How much money do I really need to retire early (my analysis of the 4% rule / 25x rule)

I was worried about not having enough money to retire early, so I went with a lower safe withdrawal rate than the traditional 4% Rule (25x Rule).

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Safe Withdrawal Rate is not a common topic of discussion, so the first two sections provide a brief overview. If you are already familiar with Safe Withdrawal Rate, then directly jump to the third section: Why I did not go with the 4% Rule.

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Money Needed to Retire Early: Safe Withdrawal Rate

When I started my Financial Independence (FI) journey, I had a tough time deciding how much money I would need to retire early. I did a lot of research, which led me to the wonky world of safe withdrawal rates…

Traditional wisdom states that you need 25 times your yearly spending to retire (also known as the 25x Rule). This 25 number comes from the 4% safe withdrawal rate (1 divided by 4% is 25).

A safe withdrawal rate essentially means how much money someone can withdraw from their portfolio every year without running out of money in retirement. Financial Independence / Early Retirement community members cite 4% as a safe withdrawal rate.

This means if you spend $1,000 every year, then you will need $25,000 to retire (4% of $25,000 = $1,000). This is the same as 25 times that number (25 x $1,000 = $25,000).

This 4% number originated from a study by William Bengen in 1994. Bengen’s paper found that retirees could safely spend about 4% of their retirement savings every year (adjusting the withdraws for inflation). Bengen found that most retirement portfolios would last at least 30 years with this 4% withdrawal rate (and, in many cases, 50 years or more).

After further studies like the famous Trinity Study, the 4% number gained more traction. Fast forward to today, and the 4% number has become so popular that it is now referred to as the ‘4% Rule’ or the ’25x Rule’.

Retirement is like a long vacation in Las Vegas.
The goal is to enjoy it to the fullest, but not so fully that you run out of money.
Jonathan Clements

Impact of Safe Withdrawal Rate on Money Needed to Retire Early

To see how safe withdrawal rates impact the amount of money needed to retire, let us take the example of Mr. Scooby. Let us assume Scooby needed $10,000 every year for his living expenses.

So with a safe withdrawal rate of 4%, he would need $250,000 to retire (4% of $250,000 = $10,000). Instead, if Scooby’s safe withdrawal rate was 5%, he would only need $200,000 to retire (5% of $200,000 = $10,000).

Higher the safe withdrawal rate, the earlier he can retire. With a 5% safe withdrawal rate, he can retire once he has $200,000; instead of waiting to accumulate $250,000.

On the flip side, the higher withdrawal rate of 5% means that Scooby’s portfolio will have to generate more returns (since he is withdrawing at 5% rather than 4%). So, he will have to invest his portfolio in riskier assets. Scooby can run out of money in retirement if the overall portfolio returns are not great.

Now, imagine if Scooby went with a withdrawal rate of 2% instead. He would have to accumulate $500,000 (2% of $500,000 = $10,000), which would mean he would have to work for a long time before being able to retire. However, there is less risk of running out of money in retirement.

So in choosing a withdrawal rate, there is always a tradeoff:

Withdrawal Rate	Money Needed for Retirement	Risk of Running out of Money in Retirement
5%	$200,000	Higher
4%	$250,333	Low
2%	$500,000	Lower

Why I did not go with the 4% Rule (25x Rule)

The world is changing faster than ever (or maybe it just feels like it). Either way, in the last two decades, we have had three recessions (including a major recession in 2008-09). This happened in the same two decades when we had the longest bull market ever, along with the sharpest correction ever! We also had a once-in-a-century pandemic. We whipsaw between bull and bear markets at ever-increasing speeds.

Everything is moving very fast, and the old rules do not apply anymore (or maybe it just feels like it). We have never seen so much money being printed by governments / central banks, and I have no idea what it will lead to. Either way, it seemed a bit risky to bet my future on a 4% number based on historical data.

This made me wonder – just how safe was the 4% safe withdrawal rate? I did what any aspiring FI person would do; I dove into the literature around the 4% rule. The agreement amongst experts was that ….. there was no agreement. Most of the FIRE community tended to coalesce around a 4% number. But most of the other folks went with different numbers (which, more often than not, were less than 4%).

