The FIRE rule of 4%: how to safely withdraw your investments
By Maude Gauthier | Published on 20 Jul 2023
Imagine that a fairy pays you a visit and, using her magic wand, increases your assets until they reach a considerable sum. Regardless of the proportion, luck and hard work will lead you to financial independence, if that is your wish! But surely it’s more about hard work. Let’s not be complacent.
How will you ensure that you don’t run out of funds before the end of your life? Calculating your FIRE number and the 4% rule are rules of the thumb to help you set your magic number and estimate your annual withdrawals.
What is the rule of 4%?
At Trinity University in the 1990s, administration researchers conducted a study to determine the safe withdrawal rates of various retirement portfolios containing stocks. Their study was updated in 2011, with data ranging from 1926 to 2009. The followers of the FIRE movement often use one of the study’s main conclusions to guide their withdrawals, once they’ve reached their FIRE number.
The 4% rule is used to forecast retirement expenses. This means withdrawing 4% of your total investments in your first year of retirement. Then the amount can be adjusted taking into account inflation over the years.
The original study’s authors tested a number of combinations of stocks and bonds to determine what happens to a given portfolio over time. It was on this basis that they determined that a 4% withdrawal rate was extremely unlikely to exhaust a portfolio of stocks and bonds. And some portfolios may allow higher withdrawals. For example, the study shows that a 7% withdrawal rate from a portfolio of 75% stocks and 25% bonds can likely fund a 30-year retirement.
But if these studies project over 30 years, but how do you apply it to early retirement, potentially lasting 50 or 60 years? The longer the retirement, the more likely we are to face unforeseeable events and deplete our reserves. So it’s probably not a good idea to go with the 7%. Someone who is cautious could aim for a 3% withdrawal rate and, if necessary, leave the excess to their favorite NPO (or their brother).
Is the 4% rule hard and fast?
Not really. Since this is a rule of thumb, it’s too general to apply to everyone at all times. Instead, financial advisors will prefer to assess a client’s specific situation and make adjustments to their disbursement strategy over time. It makes sense!
What if you run out of money after 10 years of retirement?
Following the 4% rule with your eyes closed is probably a bad idea. The tables from Trinity researchers should help you pinpoint your position, depending on your portfolio’s makeup. Either way, your retirement may last more than 30 years. And we can never be 100% sure that the past guarantees the future.
The 4% withdrawal is intended to cover all of your annual expenses. This amount does not take into account any government credits you may receive, which could be very useful in helping a young retiree through a time of turmoil.
However, to avoid running out of money, it’s best not to rely too much on governments and so you should view their credits and programs as bonuses. Young retirees can implement simple mechanisms, such as keeping a substantial part of their portfolio in cash. These will not grow their assets, but they will not be in play if the markets crash, whether they are stock or real estate. A well-stocked high-interest savings account is one avenue to consider. If you want to go further, why not invest some money in securities that are liquid or easily convertible into cash?
If you ran out of money, could you go back to work? Do you specialize in an area that requires updating training or taking exams? If so, you might not be able to go back to work overnight without going over some hurdles, but that probably also means that the wages are good.
Do you have other talents that you could leverage? Would you be eligible for certain training programs? Do you have loved ones to count on? The answers to these questions can help you plan a B, C, and D plan. They may not be enough to reassure someone who worries by nature. Why not surf on the multiple variations of the FIRE movement and work on contracts or on a part-time basis?
