The 4% Rule: or How I Learned to Stop Worrying and Love the Trinity Study
In my monthly financial updates, I calculate the amount of money I need to be financially independent based on the current month’s expenses and my average monthly expenses. I do this by multiplying by 300, which is the same as multiplying annual expenses by 25 (because 12 x 25 = 300). Reader Spencer^{1}Hi Spencer! asked why this works, so this post is about that.
Multiplying yearly expenses by 25 to get your financial independence number is based on the 4% rule.
The 4% Rule states that you can indefinitely withdraw 4% of your total invested income each year and not run out of money.
4% is 1/25, hence the multiplying by 25. The original study that looked at this was called the Trinity study, which looked at rolling 30 year periods going back to the 1920s. For example, 1930-1960, 1931-1961, etc. It found that a portfolio of 75% stocks/25% bonds (not a bad Asset Allocation for retirement) had a near 100% success rate when withdrawing 4% the first year, with annual “raises” to keep pace with inflation. Success is defined as not running out of money after 30 years. Because 30 years is such a long time, not running out after 30 years means a very high probability of not running out at all. In fact, on average you’ll end up with more money than you started with.
Several follow up studies have essentially extended the Trinity study and made small modifications. This Forbes article talks about that. Check out the table below from that article. At the top, horizontally, are different inflation-adjusted withdrawal rates. On the left, vertically, are different time periods. And the boxes of the table show the success rates (i.e. chance of not running out of money) for each specific withdrawal rate and time period. There are two sections of the table that I’ve included here: an all-stock portfolio and a 75% stock/25% bond portfolio:
3% | 4% | 5% | 6% | 7% | 8% | 9% | 10% | |
100% Stocks | ||||||||
15 Years | 100 | 100 | 100 | 90 | 79 | 69 | 67 | 54 |
20 Years | 100 | 100 | 92 | 82 | 71 | 62 | 48 | 40 |
25 Years | 100 | 99 | 82 | 72 | 63 | 54 | 40 | 28 |
30 Years | 100 | 94 | 78 | 67 | 56 | 43 | 37 | 21 |
35 Years | 100 | 91 | 76 | 59 | 52 | 36 | 26 | 14 |
40 Years | 100 | 89 | 70 | 55 | 38 | 28 | 21 | 9 |
75% Stocks | ||||||||
15 Years | 100 | 100 | 100 | 97 | 82 | 72 | 60 | 47 |
20 Years | 100 | 100 | 95 | 81 | 68 | 53 | 45 | 26 |
25 Years | 100 | 100 | 84 | 69 | 59 | 47 | 28 | 12 |
30 Years | 100 | 98 | 78 | 59 | 48 | 37 | 13 | 3 |
35 Years | 100 | 93 | 69 | 55 | 38 | 26 | 5 | 2 |
40 Years | 100 | 92 | 66 | 45 | 30 | 6 | 2 | 0 |
This includes data through 2017. Note that in the 75% stock portion of the table, a 4% withdrawal rate has a 92% chance of success based on historical data after 40 years. Even a 5% withdrawal works the majority of the time, and you’d have to withdraw around 6% per year to get to a coin toss situation. On the other hand, a 3% withdrawal rate works 100%, even with a more volatile 100% stock portfolio.
Since running out of money seems like a really bad thing, many people^{2}My sample is mainly from the Financial Independence sub-Reddit aim for a 3% withdrawal rate. Personally, I am more than comfortable taking the “risk” of a 4% withdrawal rate, and here’s why.
Remember that these studies assume you withdraw 4% the first year and blindly continue to withdraw an inflation-adjusted 4% every year after that no matter what like a robot. But I am not a robot (I think). I’m able to adapt to different situations. If there’s a horrific market crash I can adjust my lifestyle, be a little more frugal, and withdraw a slightly lower percentage for a year or two. Similarly, if the market is booming it might be safe to withdraw a little more. In fact, one of my favorite investment bloggers JL Collins has gone through periods where he withdraws more than 5% a year, basically based on the principle that he’s not a robot and can adjust if needed.
Additionally, many people find that they spend less than they think they will and earn more than they think they will during retirement. Which leads me to another point: it’s quite easy to make a little bit of money without much effort if you want to. If I’m retired and wanted to supplement my investment withdrawals I could simply pick up a side gig like tutoring high school students (which I already do a little), start a profitable blog^{3}Hahaha! Just kidding!, or use another skill to earn some income with minimal work. You might say that doesn’t sound like retirement. But if working two hours a week allows you to live your life the way you want to while others your age are stuck in a job they don’t like, I’d say it’s a pretty good situation to be in.
tl;dr
The 4% rule says that you can withdraw up to 4% of your portfolio each year and you’ll most likely never run out of money. In fact, you’ll probably continue to get richer. This is based on historical data over the last 100ish years. The studies looking at this make some pretty rigid assumptions that are not really representative of real life. So instead of worrying about about a 5% theoretical failure rate: adopt a frugal and flexible mindset, become financially independent, and start living life on your terms!
Thanks for the detailed breakdown, Joey! That is really good stuff. I may not be FIRE ready yet, but this is definitely helpful for making goals! Also, I believe that you are not a robot…until I see you running. Very few would challenge the speed and constancy of the “Joe-Bot!”
Hahaha, glad you liked it Spence! I’ll take being a Joe-Bot :). Hope you’re doing well!