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My “never have to work again” number – An introduction to the Safe Withdrawal Rate

Reading Time: 9 minutes

This post will go into the basics of Safe Withdrawal Rate and the 4% rule, so if you’re already familiar with the concept, you may wish to skip this one.

When speaking to my friends about financial independence – and the freedom you get from knowing you’ll never have to work again to earn money unless you really want to – I often get exasperated questions like:

“How do you know how much you need?”

“Won’t you run out of money and then have to eat maggie mee for the rest of your life?”

“How do you know when you already have enough so you can stop working?”

These are all very valid questions. In Asia we may already be saving a lot more than our American counterparts because we are taught from young – sometimes overly so – to be fearful of debt and credit cards; however most people don’t know when to stop.

I mean, how much is enough really? I see a lot of people who save and save and invest and invest, forever growing their net worth but with no end goal in sight.

Without knowing when we have enough, we’re navigating blind

If you don’t know when you have enough then you’ll never feel safe – you’ll never be free and you’ll never feel or be financially independent.

We’d just be walking around aimlessly saving until we’re 75 and “maybe retire” because we’re too old to work, but we’d have no clue about whether what we’ve saved is enough. Maybe it’ll last until I die but maybe it’ll run out 10 years down the road! I’ve got no time for that kind anxiety man.

So it’s very important to know your magic “FIRE number”, the amount you need to have in a diversified portfolio of investments which will be “enough” for you to never have to work again, forever.

This number gives you a finish line, it lets you know when you can stop working, it lets you plan your investments and savings so you know when you will likely reach financial independence.

So how do you go about calculating this number for yourself? For that, you’ll need to be able to answer some important questions.

How much income do you need after FIRE?

Before we look at how much you need in your investment portfolio in order to FIRE, we need to look at how much you think you’d spend after you are financially independent.

Think of it this way, the idea of FIRE is to provide you with a stream of passive income that essentially covers all of your expenses so you don’t have to work unless you feel like it.

In order to do that we first need to understand how much you’re spending and how much income would cover your expenses or expenses that you think you’ll have after you’ve reached financial independence.

Let me take myself as an example. I think for myself – because my wife is also on this journey – I will need at least S$6,000 in monthly income or S$72,000 in yearly income (in today’s dollars) to support all my expenses if I stop working.

The expenses should already include:

  • Utilities
  • Transportation
  • Food
  • All insurance payments: Health, Life, Accident, Hospitalisation, Pregnancy, etc.
  • Medical expenses (in addition to the insurance payments)
  • Mortgage Payments
  • Car Loan Payments
  • Any costs related to any children or potential children
  • Any discretionary spending budget: gifts, doodads, toys, etc.
  • Holiday or travel budget for each year

For me, I feel that S$72,000 per year for me and S$72,000 per year for my wife, will be able to cover all of the above and the potential children we may have down the road (we are planning for ~2).

So for just my part of the calculation, S$72,000 a year in income is a good place to start. You will need to work out this number for you and your family. Find a number that you think will allow you to live comfortably and start from there.

Now we are ready to calculate your FIRE number – let me introduce *drum roll* “The Safe Withdraw Rate!”

The Safe Withdrawal Rate – The 4% Rule

The safe withdrawal rate (aka SWR) is a concept of how much money you can withdraw from your portfolio on a yearly basis so that it does not run out.

This concept works due to the fact that money invested in a balanced portfolio will earn a certain rate of return. If you withdraw from the portfolio each year less than the portfolio has grown each year then, in theory, the money will never run out before you pass on.

So what is this safe withdrawal rate that will give you the number that you’ll need to save? Well as the heading of this section states, the figure is 4%.

What this means is that if 4% of your total portfolio value is enough to cover all your expenses in the above section (S$72,000 per year in my case) then my “FIRE number” is:

S$72,000 / 4% = S$1,800,000

An easy way to calculate this number is to just multiply your yearly expenses by 25, you will get the same result:

S$72,000 x 25 = S$1,800,000

This mans that if I continue to save and invest my money into a well-diversified portfolio of broad-based low-cost index funds, then once I reach a portfolio value of S$1.8 million, I have reached my goal of being able to withdraw S$72,000 per year (even adjusting for inflation each year) from the portfolio without having it run out.

Important Note: It is important to note that your money must be invested in low-cost broad-based index funds and in well diversified portfolio and not left in cash for this to work. Cash depreciates in value through inflation, a diversified portfolio should grow with the economy which – at sufficient size should grow quicker than you can spend it all down – allowing you to withdraw the funds until you are no longer in this world. Click here to read how you can build a portfolio like that in Singapore.

Let’s take another example. Say you are a single income earner who needs to support a family of 4 and believe that in order to stop working, you will have a post-FIRE expense of S$10,000 per month or S$120,000 per year to support your entire family forever. This is what the calculation would look like:

S$120,000 x 25 = S$3,000,000

This will work for all income levels and for all lifestyles that you are shooting for. All you really need is your yearly expense number that will sustain you and your family forever. The beauty of this method is that it has already taken into account. Every year you are allowed to adjust the withdrawal amount up by 2% to cover any reduction in purchasing power due to inflation.

So when I say this method will cover your spending long-term, I really mean long term.

Side note: Based on this starting point, you should already see that if you can reduce the amount that you will need, it will reduce the amount you’d need to have in investments to reach your number. This is why a lot of personal finance and financial independence bloggers advocate reducing your spending. Aside from reducing the amount you’d need to reach FIRE, it will also increase the rate at which you can save (aka the savings rate aka SR) because whatever portion of your income that you don’t spend, you can use to save and invest, further accelerating your progress.

Now we have a clear number to work towards and plan our journey.

