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Financial Independence, Early Retirement, and the 4% Rule

2 minutes

Does the 4% rule of thumb for retirement spending still apply if you’re striving towards the ultimate goal of the FIRE lifestyle movement — Financial Independence; Retire Early?

Gaining financial independence through frugality, saving, and investing for the purpose of retiring early has become a popular goal amid an overall rise in anti-consumerism and an unusually long bull market cycle for stocks.

What is the 4% Rule?

For years, financial experts and advisors have relied on the 4% rule of thumb, which states that the maximum annual withdrawal amount is equal to 4% of total savings in order for retirees to ensure that their funds will last. Like so many other pieces of “traditional financial wisdom,” the 4% rule is coming under increased scrutiny in recent years.

So what are the drawbacks to this conservative financial approach to retirement spending?

  • It’s extremely conservative. Many would argue that it’s entirely too conservative, and often leads to retirees having large sums left to pass on through inheritance or other means.
  • It doesn’t take fluctuating market conditions into account. The 4% rule is based on a relatively low rate of return on your savings and investments. What it doesn’t consider is the possibility that your gains will exceed this conservative estimate, and that you can safely spend more in this case.
  • It’s not dynamic or flexible enough. Just applying the 4% rule across your retirement portfolio fails to take into account other sources of income, and the timing of when you’ll receive them. For someone who retires at age 62 but doesn’t begin collecting Social Security until they’re 70 years old, the 4% rule is an unnecessary austerity measure during the yeas in between.

How has the FIRE Movement Changed How We Think About Retirement?

This growing movement believes that the status quo retirement age of 65 is far too old, and that through saving a large portion of your income, investing inexpensively, and living frugally it’s possible to reduce it substantially. Subscribers to this lifestyle rarely believe in living a miserly, deprived existence just for the sake of saving every penny.

Instead, they use careful planning and honest assessments of their finances in determining exactly how much they’ll need to save up so the can maintain their lifestyle indefinitely during retirement. You can learn more about saving and investing here.

Does the 4% Rule Make Sense if Your Goal is Early Retirement?

While the 4% rule can be a good starting point, it just doesn’t fit with the FIRE mentality to suddenly “set and forget” retirement spending. When you value making informed decisions about your finances and take a hands-on approach to achieving financial independence, it wouldn’t make sense to abandon these principles as soon as you reach your retirement goals. Use our compound interest calculator to see how your savings can grow over time.

In the current investment environment, a 4% rate of return is well below the average total return. Even low-fee, relatively low-risk index funds have returned an average of 10% over the past decade, which has had its share of market volatility. The bottom line is, there’s no rule of thumb that will fit every scenario, so strategic planning and good financial habits will serve you better if your goal is to achieve financial independence and retire early.