006 The 4% Rule (Trinity Study)

“How much is enough?” How much should you have invested to live through your retirement?

The answer? “4%”.

If your annual expenses are less than 4% of your investment in capital markets, you may live off the investment corpus through decades without exhausting your nest egg. If you have saved 25 years’ worth of expenses in stocks and bonds, you are financially free.

This is the result of an academic analysis popularly known as the Trinity Study. The study evaluated the impact of various withdrawal rates to different portfolio mix of stocks and bonds and considered US market data from 1926 to 1995. A portfolio mix of 75% stocks and 25% high quality corporate bonds, subject to a constant annual withdrawal rate of 4% of the initial portfolio value at the start of the year, can outlast a thirty year period 100% of the time. The tables of portfolio mix, length of retirement and withdrawal rates are summarized in the original study

The key conclusions are:

  1. To beat inflation, a minimum 50% allocation to stocks is essential
  2. Basis history, withdrawal rates of 3% or 4% are extremely unlikely to exhaust any portfolio of stocks and bonds during any of the payout periods considered in the study
  3. You are likely to end up with a terminal portfolio value higher than what you started off with, so you may continue to withdraw infinitely at the safe withdrawal rate without exhausting it.

What’s interesting is that a portfolio of 100% stocks is less likely to outlast a portfolio of 75% stocks and 25% bonds. The bonds seem to function as a ballast, a low volatility asset to withdraw from in the years where your stock portfolio has crashed and you want to avoid selling stocks when they are low.

This is a Thumb Rule, a general case that may not be applicable in every situation. This is not factoring inflation, mutual fund fees, taxation, assumes a uniform withdrawal rate, and is based on US market 70-year historic returns, etc. To account for this, you may apply factors of conservatism to build in a cushion of certainty. You may consider a lower withdrawal rate to adhere to, say 3.5%, before you consider yourself financially free.

The study also assumes zero money inflow during your retirement. However, when financially free, you may choose to still monetize your time. So even during your retirement, you may have cash inflows to meet a portion of your expenses, and may even be adding to your investment portfolio. This allows you to retire earlier – You may retire when you can withdraw 4% a year to meet the difference between your expenses and your reduced future income.

The study has since been updated and enhanced by many to factor in variations. An example is this analysis by “The Poor Swiss” which incorporates a longer retirement period, stepped up withdrawals, a bigger time window and inflation adjustments. Early Retirement Now has also analysed multiple variants and these findings are generally in the same ballpark as the original trinity study. As a conservative viewpoint, Wade Pfau has determined that in the times of the current Coronavirus pandemic and low interest rate scenario, a lower 3% (or 33 years expenses) is a more appropriate safe withdrawal rate.

There you have it, a simple number to focus on. You are financial independent once you have invested 25 years’ expenses in stock-focused mutual funds. Start now!

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