I also ran several simulations about future scenarios. The result was that essentially you could make any withdrawal rate number work as long as you play around with the assumptions!

So, in the end, I settled for a 3% safe withdrawal rate. Is it scientific – of course, not! But then killing brain cells trying to review hundreds of articles / running multiple simulations was not helpful either. I felt that a conservative 3% number was better than going with the historical 4% number.

Reading all the research and articles on safe withdrawal rates felt a bit like this:

Two people were arguing over a case in front of a judge. The first person made a compelling case as to why he should win the case. The judge listened patiently and said – “By gosh, you are right!”.

The second person then laid out a compelling case as to why he should win the case. Again, the judge listened intently and said – “By gosh, you are right!”.

Seeing this, a person sitting in the audience was annoyed and asked – “Judge, this makes no sense. How can both of them be right at the same time?”. The judge listened to the third person and said – “By gosh, you are right!”.

How to Calculate the Money Needed to Retire Early

With a 4% withdrawal rate, you need 25 times your yearly expenses to retire early. With a 3% withdrawal rate, you need 33 times your yearly expenses to retire early (1 divided by 3% is 33.33).

Calculating the amount of money needed to retire early is a time-consuming process, mainly because keeping track of all your expenses for a year takes a lot of effort (and not to mention time). You can use one month’s expenses (times 12 times 33) to calculate how much money you will need to retire early.

But some expenses are quarterly (like property taxes) or yearly (like annual memberships). Also, monthly expenses can vary month to month. Hence, it is better to take an annual view.

I tried to calculate this a couple of times, but it was not easy. Finally, I came up with a new tracking plan. We switched all the Finer household spending to just one credit card, making it easy to see all of our expenses in one place. After the first month, I used the expenses for that month to calculate the amount needed to retire. I continued keeping track of our expenses for a year and kept updating the number.

When we first did this exercise, the number was ridiculously high! That is because our monthly expenses were high. I started focusing on saving money, to bring down the number.

3% Withdrawal Rate: Pros and Cons

Advantages of 3% Withdrawal Rate

• Margin of Safety: 3% is a conservative number that works in almost all the past scenarios. Of course, nothing is guaranteed to work in every conceivable scenario, and the future may look very different than the past. But with a 3% withdrawal rate, I feel there is enough buffer to withstand whatever happens.
• The Sleep Test: I have always believed that the best investment approach for me is the one that lets me sleep at night. Having a higher safe withdrawal rate is great. But if it leads to sleepless nights, then it is not worth it. A 4% withdrawal rate would have made me nervous, and it would not have passed the ‘Sleep Test’.

Disadvantages of 3% Withdrawal Rate

• Increased Time to FI: Of course, the biggest disadvantage is that the time to FI increases by 33% for a 3% withdrawal rate compared to a 4% withdrawal rate. However, in practice, it may not take that long due to the magic of compounding. I was okay with working a few more years to reach the 3% rate.
• Unspent Money: The other disadvantage is that you may end up with a huge chunk of unspent money at the end if the 3% rate happens to be too low. The way to mitigate this is – to spend more!! Not a bad problem to have.

Impact on Money Needed to Retire Early if 3% is Wrong!

No one can predict the future. If the safe withdrawal rate number turns out to be higher than 3%, it will mean my local charity will get a lot of money.

On the other hand, if the number is lower, then that will mean I will have to adjust my spending (spend less) or continue to work more (I have not left my job after FI, so this should not be an issue).

Given how conservative the 3% number is, there is a more than likely chance that the first scenario will play out.

In Conclusion

There is no good way (at least that I have found) to predict what will happen in the future!

The rate at which things are changing nowadays and reading all the (often contradictory) literature on the 4% safe withdrawal rate does not help. In fact, it makes it seem like the 4% safe withdrawal rate is not so safe anymore.

So during my FI Journey, I decided to go with a conservative 3% safe withdrawal rate for my Early Retirement Planning.

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