I have talked a lot about 4% rule, and today I want to clarify a little bit what is it and how I see it.
Old 4% way
I have seen a lot of texts and guides talking about this rule as well, most of those are you would withdraw the 4% of your portfolio and adjusted it yearly with the inflation. It means like this:
One year: portfolio x 4%
2 year: portfolio x 4% x 1,02 (2% inflation)
Also, you would always withdraw at least same amount than a year before + inflation, and you would have same purchasing power for every year. To me, this is not a correct and long-lasting solution. Today, people are living longer, and by following this rule, you might end up burning your money before you die. Why? In this solution, you will touch the original investment, and it means you are withdrawing the money working for you. To me, this is a no go.
Yeah, I know, you never know what will happen, but if something is still left when you die, hopefully, this money will be used for grandchild’s education, etc.
My 4% way
How I see the 4% rule is a little bit different. In my solution, you need to modify your way of living, and you would never touch the original investment. You need to have cash only for around three months of living, and everything else should be invested. If you have this money invested for example SP500 index which has had average inflation corrected growth around 7%, you don’t need to touch original investment. You just need to take care of costs, never invest in funds which have cost more than 0,3%. Costs are the only thing to what you as an investor can affect in a long-run.
There might be years which you get 30% what you got last year, and this is why you need to have this extra cash. The buffer is used only when the return on investment is below 7% and raised when the return is more than 7%. 87% of investing is psychology and 48% of the time you will see red figures. But 52% of the time you will see green statistics and this is the key.
So, the basic idea in my 4% solution is, don’t touch the original investment.
“Don’t bite the feeding hand”