The Four Percent Rule (and how much your freedom costs)

A while ago, I wrote about how important it is to know how much you’re actually spending. It’s really easy to say “this month is higher than usual because I bought that $300 plane ticket” – until you realize that you buy three $300 plane tickets a year, and then usually have car repairs for about the same amount once or twice a year, and then there’s the month when you move and have to plop down a security deposit, and then month when you need to get a cavity filled … so actually, your budget is about $300 higher than you planned on almost every month.

I’ve done the math (and lots of expense tracking) and know that my annual budget is about $18k-$20k. That’s when I’m not really worrying about my expenses too much (so, I could cut that down a bit more, but it would involve cutting out things that I’ve decided are important to me).

Knowing how much you’re spending is important just because knowledge is power. It’s also important because then you know exactly how much your freedom costs.

As long as you’re tied to your salary, you have to make decisions around your employment, because food and shelter are important. Once you reach the point when you can live off your savings, you’re not tied to that anymore. You may choose to keep working, but you don’t have to. That sounds like a pretty cool option to me.

Many much smarter people than me have explained why the 4% rule works (basically it’s that, over the long term, the stock market tends to return about 7%, and inflation is about 3%, so if you withdraw 4% of your investments annually, you can expect them to last forever), so I’m not going to get much further into the math here.

Once you know your annual living expenses, you know how much it would cost you to never work again (except on things you wanted to) if you maintain your standard of living where you are now. Just multiply that number by 25.

(Most people would want to build in a buffer as well, in case there’s a huge market crash or you have a giant expense, like heart surgery. Some people go by a 3% rule instead for more of a safety margin.)

Your annual expenses * 25 is going to be a big number. In the hundreds of thousands of dollars, maybe over a million. It might seem prohibitively high, especially if you think about the fact that they’ll probably go up in the future (I plan on having kids eventually, and my annual expenses will definitely exceed $20k). But still, the number is probably smaller than you would think it would take to be completely financially independent.

For me, the idea that there even was a number (that wasn’t $50 million or something equally ridiculous) opened up my eyes to a world of possibility that I didn’t even know existed. I can start saving towards it inch by inch. I don’t think about life in terms of “what do I want to do until I’m 65?” anymore. I think about what I want to do during this journey that will get me where I want to end up while still having an awesome life on the way, with the idea that life isn’t “done” when I’m done working a traditional job. I may even have a career that I’m into enough that I keep pursuing it once I’ve hit that number. Who knows!

Know your number. You may love your career and want to stay in it forever – but what if an elderly parent gets sick and you decide to quit your job and move home to care for them? Or if you eventually decide you’d like to be a stay at home parent, even though you always pictured yourself as a career person? Or if, 20 years down the road, you have something you really want to pursue and you want to jump in with both feet and work on it full time, even though it’s not profitable? Knowing your number and saving towards it means you can do those things.

On the other hand, maybe you’ll end up progressing fabulously in your job and working until you’re 70 by choice. That’s cool – you’d have savings to help your kids and grandkids go to college without debt, and donate to charities that matter to you, and not worry about it if Social Security get cut. No one ever said, “Ugh, I sure wish I had less savings.”

Annual expenses * 25 = the price of your freedom. I’m aiming for it, are you?


3 thoughts on “The Four Percent Rule (and how much your freedom costs)

  1. our next life says:

    We’re planning on the 4 percent rule generally, but it’s not totally straightforward with early retirement, because you have to have some regular, taxable investments to get you through to 59 1/2 when you can access 401(k)s and IRAs. We did a better job saving in 401(k)s early on, so have plenty saved up there, and have been working diligently the last few years to get enough saved in our taxable investments to get us from ~40 to 59 1/2. So ultimately, we’ll have more in 401(k)s and so will end up withdrawing more like 3 percent of the total each year. We think 4 percent is a good rule, though, based on what we’ve read from many sources.


    • Stacking Twenties says:

      Yeah, that’s definitely true. My NW is still so low that I don’t really worry about it, but when it gets up there, if I’m still interested in early retirement, it’s definitely something that would take more careful math. I just like having a goal number to work towards for now 🙂

      Liked by 1 person

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