What is the 4% Rule?

The 4% rule was created based on historical market returns data. Simply put, it showed that a typical retiree could withdraw 4% of their portfolio while keeping the initial pot intact. The withdrawn amount would increase by inflation each year.

The rule came about from work by Bengen and later, the Trinity study. Both were based on the same data.

This rule of thumb has been widely adopted in the FIRE movement as a way of calculating the required pot to fund early retirement. It is the basis of Mr Money Mustache’s famous article The Shockingly Simple Math Behind Early Retirement

Negativity

There have recently been a lot of articles criticising the 4% rule. I still think this rule provides a great initial estimate for anyone considering FIRE. That’s why I wanted to create an article giving the other side of the argument.

The Defence

Here are some of my views in defence of the 4% rule.

1. It’s only a rule of thumb

The overriding defence for the 4% rule is based on using it as a rule of thumb. That means it gives you an initial guesstimate, to be ratified with more detailed, personalised calculations later.

As an engineer, rules of thumb are something I use every day. They’re a quick way of getting an answer to provide initial guidance, before you carry out a full and detailed analysis.

To me, this is exactly where the 4% rule should sit. It’s a fantastically simple way for anyone new to FIRE to work out a rough guide of how much they might need to accumulate.

I would like to think nobody in the FIRE community is naïve enough to base their entire retirement strictly on the 4% rule without any personalised calculations. Maybe I’m just too trusting but I have faith in you!

If you’re anything like me you will be running numbers based on a multitude of different scenarios, with different income levels and spending levels. This is where the 4% rule comes into its own. It’s a quick and easy way to estimate an outcome.

By the nature of a rule of thumb, it MUST be kept simple. There’s no use over-complicating it at this stage. More complex numbers can be checked out as you get closer to FIRE status.

2. It’s based on a 30 year retirement

One of the main criticisms of the 4% rule is that it’s based on a more ‘traditional’ 30 year retirement. If you’re retiring early you are likely to need to sustain your portfolio for roughly twice that amount, maybe even more.

While that is clearly true, the 4% rule is still a valid rule of thumb to use to get an initial target. Some people prefer to use a lower value of 3 or 3.5% to be on the conservative side. That’s fine too, but the 4% rule still seems like a fine benchmark to me. Remember – we’re only working out an initial estimate here.

Regardless, if you can make your portfolio last 30 years, it seems pretty likely you’ll cope just fine…

3. It’s based on historical market data – what if future returns aren’t as good?

Remember you’re dealing with global stock markets here. By their nature, markets are unpredictable. The best we can do is base our estimates roughly on what has happened historically and assume future trends will follow a similar path.

This could be completely wrong, but it’s the sensible assumption.

The market is, by its nature, unpredictable. If it performs really badly in the early stages of your retirement you will do worse. If it performs well, you will do much better!

As you get closer to retirement you can adjust your own calculations to allow for the current market state. You can also try to predict the future, but that will always be a bit of a finger in the air exercise!

If one thing is for certain in investing, it’s that you can expect the unexpected.

That’s why getting bogged down in intricate analyses seems a little counter-productive.

4. Be more flexible

The biggest power you have is in altering your spending in retirement. A few years of lower spending can have a huge impact on the long term survival of your FIRE fund. I would recommend spending a lower amount in the first few years of early retirement. For example, you could visit cheap countries. A great example is that of Go Curry Cracker. They spent the first few years in cheaper countries (e.g. Mexico) while their retirement pot continued to grow. They have since been able to significantly ramp up their expenses!

I intend to work on an assumption of withdrawing 4% at a ‘comfortable’ spending amount. Within our spending, we will leave enough wiggle room to be able to alter this if required. If the market crashes, we would be able to cut back to a minimum spending covered by <3%. We could happily cut back on some of our spending in order to give our portfolio a better long term chance.

Example

As you can see in our March Spending, we are currently spending around £2,000 per month. That’s between 2 of us but doesn’t include for any holidays etc which we would like to feature in our retirement plans. We are aiming to have the mortgage paid off when we reach FIRE status, so our ‘minimal’ spending would be around £22,000 per year.

We could even resort to earning an income to get through this period – shock horror!

If you’ve read Our Version of FIRE you’ll know that Miss Way actually always plans to keep some element of work, so this would fit well! I could also take up some contracting work if the market really has a wobble.

What About You?

We all have our own unique plans for retirement, with different spending plans and often even some income thrown in there. Do the numbers for your own situation and be happy with how much you can withdraw. But above all, BE FLEXIBLE!

If you were to retire with only enough to cover your minimum spending at a 4% withdrawal rate you would be pushing the limits and be much more likely to fail. But we don’t think many people are that naïve! To even be interested in FIRE you have to have something about you. Most of the other FIRE types we have interacted with are very prudent and almost all of us seem to have our own spreadsheets for predicting our retirement incomes!

Summary

So there we have it – my defence of the 4% rule. While I agree that many of the points against this rule are valid, I still think it has a key place in the FIRE community. It can be used to give a quick guesstimate at how much you need to accumulate in your FIRE fund and for that purpose, it’s great.

Provided you use it as a rule of thumb in this way, you’ll be fine. While you’re in the accumulation phase you’ll likely be going all out to save as much as possible. As you get closer to that number, you can carry out a more detailed prediction and tweak accordingly. In all likelihood, your spending requirements will have changed in that time period anyway!

You will notice I haven’t dug deep into the numbers behind the 4% rule. That is deliberate. As I’ve mentioned, I see this as a rule of thumb rather than an accurate retirement calculation so will continue to use it in that way.

Above all, make sure you do your own research and settle on something you’re happy with. What if you think the 4% rule is a terrible idea and you shouldn’t use anything above 2%? Well, if you’ve done your research and come to that conclusion then that’s what works best for you! We all have different risk tolerances and have to adjust our numbers accordingly.