The 4% Rule - The coolest rule by far! |

This ingenious little rule takes out all the complications of retirement planning, and allows you to figure out exactly how much you need to safely retire. It also allows you to determine how much you can withdraw from your retirement savings each year without having to worry about running out of money. And it makes provision for inflation.

Pure awesomeness - Lets investigate some more!

A lot of information on the 4% rule for retirement is available on the internet, and a number of articles and blogs have been written about it both internationally and locally (Google is your friend). I first came across this concept on Mr Money Mustache's blog, and it literally changed my life

^{1}. It gave me an eye opening target to aim for, and for the first time I could actually put some figures down with regards to early retirement and exactly how much I needed. And it seems pretty fail safe too.

In a nutshell, the 4% rule was developed in the 90's to figure out what would be a safe maximum withdrawal rate that would allow you to keep up with expenses in your retirement whilst ensuring you never ran out of money.

Basically at a 4% withdrawal rate you are pretty much certain to never run out of money.So lets see how this will help you in your (early) retirement planning. Examples work best, so please meet John Smith. John has worked out that his annual expenses in retirement will be exactly R240000 (He was amazed that after tallying everything he spent, it worked out to exactly R20000/month - what a luck, we now have a nice round number to work with!)

So according to the 4% rule, John can draw 4% of his retirement savings every year. Using this information we can calculate the value of a retirement lump sum that will give R240000 if you take away 4% of it.

R240000 = 4% of x => x = R240000/4% => x = R6 million.

And that is all there is to it! Simple and Awesome! You just divide your annual expenses by 0.04, and you get your magic retirement number. But there is a nice quick cut to work this out - take your annual expenses and multiply it by 25 (which is the same as dividing by 0.04, just sounds a lot easier). Using the example, R240k x 25 = R6 million. Even easier than this is to just take your monthly expenses and multiply by 300.

How much do you need to retire? Easy - it's your monthly expenses times 300.So lets see what would have happened to John Smith (in theory) if he had retired at the end of '99 (wow R20k a month would have got you a shit load back then!). Ok so John is stealthy and used the 4% rule to work out that he needs R6 million to retire. And in John's perfect world of round numbers he finds he has exactly that at the end of 1999. Onward to early retirement!

So at the end of 1999 John draws down his R240000 and leaves the rest in the Satrix 40. Now I have been so kind as to pull out the actual price and dividends paid for the Satrix 40 for each year from 2000 (that's as far back as it goes). It looks as follows (with the previous years dividends included in the returns)

Numbers don't lie |

Ok so lets throw John's cash into the mix, and include some inflation....

Throwing some real world stuff at the 4% rule - complete with slightly blurry text box descriptions |

Okay let's do a little worst case scenario now. What if John was a naughty boy and karma is a bitch - so he retires just before the financial crisis of 2008:

More numbers to bore you into believing the 4% rule really works! |

My little scenario is over quite a small period in terms of how long the market has been operating for (unfortunately Satrix only launched in 2000). Also it assumes that you will invest all of your retirement funds into Equities. However Mr Money Mustache did some very good analysis showing the fool-proofedness (I made a word) of this method, and references a study that reduced some of the market volatility by allocating some of the retirement capital to bonds. It is definitely worth a read and it will become evident just how resilient this method actually is. And even though the study is based on American returns, it is still very relevant since the real return of Bonds and Equities in the US is quite similar to the returns in South Africa.

^{2 }And if you are still a little nervous, you could build in some more safety and use a 30x multiple instead of 25x)

I have given SARS way too many of these elephants |

#### One rule to rule them all!

After reading all the pros and cons for this 4% rule, it has left me very convinced of it's effectiveness in answering the very common question - How Much Do I Need to Retire? I am all for it and will definitely be doing a post on using it for my early retirement plan - so look out for that one.Tweet

Till next time, Stay Stealthy!

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^{1}I would say this single eye opening discovery is what got me started on this financial freedom/early retirement journey.

^{2}In the Mr Money Mustache blog with regards to the returns on a 50% Bond 50% Equity portfolio split they say "They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever." The Stealthy Wealth official return figures puts local Bond returns at 7.78% (real return = 7.78% - 6.28% = 1.5%) and Equity returns at 15.28% (real return = 15.28%-6.28% = 9%). So if we have a 50/50 split between Bonds and Equities we get a real return of (1.5% + 9%)/2 = 5.25%. So we may be slightly better off here in good old