not understanding the 4% rule - please help

[Jamese20]

hi guys,

i think i am being thick,

but for an example you need 20k a year to live on which would require a 500k stash according to the 4 % rule....You are there and have reached it time to celebrate!

your first year you withdraw this 20k so you are now at 480k at the end of year one - lets say for this example its a flat year. Year 2 2008 happens all over again and you see a 50% drop in the market and now you have 240k worth of stash remaining (assuming 100% stocks) - does the 4% rule say that you withdraw 4% of 240k? now? if so this is now 9,600 to live on!

am i missing something here? how does this work as 9,600 probably would only cover bills barely?

[caffeine]

I wouldn't siphon off the whole 4% in total for the year.

$20,000/12 months = $1666.67 per month.

You should review simulations to see what could happen.

http://www.firecalc.com/

But yeah, you could continue to withdraw that $1666.67 a month and probably be fine. If it were me, I'd adjust to account for the bad timing by taking part time work or reducing my spending further.

[Jamese20]

I wouldn't siphon off the whole 4% in total for the year.

$20,000/12 months = $1666.67 per month.

You should review simulations to see what could happen.

http://www.firecalc.com/

But yeah, you could continue to withdraw that $1666.67 a month and probably be fine. If it were me, I'd adjust to account for the bad timing by taking part time work or reducing my spending further.

my main point is - if you find that half the value of your stash is gone, do you still take out 20k using 4% rule or is the 4% rule stating 4% of whatever the stash value is at the time? because the second one surely isnt viable to most unless they plan for this in advance which would mean working alot longer

[Feivel2000]

Also, having 100% in stocks is a real risk.
Consider 20/80. If then the stock market crashes, you still would have ~100000$ in bonds, enough for 5 years and hopefully enough time for the stocks to get better.

But of course, in such a dire situation, you would need to scale your spending back and probably take some work.

[Tyson]

Also, having 100% in stocks is a real risk.
Consider 20/80. If then the stock market crashes, you still would have ~100000$ in bonds, enough for 5 years and hopefully enough time for the stocks to get better.

But of course, in such a dire situation, you would need to scale your spending back and probably take some work.

Agreed with this.  Bonds are a hedge against crashes.  Live off them if there's a big drop.  Stocks will recover, as they always do.

[Acastus]

James,

The rule is to start at 4% of the original nest egg, then blindly increase it by the CPI every year. This is how the Trinity analysis was conducted. In your example of having 240k after a bad year, you spend 4% x 500k x 1.03 = 20.6k in year 2, assuming 3% inflation. You would withdraw the same dollar amount if the portfolio had grown 50%, too.

There is plenty of boisterous discussion on this board and elsewhere about whether to use a larger or smaller initial draw, and whether to blindly follow the rule at all times. If you are retiring young, reducing to 3 or 3.5% initial draw is considered safer. A true mustachian would tighten their belt until the portfolio recovered, or would have built a slightly oversized 'stache in anticipation of the first crash they experience. Both of these are different perspectives on the same thing, really.

[MrMoogle]

Theoretically:
You would withdraw 20k + inflation the second year, no matter what happens to the market the first year. 

In practice:
The few times this fails is right before a crash though.  So if you retired right before 2008, I wouldn't expect the 4% rule to hold.  If you started at 3%, you'd probably be fine, but otherwise, I'd start looking for part time work.  It only took like 3 years for it to get back to previous levels, so if you worked part time making $20k a year for those 3 years, you'd be set!

[Jamese20]

Theoretically:
You would withdraw 20k + inflation the second year, no matter what happens to the market the first year. 

In practice:
The few times this fails is right before a crash though.  So if you retired right before 2008, I wouldn't expect the 4% rule to hold.  If you started at 3%, you'd probably be fine, but otherwise, I'd start looking for part time work.  It only took like 3 years for it to get back to previous levels, so if you worked part time making $20k a year for those 3 years, you'd be set!

i see thanks for the clarity - i guess it would fail after this bad timing of retiring but as above you put 20% in bond or have cash to use in case of this type of situation

here is hoping the first few years in retirement are like the last 5 :)

[Tyson]

Theoretically:
You would withdraw 20k + inflation the second year, no matter what happens to the market the first year. 

In practice:
The few times this fails is right before a crash though.  So if you retired right before 2008, I wouldn't expect the 4% rule to hold.  If you started at 3%, you'd probably be fine, but otherwise, I'd start looking for part time work.  It only took like 3 years for it to get back to previous levels, so if you worked part time making $20k a year for those 3 years, you'd be set!

i see thanks for the clarity - i guess it would fail after this bad timing of retiring but as above you put 20% in bond or have cash to use in case of this type of situation

here is hoping the first few years in retirement are like the last 5 :)

Another hedge is to pay off you house before you retire.  That's what I'm doing - saving enough to live on $50k per year plus have no house payment.  This gives a lot of wiggle room because most of the $50k is luxury not necessity.  Plus I will have 80/20 stocks/bonds.  Between these 2 things (plus the inherent safety of the 4% rule), it's pretty darn safe.

[Dezrah]

This is good reading for your question: http://www.madfientist.com/safe-withdrawal-rate/

[RyanAtTanagra]

here is hoping the first few years in retirement are like the last 5 :)

Are you getting ready to retire early?  I ask because your question, while a very good one, is generally an early-on question, not a "Ok I'm retiring... how does this work?".  If you're retiring now you have A LOT of reading to do, imo, to fully understand what you and your money are doing, and how to know if you need to change tactics partway through.

