Tuesday, 13 August 2019

Is 4% withdrawal safe for early retirement?

So much has been talked about regarding the 4% withdrawal rule by Mr. Money Mustache (MMM) and FIRE - Financial Independence Retire Early - pundits that I thought I should add my two cents worth.

You see, people are petrified of giving up their careers and day jobs because they are scared stiff of running out of money when they grow older. Hopefully this article will help put everyone at ease regarding early retirement, and what it would take to kick back and relax.

The 4% withdrawal rate has its roots in a 1998 study named "Retirement Spending: Choosing a Sustainable Withdrawal Rate" by a few professors at Trinity University in Texas. This study has since been nicknamed "The Trinity Study", and to explain it simply, calculates portfolio success rates for different withdrawal rates. These withdrawals are inflation-adjusted, and are also calculated for different types of asset allocation.

For an all-stock portfolio, the success rate of a 4% withdrawal rate of not running out of money in 25 years is 99%. For a 75% stock portfolio, the figure is 100%. A 50% stock portfolio is even more promising at 100% for 30 years. What is interesting is that if you decrease from 4% to 3% withdrawal, the picture looks a lot brighter with 100% success rates up to 40 years of retirement for 100%, 75% and 50% stock portfolios.

MMM's personal preference is still 4% withdrawal, and he says that with a couple odd jobs here and there, the success rate becomes 100% pretty quickly. That is not entirely incorrect, and I do urge some caution as the Trinity Study is based on historical data. Like they always say in mutual fund prospectus, past performance is not an indication of future.

I feel that to retire early, an individual needs to be flexible in terms of spending and living arrangements. Heck, I would even say he / she needs to be flexible when it comes to getting a part-time gig if the stock market crashes so as not to deplete the portfolio while in retirement.

My recommendation is to go with a more conservative 3% withdrawal rate before taxes, and if after taxes the withdrawn amount covers your expenses, then you are good to go. In any case, it is good to stay active after retirement, and if you can turn your hobby into a paying income stream, all the better. This 3% assumes that you will not be drawing upon any social security at a later point in time.

There you have it. It is possible to retire early and get excited about the FIRE movement. I know I am.

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