Every week we here at ChooseFI get hundreds of emails from our community. There have been so many interesting and thought-provoking questions that we created a series dedicated to answering the most frequently asked each week.
This week’s question is about calculating your FI number and withdrawal rates, and comes from YandaPanda, who writes:
“I am confused…
- FI Number. Once you’ve determined what your life costs (your annual expenses) you can determine your Financial Independence number by multiplying that number by 25 using the “4% rule of thumb” for safe withdrawals. If your annual expenses are $60,000, multiply by 25 to get a FI number of $1.5 million. This is also a good time to determine if you’re still comfortable with a 4% withdrawal rate, or maybe you want to be more conservative at 3% (then multiply by 33) or even potentially more aggressive at something like 5% (multiply by 20).
Why would you multiply by a larger number, when utilizing a smaller amount from the front end. I get that the numbers work, but how could you survive on a 5% withdrawal rate that starts with a significantly lower starting number. (3% = $1.98m, 4% = $1.5m, 5% = $1.2m) That seems backward to me. Wouldn’t your money run out faster? Why do you need MORE in investments to get LESS out of them?”
Your intuition here is correct: the higher your withdrawal rate, the more aggressive you’re being and the higher likelihood you have of running out of money if returns aren’t as ideal as you hoped.
Having a larger net worth and taking out a smaller percentage is safer.
This leads us to a few related questions we get from the community: what exactly is the 4% Rule and FI Number?
If you know ChooseFI, you probably have at least heard about your FI Number.
Your FI Number is: Your yearly spending divided by your Safe Withdraw Rate (more on that in a bit).
A great example can be found in a cornerstone article here. Also, there is a cool video the guys did about finding your FI Number and getting incrementally better here.
4% Rule and the Trinity Study
The “4% Rule of Thumb” our reader spoke about is an investment strategy conceived in 1998. We take a deep dive into this concept in our Ultimate Guide to Investing.
In essence, three professors from Trinity University (Texas) studied hundreds of variables over the course of the market (1929-1995). They concluded that within about a 96% certainty that if you withdrew 4% of your money each year after retirement, you’d have enough money for the rest of your life.
You need to determine first when you want to retire. Second is how much money do you think you’ll need for the rest of your life? If you are older, are you willing to be more aggressive financially if need be? These are all questions you should ask yourself regarding retirement planning.
4% rule of thumb is just that. We are all different. We’ve all taken different roads to get here. What it comes down to is risk. Are you risk-averse or risk-tolerant? With 4% being the suggestion, hedge the side you are more comfortable on. Want to be a bit more aggressive? Take a 4.5% withdrawal rate.
We just want to give you the best information given each and everyone’s needs
The Bottom Line
Know what your own “4% Rule of Thumb” is. If you are struggling, it’s this: it’s the percentage that when you see it, you don’t want to throw the smartphone out the window. Solace…mmmmmm…..beautiful thing!
And if you are just starting or on the fence and are intimidated by your FI Number (good or bad) come aboard. We’re a group of thinkers. Like we said in an earlier article, we have jackets and everything.