If you want to reach financial independence, you should know about the 4% rule. Also known as F-you money.
Financial independence is when you have enough money to walk away from your job and you can live off the income off your investments.
I became aware of financial independence when I went through a bad break up. My boyfriend broke up with me and the next week I was let go from my job. I was devastated. But not defeated.
I felt such a feeling of loss. And also a feeling of pressure about what I was going to do for money? I felt powerless.
I hated that I had to rely on an employer to take care of myself. And then that enployer can just dumo you at anytime and not even gove a reason.
So I decided I wanted to be financially independent. I want to be able to walk away from a job, because I dont like it or I dont want to do that type of work. Or really just any reason, because I dont have to have the money.
I dont just want that feeling of security for myself, I want it for my family, my friends and strangers like myself.
That is where I started my financial independence journey really began.
Your first mission on the road to FI should be to save money. F-you money.
Once you have saved enough investment income that is when the 4% rule comes into play.
The 4% rule was established by William Bergen in 1994 as a rule of thumb for withdraw rates from retirement savings. He went back and looked at the historical data of the stock market back to 1926, to see if this rule would apply to 30 year portfolios at different times in history. And it proved solid.
4% is the amount of money you can withdraw from your investments without the underlying principal being diminished. It most cases you can withdraw 4% and your principal will still continue to grow due to capital gains in the market, interest and dividends.
The 4% withdraw should supply a consitent stream of income for the individual.
But how much income do you need in “retirement”. That depends on you. Everyone spends money different. Some people may need $20,000 per year. Some may need $50,000 per year in spending money. It is a good exercise for anyone to look at how much they spent in the previous year. I track my spending using the Personal Capital app to make sure that the purchases I make are actually adding value to my life. There have been too many times in my life where I spent money, had no idea where that money was going and had nothing to show for it after it was gone.
$500,000 x 4% = $20,000 per year in spending money
$1,000,000 x 4% = $40,000 per year
$1,500,000 x 4% = $60,000 per year
$2,000,000 x 4% = $80,000 per year
The more you spend each year the larger your FI number will need to be in order withdraw that 4%. This is where you should also watch out for fees. If your investment adviser is charging you 2% in fees that means you have to make up that 2% in performance. Unlikely. Or you get reduce you withdraw rate by 2%. Or you have to work many more years in order to make up that 2% difference.
Keep in mind if you withdraw this money from a tax-deferred account like a 401k you will also have to pay tax to the government on that money. So you may need withdraw more than expected to pay the tax and get the amount you need for living expenses.
Here are some great calculators to help you figure out your FI number:
The 4% is also just a guideline. If the market is killing it with gains you can adjust your spending up. If the market slumps, you can adjust your spending down.
Ready to reach your FI number? Read article about how to increase your income in order to reach FI faster.
How to do it:
- Increase your income with your current employer
- Start a business
- Increase your savings rate
- Reduce you lifestyle costs
I love the quote by Ramit Sethi: There is a limit to how much you can save, there is no limit to how much you can earn.
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