Having 25 years of expenses can give you a safe withdrawal rate of 4%. Why would you want to save more than 25x for an even safer initial withdrawal rate?
Financial independence is defined as owning assets that will support your intended lifestyle for the remainder of your life.
While those assets may include rental properties or cash flowing businesses that provide passive or semi-passive income, the most common scenario, particularly for high-earning professionals, is to accumulate a portfolio consisting primarily of stocks and bonds.
A couple of studies in the 1990s showed us that a historically safe withdrawal rate for people wanting their money to last at least 30 years was not the 6% or 8% that many financial planners were quoting, but actually only 4% to have an excellent chance of your portfolio surviving some of the worst periods of investment returns in modern history.
To start withdrawing 4% of your portfolio while maintaining your desired spending level, you need to accumulate 100/4 or 25 times that annual spending number.
You can then increase your annual spending with inflation and the odds of your money lasting at least three decades, based on historical returns going back to the early 20th century, are about 97% when invested in a reasonable mix of stocks and bonds.
Is 25x enough for you? There are more than a few reasons you might want to exceed that number, as I did, before you leave your career behind.
#1 Your Safe Withdrawal Rate May Be Less Than 4%.
A particularly poor sequence of returns combined with a lengthy retirement of more than 30 years could lead to premature depletion of your portfolio.
The 40+ part Safe Withdrawal Rate series from Ph.D. economist Karsten Janske at Early Retirement Now has shown that a safer withdrawal rate for those of us expecting a retirement as long as 60 years is on the order of 3.25% to 3.5%. You may have to lower that a bit further if you want to “play it safe” with a bond-heavy portfolio.
How stable is your marriage? If your annual expenses are the expenses of a couple or a family, don’t expect the number to be cut in half if the size of your household is.
One financially independent couple can sadly become two people who no longer have enough money to support themselves independently, and that’s not even factoring in how much of the couple’s assets can be lost to lawyer fees in the unfortunate situation of a divorce.
Some expenses may rise annually at a higher rate than overall inflation. In recent decades, we’ve seen this with both healthcare and higher education. Housing costs can increase at a faster pace than inflation, especially in up and coming neighborhoods.
A 4% withdrawal rate is going to be safe in most circumstances, but a withdrawal rate closer to 3% is more bulletproof. Saving up 30x to 35x your anticipated retirement spending can go a long way towards ensuring your money will outlast you.
#2 Future You May Want to Spend More than Current You.
The issues raised above are mostly out of your control. However, there are circumstances within your control that can change and require you to have more money.
It’s a fool‘s errand to make detailed life plans more than five or ten years into the future. Has anything changed about your wants and needs or position in life over the last five or ten years?
It’s possible that your spending needs will go down over time. Maybe you’ll travel less once you’ve had a chance to explore the world. You might trade in your golf clubs for a good pair of hiking boots and a walking stick.
On the other hand, you may find that you prefer higher-end hotels to the chains you once deemed adequate. Your new friends might be into driving sports cars at the track on the weekends.
Lifestyle inflation may be a part of your future plans whether you know it or not. I’ve argued that you do not have true financial freedom until you could double your discretionary expenses without violating the 4% rule. I came up with a number of about 36x for my family, and we exceeded that multiple before I retired from medicine.
#3 It’s Easy (for a high-income professional)
I challenge my readers to live on half of their takehome pay. If they do, they’re setting aside one year’s worth of expenses each and every year. I was setting aside closer to three years worth of expenses towards the end of my working career.
Also, consider the fact that your investments will also make money most years. If you’ve already saved up your 25x, a normal year with returns of 4% to 8% will give you another one to two years of living expenses.
By working one more year, you could add two to five years worth of living expenses to your portfolio. Work a few more years after achieving financial independence and you’ll likely find yourself with an initial withdrawal rate of less than 3%.
You don’t even have to work that hard to make it happen. If you earn just enough to cover your living expenses, your portfolio can do the heavy lifting. That is, unless you happen to time your cutting back on work with the onset of a prolonged bear market.
#4 Bear Market Insurance
When you decide to time your retirement not by date but rather by a portfolio value, you’re more likely to retire after the market has treated you well. We are certainly seeing this in recent years as a now decade-long bull market has allowed many aspiring early retirees to meet their retirement savings goals.
A substantial market correction could come along without notice. If the next one looks anything like the two nasty bear markets we saw in the 2000s, 25x could become 15x or less in a hurry with a stock-heavy asset allocation. We got a taste of this in March of 2020 with stocks down nearly 35% in a matter of weeks.
One form of insurance is to switch to a safer asset allocation when your portfolio is most vulnerable to long-lasting damage from a terrible sequence of investment returns.
The first five years of retirement are the most influential, but the five years before retirement and years 6 through 10 afterward are also years in which big market downturns can torpedo your retirement tugboat.
Oversaving for retirement is another way to combat the bear. If you started with, say, more than 40x your anticipated retirement spending, even a 40% drop should leave you with about enough to allow you to withdraw 4% safely.
#5 Allow You to Maintain an Aggressive Asset Allocation
Stocks have a higher expected return than bonds over the long haul. They also have more volatility, which is why it makes sense to dial back the stock allocation, particularly early in your retirement, and perhaps in the years leading up to it.
Let’s say you want to have an allocation of 50% stocks and 50% bonds when you begin your retirement. If stocks lose half their value, bonds will probably see a bit of a rise, and your portfolio value would drop by less than 25%.
By playing it safe, though, you will also miss out on half of the stock market gains, and historically the market has been up for the year about 70% of the time.
If you want to have your cake and eat it too, play it safe with your first 25x and any additional money you have saved up can be invested aggressively. You can put the extra in 100% stocks if you like. You could also invest in a small business or diversify with crowdfunded farmland and other real estate investments.
My plan has been to own at least five years worth of bonds in retirement. That would represent 20% of a portfolio with 25x expenses. As the portfolio gets larger, the bond portion becomes proportionately smaller.
At 50x, 5 years worth of bonds is now 10% of the portfolio. Of course, the greater your multiple, the more likely your portfolio is to grow as you’ll be spending a smaller percentage of it, and the lower your bond percentage can safely be.
This is the reverse glidepath that has become popular in recent years. Once you’re safely past the first five to ten years of retirement where poor returns can inflict the most damage, you can afford to safely increase your stock allocation.
The venerable Dr. Bill Bernstein is known for the quotable “If you’ve won the game, why keep playing?”
I think that’s a great way for a retiree with 20x to 25x to think.
However, the more you have, the more you can afford to remain aggressive with your portfolio. Why play that game? If not for yourself, for your heirs or favorite charitable organizations. I’m sure there’s someone out there who would love for you to run up the score.
With substantially more than 25x your annual expenses in your portfolio, you have the opportunity to achieve a very high score.
If, on the other hand, you’re more interested in freedom sooner or later, be sure to check out this followup post: Top 5 Reasons to Retire With Less Than 25 Years of Expenses.