However, an initial withdrawal rate of 5 % from a portfolio of 100 % stocks was successful through 80 % of the 30-year payout periods when adjusted for inflation.

Let’s stop there for a minute.

If you stick with a 4% withdrawal rate and 100% stocks (adjusted for inflation) there’s a 98% probability that you won’t run out of money ever again. 

If you stick with a 5% withdrawal rate and 100% stocks (adjusted for inflation) there’s a 80% probability that you won’t run out of money ever again. 

If you’re like me (32 years old, working 9-5, interested in starting a business), is there any point in making this a 100% “safe” bet?

What these assumptions says is that:

-You won’t earn any money ever again
-You will not recieve social security
-You will not recieve any form of inheritance
-It would be impossible to find a job again

Therefore: A lower withdrawal rate has a large opportunity cost, but it only protects against a potential risk.

The question is if it’s worth to work more years in order to minimize this low risk?

How Much Do You Want Financial Independence?

Why do you want to reach financial independence?

While there are millions of reasons, most are some form of:

-I would live my life differently
-If I didn’t have to worry about earning money

This may mean stop working, working somewhere else, volunteering, traveling, etc.

The point is, every year you are not financial independent you are not living that life.

So why are people spending so much extra time to get to a higher FI-number?

Isn’t a 80% success rate good enough?

Let’s illustrate with an example.

Income after taxes: $80K
Expenses: $40K
Savings Rate: 50%
Stock portfolio:$75K
Amount needed to FIRE: 4%-rule: 40K x (100/4) = $1,000,000 | 5%-rule: 40K x (100/5) = $800,000

Results using the 4%-rule

 

As you can see on the figure above, you’ll be able to retire in 13.1 years if you’re depending on the 4%-rule.

That’s not so bad. But what if you could take more “risk” and accept a 80% success rate with a 5%-withdrawal rate?

Results using the 5%-rule

As you can see from the figure above you’ll be able to retire 2 years earlier if you depend on the 5%-rule.

2 years may not sound much, but remember these are the best years of your life.

What If You Combine The 5%-Rule & Reduce Your Expenses From $40K To $32K?

There are many ways to financial independence, but by accepting a 80% success rate (5%-rule) and reducing your expenses a little bit you’re able to reduce in only 8.2 years.

That’s a lot less compared to over 13 years in the first example!

How Much Of Your Portfolio Will You Have Left After 30 Years Of Retirement?

Let’s take a look at how much your portfolio would be worth after 30 years in retiremnet using the 4%/5%-rule.

Portfolio value after 30 years (median) using the 4%-rule

So if you have a portfolio consisting of 100% stocks and withdraw 4% (inflation-adjusted) every year, you’ll left with over 10x your initial retirement portfolio.

In other words, if you retired with $1,000,000 your portfolio would be worth $10,075,000!

So how sick isn’t that?

Imagine that you retire with $1 million today and live your life happy for the next 30 years spending 4% per year, and then when you check your portfolio there’s over $10 million left! 

No wonder why Albert Einstein said that compound interest is the 8th wonder of the world.

Portfolio value after 30 years (median) using the 5%-rule

If you have a portfolio consisting of 100% stocks and withdraw 5% (inflation-adjusted) every year, you’ll left with over 7,2x your initial retirement portfolio.

In other words, if you retired with $800,000 your portfolio would be worth $5,760,000.

Still a decent sum, right?!


Conclusion

So what is important for you?

Is it necessary for you to have extra money when you’re old?

Maybe you want to have some money you could give to your children or grand-children?

The point is, every year you are not financial independent you are not living the life you want.

You’re the only one who knows what’s right for you.

But most people I know wont stop earning money completely when they retire early.

I wrote a pretty detailed post about how you’re time to FI would be reduced, if you earn only $2,000 per year in retirement, you can read it here.

If you stick with a 4% withdrawal rate and 100% stocks (adjusted for inflation) there’s a 98% probability that you won’t run out of money ever again. 

If you stick with a 5% withdrawal rate and 100% stocks (adjusted for inflation) there’s a 80% probability that you won’t run out of money ever again. 

Only you know how much risk you want to take.

As I said in the intro:

If you’re like me (32 years old, working 9-5, interested in starting a business), is there any point in making this a 100% “safe” bet?


 

Read all my posts in chronological order here: Archives

 


Have questions, comments or suggestions? I would love to help you with your FI-journey.

Feel free to reach out directly at @Route2FI on Twitter or email me at post@route2FI.com


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3 Replies to “Is the 4%-Rule Too Conservative? If You Accept Some Risk You Could Retire From The 9-5 Much Earlier!”

  1. Is a valid point that odds are in your favor at 5% withdrawal. But a 20% failure rate is kind of scary, and that’s within 30 years. In your example the retirement period could be 60 years with advancements in health care, very expensive advancements. However many of us find enjoyable side gigs, and those can easily knock 2‰ off the withdrawal rate. Mine keeps my withdrawal at zero. So I still agree 5% is pretty safe if you monitor your net worth and cut spending or supplement your income a bit during major marjet downturns.

  2. I appreciate that the first table bases its assumptions on the S&P 500 from 1929 to 2009, in other words, from just before the Great Depression to just after the Great Depression.
    This makes the figures conservative and therefore worth our time.

    Interesting to see that the 75/25 stocks and bonds split actually works out slightly better over this time frame, probably because it offers more stability. Food for thought.
    If you are young, the ‘risk’ of needing to go back to work is not too terrifying. I’ve seen older people need to return to work after thinking they were retired for good and they were doing it tough, but that’s a different case.

    Taking the 80% chance of success at your age might make sense, so long as your odds have increased to 100% by the time you reach 60. If not, might be worth returning to the 9-5 for a few years in the meantime just in case.

    1. route2fi says: Reply

      Awesome!

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