If you want to learn more about Financial Independence, check out my post, Introduction to the F.I.R.E. Community.
Here’s the gist of the 4% Rule.
- The 4% Rule refers to the Trinity Study, which was an influential paper from 1998 written by three professors at Trinity University. One of the topics the paper dealt with was “safe withdrawal rates.” In other words, how much money could you draw out of investment accounts each year and be able to do this for decades without running out of money?
- They looked at the historical returns of the stock market over a 70 year period and concluded that 3-4% was a safe withdrawal rate. In other words, if someone withdrew 3-4% per year from certain portfolios (high percentage stocks) over the 30 year payout periods they studied, they’d likely never exhaust their portfolio.
- The 4% Rule assumes the historical average stock market return of 7% with 3% average inflation a year, so 7% - 3% = 4% to live off of
Let me put this more simply by showing the same math a different way:
- If you have 25x your annual expenses invested in total market index funds, you can withdraw 3-4% per year and likely never run out of money.
- According to the Trinity Study, you could “safely” retire at that point. There’s definitely some debate about this in online communities. Some would consider the “safe withdrawal rate” closer to 3% (especially for a longer timeframe), but in the F.I.R.E. community, 4% is seen to be pretty conservative & at least gives you something to aim for.
Here’s an example:
- If you currently spend $40,000 per year, $1,000,000 in low-cost index funds ($40k x 25) would allow you to no longer have to “work” for money. At that point, your money you’ve invested is doing all the “working” for you and you’re reaping the benefits. Withdrawing 4% per year would give you the $40,000 you need to live on.
- If you currently spend $60,000 per year, $1,500,000 in low-cost index funds ($60k x 25) would accomplish the same thing. If you withdrew 4% of $1,500,000 per year, you’d have the $60,000 you need to live on.
- There will obviously be fluctuations here. The Trinity Study assumes that. Sometimes the market returns well over 7% & sometimes well under. Sometimes inflation is well over 3% and sometimes well under. The study attempts to factor these variables in.
Ok, so who cares about all of this? Ha!
The reason this was exciting to me is because it gave me my Financial Independence (FI) number.
I multiplied 25 times my annual spending and I knew what I needed to have invested in order to “retire” from making money. Not “retire” from ministry or from doing what I loved. But “retire” from needing to make any money in ministry or through any other mediums. It’s your FI “freedom” number.
And what’s awesome is you don’t have to wait until 65 to hit that number. Some people hit it at 30. Some people at 40. Some at 50. “Retirement,” from a financial perspective, is not about age, it’s about a number. Once you hit that number, you could give all of your salary back to your church (or even before then if you start a business or have other side income). Or you could become a missionary to Thailand & not even need to raise support. You get the idea.
Being financially independent gives you the freedom to do whatever the Lord calls you to do whether it pays you anything or not! And that’s incredibly exciting!
*Note: In this post we are talking about returns from investing in the stock/bond markets (which is how most people are saving for “retirement”). This, of course, is not the only way to become FI. You can also become FI investing in real estate, businesses, or other assets.
If you’re interested in reading more about the 4% rule, here’s another article by someone in the FI community talking about the rationale behind the rule:
https://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/
