Living Life 4% at a Time: Financial Independence

The golden rule in the financial independence/retire early (FIRE) space is to amass investable assets worth 25 times your annual expenses, that is, you live off 4% of your investments, adjusted for inflation. So, during the first year of retirement, you withdraw 4%, during the second year, 3% plus the amount needed to cover inflation, and so on.  

The original financial planner that introduced this idea was William P. Bengen. If you want to dig into his article, Determining Withdrawal Rates Using Historical Data. His work in 1964 was followed up in 1998, by three professors of finance in the Department of Business Administration, Trinity University, San Antonio, Texas, affectionately nicknamed the Trinity Study.

The Trinity Study analyzed withdrawal periods up to 30 years. While it did not account for taxes and transaction fees, the study did account for inflation. The Study concluded that stock-dominated portfolios (75% stock/25% bonds) would last 30 years 98% of the time based on all historical data.  

Plus, the math is easy with the 4% rule. Examples are often represented by showing someone that can live on $40,000/year (though in most places, I would consider that EXTREMELY frugal). They just need to make it to the 2 comma club for a nest egg of $1,000,000 to FIRE.  

$40,000 / 4% = $1,000,000

Or as it is more commonly stated

 $40,000 x 25 = $1,000,000

In the second year of FIRE, adjust for 3% inflation and you would withdraw:

$40,000 x 1.03 = $41,200

Should I trust the 4% rule?

When you are starting from a negative net worth (more debt than assets), or you’re socking away your first $100,000, your FIRE number is just a concept to move you to action. It doesn’t really need to be that accurate. But the closer you get, the more comfortable you need to be with that number.

The key finding from the Trinity study that keeps me from blindly following the 4% rule is the very first conclusion they draw,

“Early retirees who anticipate long payout periods should plan on lower withdrawal rates.”

I’m looking at 45-50 years here and FIRE is no longer an abstract concept. I don’t feel like abstract generalizations are good enough anymore, so my FIRE number has become more complicated. I use a more conservative 3.5% withdrawal rate for my planning purposes. 

Our income in retirement will come from a pension for Mr. FIF and assets invested primarily in low cost index funds. We will also keep our mortgage with a rate of 2.875%. It is unusual for early retirees to keep the mortgage, but it is our only debt and that rate is amazing! 

In order for us to feel confident in our financial independence, I have broken out our FIRE plan into these four components:

FIRE Component	The Explanation	FIRE #
Kid’s College (529s)	We have saved for 2 years per child at an in-state school, plus each child has another year of school paid for as benefit from Mr FIF’s educational benefits from his military service.	8 x In-State Tuition
Mortgage	I consider the mortgage separately from my annual spending. Since our mortgage payments will not change with inflation like the rest of our spending will, to estimate it with inflationary spending would be an over estimate. You can add the payoff amount to your FI number, but I also see that as a little conservative. So I actually used a present value calculation for an annuity with a 3.5% rate	PV(3.5%/12, remaining mortgage payments, -monthly principle and interest payment, 0)
Spending over Pension (not including mortgage)	This is where the standard FIRE number calculation comes in. I have settled on a safe withdrawal rate of 3.5% of our annual estimated spending above Mr. FIF’s pension (which is adjusted for inflation every year).	(Annual retirement spending – pension – mortgage payments) / 3.5%

Expenses, the real key to FIRE

I’ve tracked our net worth since 2010 because I’m a money nerd. I used Microsoft Money originally, but Microsoft quit supporting it, so then I used Quicken for many years, but then I got very annoyed with their insistence on forcing me to update (read: PAY) for a new version every 2 years, or they would no longer support importing my account balances. Enter Mint, Personal Capital, and so many spreadsheets. I’ve settled on a mix of my own tracking Google Sheet, Personal Capital, and Tiller, which is probably still overkill, but did I mention, I’m a nerd.

Mint is ok for tracking expenses, but Personal Capital does that too and so much more. I love the dashboard. It offers a snapshot of my net worth (to the extent I’ve loaded all my accounts into it). It also shows a budget widget that compares how much I’ve spent to last month. I only have two complaints for Personal Capital. One is that two-factor authentication (the additional annoying step of needing to get a code texted to you) for my bank and investment accounts often break the import. Sometimes it fixes itself and sometimes I have to spend too much time figuring out why it doesn’t work. The second annoyance is that once you have $100,000, they offer a “free” call with one of their advisors. Remember, as the saying goes, if the product is free; you’re the product. Have no doubt, with Personal Capital; you are the product. I still look at it almost every day though for a quick and easy estimate.  

I ended up building a Google Sheet that tracks my annual net worth as in the above picture. It also tracks monthly net worth for the current year, monthly income and spending, and all of my quirky FI calculations. I still need to clean it up and put some dummy numbers and instructions in it, and then I’ll offer it to the masses or the three of you reading one of my first posts.

Where are we on our FIRE journey?

*Updated as of November 26, 2022

We sold a rental property in 2021, the proceeds of which allowed us to “fully fund” the 529s for our kids. As discussed above, fully funded for us was approximately 8 years of In-State Tuition. I consider the 529s checked off, so I don’t consider their balances as part of my FI # anymore since I won’t be able to draw on them for retirement expenses. I track it as part of our net worth, but not as part of the FI # and FI assets (assets we’ll be drawing down in early retirement) going forward. I also don’t include our real estate as part of our FI # for the same reason. So our real FI journey looks more like this.

As you can see, we just barely hit our FI # at the end of 2021, but I kept working. As the market retreated, so did my FI assets. I finally retired in October of 2022, when my FI assets had dropped to about 84% of the my originally calculated FI#. Check out So Come On and Let Me FIRE to read more about how I made the decision.