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The 4% rule
One of the foundational rule for FIRE
If you’ve been following the personal finance community for a while, you’ve probably heard about the FIRE movement. FIRE stands for Financial Independence Retire Early, and it’s a concept that has gained a lot of popularity in recent years.
The idea behind FIRE is to save and invest aggressively to accumulate enough wealth to retire early, typically in your 40s or 50s. While this may sound like a pipe dream to some, many people have successfully achieved FIRE by following a set of principles and strategies.
One of the key strategies that FIRE enthusiasts swear by is the 4% rule. The 4% rule is a guideline for how much you can safely withdraw from your investment portfolio each year without running out of money in retirement.
Here’s how the 4% rule works:
Step 1: Determine your annual expenses in retirement The first step in calculating how much you need to save for FIRE is to determine your annual expenses in retirement. This includes everything from housing costs to food, transportation, and entertainment.
Step 2: Multiply your annual expenses by 25 Once you know your annual expenses, you need to multiply that number by 25. This is because the 4% rule assumes that you can safely withdraw 4% of your investment portfolio each year in retirement. By multiplying your annual expenses by 25, you’re essentially calculating the total amount you need to save to support that level of spending in retirement.
For example, if your annual expenses in retirement are $50,000, you would need to save $1.25 million ($50,000 x 25) to safely withdraw 4% each year.
Step 3: Adjust for inflation It’s important to note that the 4% rule assumes a constant rate of inflation over time. To adjust for inflation, you’ll need to increase your annual withdrawal amount each year by the rate of inflation. This ensures that you maintain the same purchasing power throughout your retirement.
Step 4: Monitor and adjust your portfolio Finally, it’s important to monitor your investment portfolio regularly and make adjustments as needed. This may include rebalancing your portfolio, adjusting your asset allocation, and considering different investment strategies.
It’s also worth noting that the 4% rule is not a guarantee, and there are many factors that can impact your retirement income, such as market fluctuations, unexpected expenses, and changes in your personal circumstances. However, by following the principles of the FIRE movement and the 4% rule, you can give yourself the best chance of achieving financial independence and retiring early.
In conclusion, if you’re looking to achieve FIRE, the 4% rule is a helpful guideline for calculating how much you need to save to support your desired lifestyle in retirement. By following this rule and adjusting your portfolio as needed, you can work towards your financial goals and potentially retire years earlier than you ever thought possible.