The 4% rule shows the amount someone can safely withdraw yearly from
his invested money and theoretically never run out of money. So someone
who can live with annual expenses that are about4% of his invested
money ,can safely retire.
For example a person who has saved 1 million euros can retire with an
annual income 4% of that, which is 0.04* 1 million = 40.000 euros
annually that's about 3.300 euros monthly.
The 4% rule is more a rule of thumb than an actual rule ,it is based on
the assumption that an investor is invested on a safe diversified
portfolio with a nice mix of bonds and stocks. These returns are based
on historical data of the last century .The 4% rule was first
popularized by an influential 1998 paper by three professors of finance
at Trinity University
Many have doubts about using the 4%, so many may use 3% but is even that
safe? In the investment world there is the notion of the risk free
rate, the risk-free rate is the return you get for bearing no risk.These
are returns you get for investing in safe government bonds of
countries with zero default chance, for example U.S.A or Germany in the
euro area. But take a look at what have happened in euro area the rates
have turned negative, so this mean you pay interest for owning the bond.
The conclusion after all these, is that you cant store your money
safely and rely on risk free-rates.Even the risk-free rates arent
really risk-free.U.S.A is considered to be the most stable and safe
country and with no default risk. The same way people in the past
thought the Roman empire will last forever!
The world isnt a safe place,we should know this by now,we cant get rid
of uncertainty but at least we can take less risks than the average
person around us and that will make us feel safe enough. Given on how
things are now, as long as you invest in businesses that produce value
you can make money. A nice mix of real estate, stocks and bonds can
easily give you 3-4 % . The good part is you dont even need to sale to
get profits. You can create for example, a safe dividend portfolio that
pays you divided of 3% and with growing dividends every year. Then you
can sell a very small part of your portfolio each year to get the
additional 1%.
The 4% is something that looks similar with what a pension after 25 or
30 years of work looks like. If you think about it, it is no different
of what an average retiree gets after working for 25-30 years. 4% is if
you reverse it 100/4=25 . That means if you make each year 4 from your
job you need to work 25 years to make 100. 3% is 33 years of yearly
income. So in other words you need to have stored 25 to 30 years value
of work to retire.If you have already accumulated 25 -30 years of work
you can retire on about that income.
Paradoxically the 4% rule is inherited in our working life system. Work for at least 25 years and then you can retire.
Retiring early through passive income for people that have an average
job is a Utopia,especially if they want to follow a passive investing
strategy.
How early you can retire it depends on the relation between your income
and expenses,if you have high income and average expenses then you can
get quicker to the average income and retire earlier ,but if you have an
average job to retire earlier you must live poor and retire as poor
that's the trade off.
If you need to take something valuable out of the 4% rule is that your
yearly income from your job worths about 4% of the same income in
retirement .If your goal is to retire earlier then you have to
accumulate money that account for at least 25 years of work.
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