Four Percent Rule and FIRE Financial Independence
The 4% rule is often used as a starting point for retirement planning, and many FIRE enthusiasts may use a lower withdrawal rate to ensure that their portfolio lasts longer. For example, some FIRE proponents may use a withdrawal rate of 3% or 2.5% to provide a larger margin of safety and ensure that their portfolio lasts through their lifetime. It all depends on which type of FIRE you’re going for. You can also work part time (BaristaFIRE) so that you can give yourself some extra leeway.
So while the 4% rule can be a useful starting point for FIRE planning, it’s important to consider your own financial situation and goals, and to be flexible and adjust your withdrawal rate as needed. Working with a financial advisor or retirement planning specialist can help you determine the right withdrawal rate for your specific needs and goals.
4% Rule Variations
Dynamic Withdrawal Strategy:
This strategy adjusts the withdrawal amount based on the performance of your portfolio. In years where your portfolio performs well, you can withdraw more than 4%. Conversely, in years where your portfolio doesn’t perform well, you may need to withdraw less than 4%. If you can be flexible with your fixed expenses, then you will not NEED to withdraw the full 4% every year.
Another way to achieve a Dynamic Withdrawal Strategy is to not take the inflation increase in a down year.
For example, if you have $1,000,000 in year 1 then the 4% Rule will give you $40,000 to withdraw for that year.
With an average inflation rate of 3%, you can then withdraw 4% from $1,030,000 which is $41,200 which is an increase of $1,200 from the previous year.
However, if the stock market was down this year, then don’t give yourself the 3% increase. Keep your withdrawals at the same amount as last year. This will help balance things out in a down year and give you a sense of control over the situation.
Pros and Cons of the 4 Percent Rule
Pros:
Simple and easy to understand: The 4% rule is a simple and straightforward guideline for retirement planning that is easy for most people to understand and apply.
Provides a starting point: The 4% rule provides a good starting point for retirement planning, allowing individuals to estimate how much they need to save and how much they can safely withdraw.
Historically proven: The 4% rule is based on historical data and has been shown to be effective in providing retirement income for many retirees over the years.
Offers flexibility: The 4% rule offers a flexible approach to retirement planning, allowing individuals to adjust their withdrawals based on their changing financial needs and market conditions.
Provides peace of mind: Following the 4% rule can provide retirees with peace of mind, knowing that they have a reliable source of retirement income that is likely to last throughout their retirement.
Cons:
Assumes a static withdrawal rate: The 4% rule assumes a static withdrawal rate, which may not be appropriate for retirees who have changing financial needs or who experience significant market fluctuations.
May not be appropriate for all retirees: The 4% rule may not be appropriate for all retirees, especially those who have significant debt, health issues, or other financial obligations.
Doesn’t account for inflation: The 4% rule doesn’t account for inflation, which can erode the purchasing power of retirees’ savings over time.
Doesn’t consider taxes: The 4% rule doesn’t consider taxes, which can have a significant impact on retirees’ income and spending.
Relies on past performance: The 4% rule is based on historical data and may not be applicable to future market conditions or changes in the economy.
Overall, the 4% rule can be a useful starting point for retirement planning, but it’s important to consider all factors that may affect your retirement income and consult with a financial advisor to determine the best approach for your individual situation.
Wrapping Up: Is the 4% Rule a Good Idea?
It’s important to remember that this rule is a general guideline and shouldn’t be taken as gospel. Over the long run, the four percent rule works, but it will not be a linear path. There will be up years and down years in the sock market. There will also be unexpected events like possible wars, pandemics, natural disasters, terrorists attacks, etc. In the moment, these will all seem like they are the end of the world, but if you keep in mind the long term data of the stock market and long term inflation data that the rule is based on then it doesn’t seem as scary.
This rule is meant for retirement and retirement requires a long term horizon. If you’ve done your 4% Rule Calculation and are not happy with the amount that you can spend each year then you might want to consider another option like Barista FIRE. This method supplements your retirement withdrawals with extra income which can give you a much better chance of success as well as a sense of purpose and something to do in your retirement years.
