Hello guys today I am going to give you my opinion on the 4% rule and how can you actually afford to stop working.
What is the 4% rule?
It is considered that in order to be able to retire early you can withdraw 4% of your portfolio annually and live a long and happy life. Let’s say you need £30,000/ year in order to achieve Financial Freedom.
That means you need to have a portfolio of £750,000. This is all good and is all in all a solid strategy, But there are some variables along the way, which are not going to make me personally comfortable using this 4% rule.
1. You Are At The Mercy Of The Market
We cannot predict the future, but you never know if sometime along the way there is going to be a period of diminishing returns. Let’s say we have your portfolio down 30-40% in the next 10 years and you are using the 4% rule. In that scenario in the 10th year your portfolio is going to be down around 80% from the withdrawals and the negative returns. If that happens you might be forced to go back to work.
2. Requires You To Withdraw Principal
This is something I really don’t like doing. In the 4% rule you have to live off your principal no matter if the markets are up or down. That means that when your positions are down you have to sell, which is not the right thing to do and can put you in tricky situations.
3. Can Delay Your Retirement
As the 4% rule have the value of your portfolio as a target things might get a bit tricky. Let’s say you need £500,000 and after years of saving you now have £475,000. But in the last year before you quit your job there is a stock market crash and your portfolio goes down 50% (happened before, most probably will happen again at some point). Now all of a sudden your portfolio is at £235,000, which is going to be a problem.
4. Don’t Feel In Control
What I mean by that is that I will have to be at the mercy of the stock market. If it goes on a steady decline over a couple of years I am going to get worried and probably need to go back to work, which is not something I would like to think about once I am financially free. No one knows what the markets are going to do over the next 10/20/30 years and assuming that 4% withdrawal rate is going to be ok is just no my cup of tea.
What Is My Plan?
My plan is to live off of dividend income and not touch the principal at all. I am going to retire once my dividend income is enough to cover my expenses. That way I have the principal who is going to increase at least with the inflation rate and my dividends are going to increase aswell.
It is also much easier to make future projections on a company’s dividend than it is to project a company’s future share price. There are companies who have been increasing their dividends for over half a century now, while their share price has been going up and down. You can check out the dividend aristocrats or the dividend kings for example.
Also by having dividend income as a goal I am much less price- oriented and I don’t really care that much about the fluctuations in the stock prices. That way I have much more of a long- term approach. In the markets it is easy to get carried away and start chasing prices and acting like a day trader.
Summary
So I don’t care about the value of my portfolio to that extent, as long as the fundamentals of the companies are still intact. Even if it doesn’t move up at all as long as the dividends are growing I am happy. After all that is going to be my paycheck down the road and that is all I need.
This is my opinion on the 4% rule and why I prefer to use dividends as my paycheck. And just to be clear the 4% can be perfectly fine and there are a lot of researches showing that it works. It is just that it is not fitting that well with my approach and I would rather go with dividend income alone.
Hope you had an interesting read, wish you great times and all the success!