[Jamese20]

Hi Ryan

No I'm trying to learn in advance I have a long time ahead yet

[rpr]

I second reading madfientists blog entry that was linked above. In that post, it seemed to indicate that the most critical time from the point of view of sequence of market returns is the first 10 years or so. If your portfolio is healthy after this time, most likely  it will survive the duration of the retirement.

[Tyson]

I second reading madfientists blog entry that was linked above. In that post, it seemed to indicate that the most critical time from the point of view of sequence of market returns is the first 10 years or so. If your portfolio is healthy after this time, most likely  it will survive the duration of the retirement.

Yes, the first 10 years are the most critical. 

[Late_Bloomer]

If you have a 100% stock allocation during the accumulation phase, and then change to a 80/20 bond/stock allocation, will you loose an undetermined amount of money on the change over from stocks to bonds? Surely it won't transfer dollar for dollar. How would you figure out whAt you would have left after reallocating a 650k all stock allocation to a 80/20 split?

[Physicsteacher]

If you have a 100% stock allocation during the accumulation phase, and then change to a 80/20 bond/stock allocation, will you loose an undetermined amount of money on the change over from stocks to bonds? Surely it won't transfer dollar for dollar. How would you figure out whAt you would have left after reallocating a 650k all stock allocation to a 80/20 split?

Why do you assume you would lose money in the switch to bonds? You should indeed be able to sell $130k of your stock allocation and buy $130k of bonds or bond funds. You would probably want to hold bonds in tax deferred accounts like 401(k)s for tax efficiency purposes. Selling a stock mutal fund or ETF and buying a bond fund within a 401(k) or IRA wouldn't result in owing capital gains tax. Perhaps there might be some transaction fee depending on the brokerage, but that should be negligible compared to the size of the portfolio, pehaps thirty or sixty bucks in a worst case scenario, and quite possibly zero.

[JAYSLOL]

hi guys,

i think i am being thick,

but for an example you need 20k a year to live on which would require a 500k stash according to the 4 % rule....You are there and have reached it time to celebrate!

your first year you withdraw this 20k so you are now at 480k at the end of year one - lets say for this example its a flat year. Year 2 2008 happens all over again and you see a 50% drop in the market and now you have 240k worth of stash remaining (assuming 100% stocks) - does the 4% rule say that you withdraw 4% of 240k? now? if so this is now 9,600 to live on!

am i missing something here? how does this work as 9,600 probably would only cover bills barely?

Just that we never plan on withdrawing a whole year worth of cash at once.  Sure, for a 2008-style crash, the market dropped 50%, but not for of the whole year, only for a month or 2 of that year.  If you DCA (dollar cost average) by selling stocks/bonds on a monthly basis, you might be selling at an average of a 30-35% loss for that year with one or max two monthly withdrawals being at a ~50% loss but most being 25-40%. 

[SwordGuy]

The US market has never (historically) failed for a 3% withdrawal rate. 

4% of $500,000 is $20,000.

3% of $500,000 is $15,000.

So, in principle, if you can cut expenses by $5,000 or come up with some income for $5,000, or any combination of the two, your withdrawal rate should be low enough to recover.  At least, if the future is not seriously worse than the past.

$5,000 isn't that hard to come by.  With a guesstimate for taxes, you're talking about 5 month's worth of full-time work at the national minimum wage.   Or, realistically, up to 10 months at 20 hours/week.

Or it's about mowing 6 yards a week for 6 months.

Not that hard to make up the difference.

Frankly, if your FIRE budget doesn't have at least $5,000 worth of fun money in it, I think you're cutting it too close. :)

Now, if you need $40,000 to live on instead of $20,000, you've just doubled the amount of savings or income you will need to come up with.    And another doubling for $80,000 of income!

So, the ability to come up with part time work that can raise that amount of money gets harder as your FIRE income requirements get higher.

We have enough fluff in our budget to keep our withdrawal rate pretty low if we need it to.   We diversified into additional income streams besides social security and stock dividends/sales.   We're also using real estate rental property and farm rental income to cover our expenses.  All but one of our six properties will be fully paid for by the time we retire next spring so that keeps our fixed expenses lower.   

As you read more threads on the forum, you'll find that I'm on the "be extra safe" side of the discussion.  Partly that's because I'm generally cautious about money matters and partly it's because of our ages.  I'm 59 and my wife is older.  Once she retires it would be a miracle if she found full time employment in her field again.   (Not too hard for me to do so over the next 5 years if I spend a bit of my new free time to stay current in my field.)

Others will argue that you should retire earlier and go back to work if need be, otherwise you're working longer than you had to if the market does well.

Both positions have a lot of merit in them.   Pick one and take your chances! :)

[Bicycle_B]

Jemese, all of the principles above for reducing the risk of market crash - diversify your portfolio, move gradually instead of quickly, have a safety margin or be willing to do small amounts of work to compensate the occasional error - are very powerful.

One way to explore the effects of different strategies is with investment analysis apps that use past financial data to see how different investment strategies would have worked.  Two of these are:

http://www.cfiresim.com/
https://portfoliocharts.com/

You can use these to determine what would have happened in many years of examples.  Nothing can predict the future perfectly, but if you experiment with these, you'll probably find that the rule of continuing to draw the expected 20k has worked quite well.

In any case, good luck accumulating the 500k and welcome to the Learning How To Do This club!