However, keep in mind that the 4% rate is not gospel, reality is much more complex than that. It all depends on your end goal and how much risk appetite you have.

For example, although based on the above calculations, my FIRE number should be S$1.8 million, but it is not. The number I’m actually gunning for is actually closer to S$2.17 million, and here’s why.

Choose the Safe Withdrawal Rate that’s right for you

In reality, the 4% rule is a general rule of thumb which should get most people started. It’s a guidepost, a line in the sand, a simple way to give people some direction.

However, if you dive deeper into the Safe Withdrawal Rates, you will realise that there is a lot of room for adjustments to fit your needs. You are able to adjust the SWR up or down based on the end results that you’d like to have. Here are some factors – aside from your expenses – that will affect the SWR that you should aim for:

  1. Your risk appetite.
  2. How flexible you are during retirement.
  3. How much money you’d like to leave for your family after you are gone.

Your risk appetite

As you dive deeper into the 4% rule, you will realise that it is more of a “rule of thumb.” This number is based on the Trinity Study first published in 1998 which determined that a 4% withdrawal rate had a success rate – the portfolio did not run out of money within a 30 year period – of 95% for a portfolio containing 50/50 stock to bond ratio.

The study spans periods between 1925 to 1995 which included the great depression, World War II, and Black Monday, some of the worst financial turmoil in history so you’ve got to be very very unlucky for your portfolio to fail.

But this also means that:

  • Roughly 5% of the 30-year-periods failed, or ran out of money before 30 years is up.
  • The odds published in the study is really valid for retirements that last 30 years. For people in the FIRE community who may be planning for a retirement timeframe of 30-40 years, the failure rate for the 4% rule can be as high as 8% or more. As the numbers of years the money must last, the failure rate of the 4% rule increases.

If your time horizon is longer than 30 years or a 5% failure rate sounds too risky for you, then you can choose to drop the withdrawal rate from 4% down to somewhere nearer to 3%. At 3% the failure rate drops to 0% within the periods that the trinity study covers (for 50/50, 75/25, 100/0 stock to bond portfolio.)

This was the reason why my personal SWR is 3.33% to mitigate the above risks.

Your flexibility during retirement

A second factor to consider when picking your SWR is whether you’re:

  1. Willing to go back to work to earn extra income if the market happens to tank early on during your retirement; or
  2. Reduce your yearly spending so you effectively reduce your withdrawal rate.

#1 Making extra income during retirement

If the market tanks early on, your 4% withdrawal may be too low for you to live on because your portfolio has dropped in value so much during a crash. However, if going back to work to earn additional income is in the picture for you, then even if the market tanks, you can still make up for the shortfall of the withdrawal by earning extra income.

#2 Buckle up and reduce spending to weather the storm

If you are able to cut down your expenses significantly during hard times, then you also may not need to go back to work and still can maintain the viability of your portfolio when we face a catastrophic market downturn.

How much you’d like to have left for your family

As how much you withdraw each year will also affect the amounts remaining in your portfolio when you pass on, one big factor that influences the SWR that’s right for you is how much you’d like to leave behind for your family and the end.

In this case, you have 3 broad options:

  1. Option 1: Leave little to nothing at the end.
  2. Option 2: Leave almost as much as you started with.
  3. Option 3: Leave more than you started with.

Option #1: Leave little to nothing

This is the option I have selected. It is the option that requires the least amount of savings. The idea is that you plan for your money to run out just around the time you will pass away. My philosophy has always been to teach my potential children how to fish and be financially independent themselves so I do not have to support them once they reach adulthood. This allows you to keep your SWR at 3.33%-4% as per above.

Option #2: Leave as much as you started

Another option is to only withdraw just as much as the portfolio increases in value each year so that at the end, you leave a portfolio that is roughly the same size as you started with when you FIRE. This requires a much lower SWR which means you must either save a lot more or spend a lot less to achieve. However, the benefit here is to allow you to leave quite a substantial sum for your family so that they may not need to work as hard to get ahead in life.

You may also want to provide support to your wife or husband after you pass on and this is the option you can elect to pursue. For this particular option, you will need to stay below 3% SWR. Using my S$72,000 figure above, the magic FIRE number becomes much larger:

S$72,000 / 3% = at least S$2,400,000 in portfolio value

Option #3: Leave more than you started

This is the most difficult option and takes the longest. You might want to build an empire, you may want your family and lineage to never have to work again. You want to set up an epic dynasty that will last for generations like the Koch brothers. You will want to leave your family and children with even more money than when you started, maybe even double or triple your starting portfolio value.

To ensure this, your SWR will need to hover between 1%-2%, which will translate to a pretty huge starting portfolio value. Let’s look at my example with 1% SWR:

S$72,000 / 1% or 2% = between S$3,600,000 to S$7,200,000 in portfolio value

Of course, I’ll have to avoid lifestyle creep and maintain my expenses to S$72,000 (inflation adjusted) per year forever.

Further reading

For another introductory article, check out Mr. Money Mustache’s Shockingly Simple Math of Early Retirement.

For a more comprehensive analysis of how to mitigate the risks inherent in the SWR, I highly recommend Big ERN’s Ultimate Guide to Safe Withdrawal Rate. It’s a deep rabbit hole and super comprehensive but trust me, it’s well worth it if you love details and numbers.

Conclusion

So I hope that gives you a pretty good introduction to the Safe Withdrawal Rate and allow you to calculate your own FIRE number.

It should give you the confidence in your portfolio and how much it can provide for you once you stop working.  It should give you something to aim for instead of sailing without a clear destination.

Although there is a bit of nuance in actually deciding on a final SWR that you are comfortable with, remember that there is no right or wrong number. Choose something you are comfortable with that will support your lifestyle.

Good luck on your own journey and thanks for reading!

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