Using the 4% rule to calculate your financial independence number
Figuring out how much money you need to retire can feel like complete guesswork — challenging and overwhelming.
Thankfully we can use the 4% rule to give us some direction on how to calculate this.
This rule simplifies how you can manage your retirement funds by setting a straightforward guideline for withdrawals.
What is the 4% Rule?
The 4% Rule is a financial principle suggesting that you can withdraw 4% of your retirement savings in the first year of retirement, adjusting the withdrawal amount each subsequent year for inflation, without running out of money in retirement.
For example, if you retire with a $1 million portfolio, you'd withdraw $40,000 in your first year. If inflation is approximately 2% that year, the next year you would withdraw $40,800, an increased withdrawal based on a 2% increase in inflation.
Based on historical data, this would ensure that you don’t run out of money in 30 years.
How to use the 4% rule to calculate your financial independence number.
The easiest way to calculate use the 4% rule to calculate your financial independence number is to estimate how much money you want to have to cover your expenses or spending per year in retirement.
This is not easy to estimate so I suggest finding a ballpark number. Let’s say you want to live off of $50,000 a year (not including social security). We would then multiply $50,000 *25 to give us $1,250,000.
With $1,250,00 invested, the 4% rule suggests that we can withdraw $50,000 in year 1, adjusting for inflation each year there after, without running out of money in retirement.
Using the 4% rule as an empowerment tool
For many women navigating investing and wanting to ensure a comfortable retirement, understanding financial tools like the 4% Rule can be empowering.
It not only aids in managing savings effectively but also boosts confidence in making financial decisions that ensure a comfortable retirement.
Is it perfect? No, but it’s certainly better than having no target or goal.
A study published in the Journal of Applied Psychology found that writing down goals increased the likelihood of achieving those goals by 42%. Once you’ve found your financial independence number, using the 4% rule, write it down!
Why is the 4% Rule Beneficial?
The appeal of the 4% Rule lies in its simplicity and its practical application.
It provides a clear benchmark for how much you can safely spend each year without the fear of outliving your savings.
Designed to sustain at least 30 years of retirement, this rule helps you plan your spending in a structured way.
*Note: If you plan to retire early, you may need to adjust your withdrawal rate down.
Limitations of the 4% Rule
Despite its advantages, the 4% Rule is not without its shortcomings.
The rule is based on historical data of market returns and inflation (things could change in the future.)
This rule also does not include the social security you will receive in retirement. Currently, social security is roughly ~$2,000/month on average as of 2024.
We also have to consider inflation, which is a pivotal factor in retirement planning. It erodes the value of money over time, which means that what you can buy with $40,000 today won't stretch as far in future years.
If we are using the 4% rule to estimate what we need in retirement based on our annual expenses, we should consider increasing our project yearly expenses to account for inflation.
A Flexible Framework
It's important to view the 4% Rule as a flexible framework rather than a strict directive.
Each women’s financial situation is unique, influenced by personal spending habits, life expectancy, healthcare needs, and other obligations.
While the 4% Rule offers a good starting point, it should be customized overtime to fit your specific needs.
What’s next
Navigating retirement need not be daunting. With the right tools and a bit of savvy planning, you can secure a future that's not just financially stable but also rich in possibilities and peace of mind.
Whether you're just starting to think about retirement or are looking for ways to optimize your existing savings, the 4% Rule and other strategic insights can help pave the way to a fulfilling and worry-free retirement.
Ready to learn more? Don’t miss my next free beginner investing workshop that will help you learn how to make the most of your hard earned money in the stock market. Learn more here.
