The 4 per cent rule turns a spending figure into a target pot in one division; the order in which returns arrive decides whether it holds.
Divide the yearly spending your investments must cover by 0.04, which is the same as multiplying it by 25. To draw 40,000 a year, rising with inflation, the 4 per cent rule says you need 1,000,000; if a pension or other income already covers 12,000 of it, you need 700,000. At an illustrative 2 per cent real return the withdrawals last 34.0 years, but the order in which returns arrive can matter more than their average.
Worked in full in Stock Market Investing for Beginners by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The rule comes from studies of historical stock and bond returns in the 1990s, which asked what first-year withdrawal, raised with inflation every year after, would have survived thirty-year retirements in the past. Four per cent of the starting pot was the answer that held up in almost every period tested. It is a rule about history, not a promise, and the arithmetic below shows both what it implies and where it breaks.
| Input | Value |
|---|---|
| Yearly spending in retirement | 40,000 |
| Other income (pension, rent), yearly | 12,000 |
| Withdrawal rate | 4% |
| Retirement length to plan for | 30 years |
| Withdrawals | at the start of each year, raised with inflation |
Pot needed = (spending − other income) ÷ withdrawal rate
In Excel, with spending in B1, other income in B2 and the rate in B3: =(B1-B2)/B3.
40,000 ÷ 0.04 = 1,000,000. Only the part your investments must fund counts, so with 12,000 of other income the gap is 28,000 and the pot is 28,000 ÷ 0.04 = 700,000. A more cautious 3.5 per cent rate is a multiple of 28.57 instead of 25.
| Spending to fund | At 4% | At 3.5% |
|---|---|---|
| 20,000 | 500,000 | 571,429 |
| 30,000 | 750,000 | 857,143 |
| 40,000 | 1,000,000 | 1,142,857 |
| 50,000 | 1,250,000 | 1,428,571 |
Half a point off the withdrawal rate adds 142,857 to the target for 40,000 of spending. How long it takes to save any of these sums is worked in how much to invest a month to reach 1 million.
With a constant real return g and a withdrawal of w per 1 of starting pot, taken at the start of each year, the money lasts n years where
n = −ln(1 − g ÷ (w × (1 + g))) ÷ ln(1 + g)
If g ÷ (w × (1 + g)) is 1 or more, the returns cover the withdrawals and the pot never runs out. At g = 0, n is simply 1 ÷ w: 25 years at 4 per cent.
| Withdrawal rate | 0% real | 2% | 3% | 4% | 5% |
|---|---|---|---|---|---|
| 3.0% | 33.3 | 53.5 | 119.6 | forever | forever |
| 3.5% | 28.6 | 41.5 | 60.4 | forever | forever |
| 4.0% | 25.0 | 34.0 | 44.1 | 83.1 | forever |
| 4.5% | 22.2 | 28.9 | 35.3 | 49.2 | forever |
| 5.0% | 20.0 | 25.1 | 29.6 | 37.4 | 62.4 |
A 4 per cent withdrawal survives thirty years at any steady real return above 1.31 per cent. At 3 per cent real, 1,000,000 still holds 467,155 after thirty years. On averages alone the rule looks conservative. The averages are not the risk.
Take thirty years in which twenty-nine return 5 per cent real and one returns minus 25 per cent. The geometric average is 3.83 per cent whichever year the fall lands in, and without withdrawals 1,000,000 would grow to 3,087,102 in either order. With 40,000 a year coming out, the order decides the result.
| Path | Pot after 30 years |
|---|---|
| The fall in year 1 | 346,064 |
| Steady 3.83% every year | 823,266 |
| The fall in year 30 | 1,093,936 |
| Two falls of 25%, years 1 and 2 | runs out in year 22 |
Same returns, a gap of 747,873. After a fall in the first year the pot is 720,000, and the next 40,000 is 5.56 per cent of it rather than 4: withdrawals sell more units at low prices, and those units are not there for the recovery. That is sequence risk, and it is why the rule was set by the worst historical starting years rather than the average. For a saver who is still buying, the order works the other way: an early fall buys more units cheaply. Early falls hurt the spender and help the buyer.
All figures are illustrative and none is a forecast or advice. Tax, the mix of assets and flexibility in spending all change what a safe rate is for a particular person, which is where qualified guidance earns its fee.
To see what a pot of this size will buy in today's money, and what fees take from it on the way, use the free workbook for this book.
Under the 4 per cent rule, 50,000 divided by 0.04, which is 1,250,000, if the whole 50,000 must come from investments. At a more cautious 3.5 per cent it is 1,428,571. Subtract any pension or other income first: only the gap the portfolio must fund is divided by the rate.
It depends on the real return. Taking 40,000 a year, raised with inflation, 1,000,000 lasts 25.0 years at a 0 per cent real return, 34.0 years at 2 per cent and 44.1 years at 3 per cent. It needs a steady real return of only 1.31 per cent to last thirty years, but a bad first year can do more damage than a low average.
The risk that poor returns arrive early, while you are withdrawing. With 1,000,000, withdrawals of 40,000 and twenty-nine years at 5 per cent real plus one year at minus 25 per cent, the pot ends at 346,064 if the fall comes first and 1,093,936 if it comes last. The average return is identical.
This article is one calculation from Stock Market Investing for Beginners. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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