4% Rule (The Simple Math Behind FIRE)

In this post, I want to get into the simple math behind how much money you need to have saved up so that you can retire early. The main method behind the math is something called the 4% rule. This means that in the first year, you would be comfortable with withdrawing 4% of the amount of money that you have saved up without diminishing the value and it will still grow in value depending on where you have your money invested.

However, to me, this is not a hard a fast rule. The markets never perform the same every year. Depending on the time, the markets might be performing better or worse. Perhaps during a recession, you don’t withdraw any money during that time and you earn income another way. Maybe you feel more comfortable only withdrawing at a rate of 3%. This is something that you can modify to your comfort zone and risk tolerance. Want to learn more about the 4% rule? Read this article here.

Let’s get into a little math.

So how does this 4% rule translate to how much money you need to save up? In simple terms

Annual Expenses X 25 = How much you need saved up to retire

For example, if your annual expenses are $40,000, you’d need $1,000,000 saved up.

$40,000 X 25 = $1,000,000

Therefore, the lower your annual expenses are, the less you need saved up. If your annual expenses are $20,000, you’d need $500,000 saved up. ($20,000 X 25 = $500,000)

Not sure how this translates to a 4% rule? Well if you had $1,000,000 saved up in an index fund and it’s making a 7% return during the year, you could withdraw 4% to live off of to cover your expenses ($1,000,000 * 4% = $40,000) and the other 3% would stay and continue to grow your investment so you aren’t diminishing your principal amount.

I think this post puts into perspective a few other important topics of discussion. First of which is annual expenses. You might be looking at that equation and thinking you don’t know what your annual expenses are. If that’s the case, keep your eyes out for the next blog post and we can step through how to figure out what your annual expenses are.

Thanks for coming to the Freedom Financial Path blog!

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