In order to determine how much money we need to sustain a careless live after working, we initially applied the 4 % rule as rule of thumb.
For those who don’t know what I’m talking about, this article explains everything in detail. For those who want the summary: The 4 % rule was established from research that is called the Trinity Study. Researchers collected all the historical data from the stock market and wanted to simulate what would happen if a person withdraws a certain percentage of his/her portfolio during retirement. So following simulation took place: A person invests money in stocks/bonds (50/50) every year throughout his/her working career. During retirement, this individual withdraws a certain percentage to be able to live. (withdrawing can be receiving dividends or selling stocks…or both)
Research showed that when you withdraw 4% of your portfolio every year, you have a 95% success rate. Meaning, of 100 people, 95 were able to live comfortably throughout their retirement and even made more money while 5 people had nothing.
In other words, if you want to successfully withdraw 4 % of your stock portfolio every year, you need to have 25 times the amount of your yearly expenses.
Example (Euro): Your monthly costs are 2000 € /month, thus, 24.000 €/year: withdrawing 4%: 24.000 €/year x 25 = 600.000 €.
Example (USD): Your monthly costs are 2360 $ /month, thus, 28.320 $/year: withdrawing 4%: 24.000 $/year x 25 = 708.000 $. (Disclaimer: exchange rate when posting this article, rounded off)
In order to calculate your number, you need to be track your yearly expenses, multiple it by 25 and BOOM… Let the games begin. However, I find it’s not that simple. It doesn’t mean our current expenses will automatically reflect our spending in the future. If anyone has a crystal ball, please contact me. And what do you think about the 95 % success rate? Pretty good odds no? Hell no… I’m not taking any chances with my money.
The study also showed that applying a 3 % withdrawal rate results in 100 % success. Meaning, multiply your annual expenses by 33 and you have your number. This strategy implies putting all your nest eggs in one basket. As we’re trying to reach freedom through multiple sources of passive income, it might be necessary to foresee some room for adjustments. If there is anything I want to avoid, it’s running out of money when I’m old.
So for now I’m using 2000 € costs/ months and a yield of 3.5 %. *
Why 2000 if you’re not going to use that much? Currently we spend far from 2000 €/month. But we want to be able to wake up in the morning and spontaneously decide to take a trip or do certain activities without having to look at our bank account. (I can’t imagine I’m not going to track my expenses but you get the point) Therefore, we’re planning in a buffer. Chances are small that our income will drop to zero once we quit the rat race, but you never know. Prepare for the unexpected. And thus, we would like to withdraw 3.5 % / year.
Withdrawing 3.5 %: 2000 €/month or 24.000 €/year * 29 = 696.000 €
(Note from the girlfriend: Let’s crank that number up until 750.000. A girl needs clothes right?!)
To consider the inflation rate, you can multiple your withdrawal rate with 2% every year. (in this case: 3,5% times 1,02)
Is this enough? Is it too much? I don’t know. I am here to share my thoughts and see what the outcome is. It might be that my calculation needs to be adjusted, if so, no problem. For now, I’ll keep it at that.
Do you have any idea about your magical number?
* This amount doesn’t take a mortgage into consideration. The girlfriend created an amazing tool where you are able to add all of these factors in order to give you a better overview of your exact number and timeframe until “freedom”. Stay tuned!