How Do I Even Retire? The 4% Rule

Retiring can seem like a daunting and distant goal, especially if you're just starting your career or are still in your early working years. However, with proper planning and consistent saving, you can work towards a comfortable retirement. One way to do this is by following the 4% rule from the Trinity study.

The Trinity study is a widely cited study in the field of personal finance that proposes a rule for determining how much money you can safely withdraw from your retirement portfolio each year. The study, which was published in 1998 by three professors at Trinity University in Texas, suggests that you can withdraw 4% of your portfolio each year in retirement and never run out of money.

The 4% rule is based on the assumption that you will have a diversified portfolio of stocks and bonds, and that your portfolio will earn an average annual return of 7%. The study analyzed historical data on stock and bond market returns and found that, over the long term, a diversified portfolio could sustain a 4% annual withdrawal rate without running out of money. The best part is that after 30 years of withdrawing 4%/year, the portfolio grew 3x on average. Something that can support your family for generations.

The 4% rule has become a popular guideline for retirement planning, as it provides a simple and conservative way to determine how much money you can safely withdraw from your portfolio each year. However, it's important to note that the 4% rule is just a guideline and there are several factors that can affect your retirement income and expenses, including your personal goals, health costs, and economic conditions. Therefore, it's important to carefully consider your own situation and adjust your retirement plan accordingly.

So how do you use the 4% rule? This is where it gets interesting, when you ask most people how much they would need to retire they usually pick an arbitrary number in their bank account ranging from $500,000 to $10,000,000. But what do those numbers really mean? Most people have no idea. Some people think it’s just about having enough money in our bank account to cover how much you spend per year multiplied by how many years you expect to live. But that would mean your money’s just sitting there, doing nothing, and losing value to inflation every year (but that’s a story for another day).

This is where the 4% rule comes into play:

For example, using the 4% rule, if you have a $1,000,000 portfolio you would be able to sell 4% or 40k every year (and can adjust for inflation).

You can also use the 4% rule to work backwards from your Desired Retirement Income to your Retirement Investment Number:

For Example, if you know you need $3,000/month to cover your expenses in retirement you can solve how much you need to have invested by:

$3,000/month = $36,000/yr >>> $36,000/4% = $900,000 portfolio.

Playing around with the 4% rule formula, it highlights another important factor to consider: Your Costs.

For every additional $500/month of income you need in retirement, you will need an additional $150,000 invested to reach retirement.

How much you want to spend in retirement greatly affects how quickly you can start retirement. This will be a a personal preference, it’s a spectrum, on one side is how soon you want to retire, and the other end of the spectrum is how much money you want to spend in retirement. Find a balance that’s right for you.

In addition to knowing your personal goals and costs, it's also important to remember that everyone's retirement journey is different. Don't feel pressure to play someone else's game or follow a certain timeline. It's okay to go faster or slower. To sprint to the finish, or find a nice slow enjoyable pace that you can sustain to the finish line. Decide what kind of life will make your 80-yr-old future self proud, and work towards it. If that means retiring at 35 on a $25,000 minimalistic lifestyle you enjoy, or retiring at 60 travelling because you want to visit 2 new countries a year choose, and create a plan.

In summary, the 4% rule is a useful rule of thumb for planning for retirement, but it's just as important to carefully consider your own personal goals when crafting your retired life.
By knowing your end goal and following a solid plan, you can feel confident, working towards your financial freedom.