When talking about financial goals I always mention the 4% rule. You may be wondering, what am I even talking about. Yes, the 4% rule. It is the rule that helps guide individuals to the magical retirement number.
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The 4% Rule
In the FIRE (Financial Independence Retire Early) community, we talk about the 4% rule.
It is a rule that came out of the Trinity Study. It was determined that if you could take out 4% of your net worth every year, your money could last for around 30 years.
Three finance professors from Trinity University decided to study the stock market and portfolios to determine what is a safe withdrawal rate for your retirement.
They took a look at stock/bond mixes and withdrawal rates from 1925-1995, and published a paper in 1998 on the results they came up with.
The payout periods they looked at was 15 and 30 years. They determined that at a 3% to 4% withdrawal rate per year could make your money last for 30 years. Of course, 3% is better than 4%, but over the course of those many years through the Great Depression, stagnant 60s, inflation periods of the 70s, and booming 80s, their research showed that it is safe to withdraw 4% of your retirement every year.
How to determine your FI number
The way to find your number you will need to take the number 25 and multiply it by the amount of money you would like to spend each year.
You can also take your annual spending then multiply it by 25. This can help you determine how much you need, and help with the goals needed to achieve our desired outcome.
Let's make this simpler for people. Let’s say you want to retire and you spend roughly $40,000 a year. You want to be able to spend that same amount throughout retirement. Take that $40,000 and multiply it by 25
$40,000 x 25= $1,000,000.
So it will equal $1 million dollars. That is a whole lot of money. The 4% rule will state that the money you had saved for your retirement will last you 30 years as long as you take out 4% or less every year.
$40,000 x 25= $1,000,000
The Total Stock Market
The total stock market from 1975-2015 averaged 11.9%. If you adjust for inflation it can be around 8%. A safe percentage is more likely 7%. If you take the 4% out of the 7%, it leaves you with 3% for the money to continue to grow from compounding interest. Compounding interest and time is a great generator of wealth.
Setting Goals for a Financial Future
As a person, wanting to seek financial independence, I want to make sure to set goals in order to safely stop full-time work.
Most people work till they are 65-70 years old. They work their 40 years, hope for a pension or social security and retire. They stop full time work.
Here is my question: what is that number you need to stop working? We are all on the hampster wheel of life, going, going, going until finally we stop.
As I have ventured through life, I have been faced with the rat race, and never really thought about how I could become financially independent. My father always said “Get a good job, work 40 years…” That is like the boomer advice I kept hearing from people.
Life at that point is about work. Nothing else besides work, have a family, enjoy weekends, retire, go on cruises, and die.
Why work your whole life?
I started reading blogs like Mr. Money Mustache, and realized that life could start whenever I wanted it too. That means it was in my hands to reach a goal in my life. I could travel and explore the world when I was young while saving for a future.
Why work for 40 plus years? I could still work for 40 years, but at some point I could work under my own terms.
Once you hit that financial goal of financial independence and get the 25 times your annual spending you control your time. No longer will a boss control my time.
Now is the time to use the 4% rule to create something different in your life. It looks hard.
My wife and I spend less than $25,000 a year. To be on the safe side of things, I would like to make the goal of hitting financial independence before I am 65. So I will take $25,000 x 25 = $625,000. If I hit that number I am financially independent.
The Path to Financial Independence
A couple of things must happen. First I need to save money. The more money you save, the less time it takes to hit your FI number.
Next, I will need to invest the money I save. To be on the safe side, I can invest it in a total stock market index fund like VTSAX. I then have a simple and easy investment that will go up and down as the stock market goes up and down with a safe return of 7% every year.
Next I will try to do what I can to earn more money to help reach my goal quicker.
Lastly, hit my goal, and figure out what I want to do with my time.
There it is a plan to achieve Financial Independence using the 4% rule. The Trinity study really changed the minds of so many, and it is great to know some of these tricks to help with the future.
Looking back at my past.
Looking back at life, I wish I had learned the lessons from these financial bloggers. I was constantly side hustling with no true goal.
My lack of financial education led me to use my money on frivolous things like eating out, cable, beer, fun nights with friends, and dates. I wasn’t saving.
Here is the time for you to think. Here are some questions to ask yourself.
Where do you want to be in life in 10 years? Where do you want your financial future to be? Are you saving enough? What can you do to make things happen?
These are the same questions I asked. I discovered the 4% rule. This is the rule to set the number for your goal.
When I hit my goal it will be time to stop working for my boss man or keep working if I would like to.
There will be free time for me. Free time to me means traveling, spending time with friends and family, reading, writing, and learning more about the world around us.
What is your number?
What is your number? Take your annual spendings x 25= (FI(Financially Independent) number)
Ex: $40,000 x 25= $1,000,000.
” Spend less than you make, stay out of debt, and invest the rest”
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.