Understanding the 4% Rule

The reason that I say it takes 25 times your annual spending to retire is because once you reach that level of investment, you are able to withdraw you annual spending each year without much risk of losing money over time. Based on the historical performance of the stock market, you can safely withdraw 4% of your portfolio each year, or put another way, you can withdraw 1/25th of your total balance.

Every year the stock market fluctuates. Some years are great and others are terrible. Sometimes terrible years get grouped together and become known as a financial crisis. But according to the Stern School of Business, on average, the market has returned around 11% over the past 100 years, not adjusting for inflation. Once adjusting for inflation, the stock market has provided real increases of somewhere around 7% - 9% on average over time. Now of course past returns do not predict future returns and it is quite possible that the next 100 years could show lower overall returns, but it has been true for many decades that the average investor could withdraw 4% from an average portfolio each year and still make money. This means that you could also probably withdraw 4% from your portfolio each year and still see the balance last or grow. I'll prove it.