I have a good friend who we’ll call Eric because his name is Eric.  It’s his real name, not even a made up name to protect his identity.  He once said I can feel free to share his social security number so I don’t think he’ll care about me using his real name in my article about the 4% rule. He might have been joking about that, but I don’t like to assume things.

Unfortunately, I can’t remember his social security number so we’ll just have to make due with his first name.

Eric was lamenting the fact that retirement was simply not in the cards for our generation.

"Retirement is not in the cards for our generation," Eric said, lamentingly.

"Sure it is, you just have to save enough money and boom! retired," I enthusiastically responded.

"How do you know how much money you need to retire?" Eric asked.

“The 4% Rule,” I responded heroically.

“You sound like you’re in a cult,” Eric said as though he was never in a cult.

I went on to plead with Eric that the idea of never retiring is a sad lie and it just takes a little financial planning to not only retire by 65, but years before 65.

In order to retire, all you need to do is become financially independent.  Once you’re financially independent you can choose to retire or choose to keep working.  It’s completely up to you.

“HOW DO I KNOW WHEN I AM FINANCIALLY INDEPENDENT?”-A question Eric could have asked if he had been more interested

In short: The 4% rule.

I went on to explain to Eric about how to calculate what you need to be able to stop working according to the 4% rule.  If you’re unfamiliar with this rule, the basic idea is, once your investments reach a magical number where 4% of your total investments is equal to your yearly expenses, you are financially independent. You can retire or continue to work but you don’t HAVE to work.

For example:  If you spend $40,000 per year for all your expenses (housing, food, knick knacks, everything) you need $1,000,000 saved up in your investments because 4% of 1,000,000 = 40,000.  A simpler way to think about it is just multiply your annual spending by 25.  40,000 x 25 = 1,000,000.

“I feel like you’re making that up,”- unknown

No, it’s a real thing.  The 4% rule was formulated by some professors at Trinity University who seem like they’re pretty smart.  Read about the  Trinity Study  on wikipedia if you don’t believe me.  Wikipedia never lies.

Astute amateur mathematicians will say your money will only last for 25 years in that scenario.  The key is the money is invested in a mixture of stocks and bonds, not just sitting in your bank account.  The more stocks you have the more potential money your money will make, but it’s also more risky.  The stock market returns an average rate of about 7% per year, some years way more and some years you’ll lose money.

Overall, for every $100 you have in the market you’ll gain about $7, on average, per year. This is assuming you’re invested in index funds mirroring the entire stock market, not just randomly picking stocks.

Let’s say you have $1,000,000 in your portfolio.  That cool million earns you roughly $70,000 annually which you spend some of throughout the year leaving you with more than a million dollars still. Ideally, you’ll be left with even more money than you started the year with. Rinse and repeat.  The idea is you never run out of money because you’re never cutting into your principal.

“But the market won’t always return 7%”-a naysayer 

Exactly, the market won’t always return 7%.   That’s one reason why we don’t call it the 7% rule and why we don’t advocate for taking out 7% of your money each year.  4% is a much more conservative number that builds in a buffer for inflation and risk mitigation for those years when the market is down.

If you take out all your gains every year, you’ll be eating into your million dollar portfolio soon as the market has a down year.  If you only take out 4% of whatever your portfolio is, then you’ll typically be taking out less than you’ve earned, giving your money a chance to grow.

“What about inflation?” – Guy walking past, randomly

That’s another reason why it’s the 4% rule, not the 7% rule.  4% is a fairly conservative number that should account for a 2-3% inflation increase as well as 4% for your spending, leaving a little cushion.  Inflation basically means that something you can buy for $100 in 2018 will cost approximately $103 in 2019.  Your $100 buys a little less every year.

Thrilling Side Note: For every $1000 of recurring bills you cut from your spending throughout the year, that’s $25,000 less that you have to have in investments to be financially independent.

You know how every January 1st you run outside in your long underwear and make a bonfire using $1000 cash as fuel? You’ll need to plan on having an extra $25,000 saved up in investments to cover that yearly ritual.  After reading this blog I hope you stop using money for fuel in your obscure New Years tradition.  Now you’ll need $25,000 less invested to become financially independent.

If you’ve been following the financial independence scene, (see also: Financial Independence- The Freedom to Choose), the 4% rule is old hat for you.  Sometimes when you hear something so often you start to think that everybody already knows about it.  Eric had never heard of the 4% rule.  We were pretty drunk when discussing it so Eric might still think he hasn’t heard of the 4% rule.

I should probably check back in with him.  My conversation with Eric got me wanting to be more outright about spreading this message of financial freedom.

It can feel weird trying to talk to people about FI.  Most people will look at you with a blank stare.  They think financial independence is so unrealistically far off we may as well be talking about saving up money to buy land on Mars.  Everyone should want to soak up as much financial knowledge as possible so that they can make the most of their hard earned dollars.

Instead, people tend to complain about how much their job sucks but then they refuse to learn any tricks to keep their money.  People are weird.  They complain about working but don’t try to learn how they can work less.

Why don’t people want to take the time to learn about this stuff? I asked Eric.

“It’s so boring.” – Eric

This is why.  It’s boring.  At least this is a big reason.  When I attempted to explain the difference between Roth and Traditional IRAs, Eric’s eyes glazed over.

Again, we had been drinking, so that may have been a factor, but he was noticeably bored.  Eric is not weird, I mean, Eric is weird, but not for thinking financial matters are boring.  Most people have done almost no research on anything financial because it’s sofa king boar ring (read it out loud if that doesn’t make sense).

To the general public investing is this black hole of confusion. It’s meant only for those with acronyms after their names like CEO, COO, CFO, MD. etc.  Not something to bother with for most people.

That is the purpose of this blog.  I’m not especially smart.  I earned a 2.7 GPA in college.  Actually, that’s being generous and adding a few numbers to make myself feel better.  We try to break stuff down for people who are bored with finances but would be willing to read a funny blog.

In future posts, I’ll get more into the weeds as to what we invest in.  We invest in Vanguard VTSAX. Damnit. I’m giving up too much information. You can copy our strategy for what buckets can make up your investments if you want.

Investing does not have to be a black hole of confusion.  Financial Independence is not impossible.  You are great! You smell good. You’re kind.  Children want to be like you.  Go Team!

Related:

Purchasing Financial Independence $11.57 at a Time

How Investment Fees Are Keeping You Poor

Investing 101- How to Invest Your Money When You Don’t Know Where to Start

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