How much money do you need to stop working?

How much money do you need to stop working?

It’s a question that’s hotly debated in the financial community: how much money do you have to save exactly so you do not have to work anymore and live off the proceeds of your fortune for the rest of your life? I, too, intend to retire before my 40th birthday and then never have to work for a job in a job again. But how much money do I need exactly for that? Maybe a million? Or even ten million dollars? Or much less?

The short answer: 25 times your annual expenditure
In order to stop being dependent on my job, I have to save so much money that I can pay for it month after month without having to spend my savings.
I send my saved money to work for once – I attach it, for example in stocks, bonds or real estate. As a result, my money generates income in the form of interest, dividends or rental income.

These investment income is now in a kind of competition with my expenses: The capital income increases my invested assets, by the regular withdrawals of my expenses it shrinks.

Let’s say you deposit your money into a time deposit account that pays you exactly 2% interest every year. Then you could also spend 2% of your wealth annually without your money getting less over time.

With 2% interest (if you even get that) is still no flower pot to win. So there must be riskier forms of investment, such as stocks, that can help you achieve more than 2% return over the long term. But they have another problem: Such forms of investment do not provide constant returns. Sometimes it goes downhill for seven years in a row, then it goes a year maybe 30% or even 50% upwards. Only over the long term, over many years, does the stock market grow at an average of around 7% per annum.

You can hardly calculate with these strong fluctuations. And even simply averaging annual returns will not help you. Because if you also withdraw money from your assets each year, the order in which the returns occur in the individual years also plays a role. [1]

So it has to be a bit more complicated. Something like the one researchers from Trinity University in Texas did in 1998. In this so-called Trinity Study , the scientists first traveled virtually back to 1925. They invested fictitious financial assets half in US equities and half in bonds and then calculated how much of that fortune could have been spent each year in subsequent years without going bankrupt within thirty years. They then repeated this calculation for all forty-one 30-year periods between 1925 and 1995 (ie 1926-1955, 1927-1956 and so on). 2

The result: Even in the worst case scenario (if you had started just before the big stock market crash of 1929), you would not have gone bankrupt if you had taken from your savings at most four percent of your initial assets every year .

So, if you invest $100,000 half in equities and bonds and the returns are about as high and distributed as in the years covered by the study, then you can spend $4,000 on it every year for 30 years (and even annually this amount) to adapt to inflation), without your assets being completely used up.

Since the original study in 1998, many researchers have reissued and updated this bill – with similar results. Despite their age, the Trinity study and the 4 percent rule derived from it are still valid today.

By the way, if you take a fixed (adjusted only for inflation) Amount of an invested amount of money year after year, without causing the assets are depleted, we speak in public finance also from a Safe Withdrawal Rate, or SWR for short . The Trinity Study proposes a safe withdrawal rate of 4 percent.

And that finally answers our question from the beginning: If you can spend 4 percent each year , or one twenty- fifth of your initial assets, then you need 25 times your annual expenditures to fully cover them by your saved assets.

“Stop, stop! …”

… some readers are sure to scream now. For the Trinity Study and the 4% rule are under criticism in the financial community – and not without reason: The study examines the tested fictitious assets only then not to be used up within 30 years. But if I want to retire at 30 or 40 , my money may have to last fifty or even sixty years.

In addition, the portfolio of securities examined in the study contains only US equities, which have achieved a particularly high return over the selected period (between 1925 and 1995) – higher than global equities over the same period. And bond yields were almost consistently higher during this period than they are today.
In addition, the Trinity Study does not consider tax payments. While these are hardly significant in the US, they can account for up to 26% of investment income in Germany.

So there are many reasons that suggest that a SWR of 4 percent could be overstated. Can the returns be transferred from the tested period to the present? How much safety buffer should I budget if my money is to last fifty or sixty years? Would I have to start from the outset to set a SWR of 3 percent to calculate the tax burden?

However, those who argue for a lower withdrawal rate for these reasons, but leaves out one thing: There are also good reasons why 4 percent could be set too low. After all, the SWR model assumes that I stubbornly spend exactly the same amount each year. In fact, of course, I can adjust my withdrawals within a certain framework. During an economic crisis or a stock market crash, I reduce my expenses. Or I assume a side job to relieve the withdrawals by an additional active income. In an emergency, working for a few months a week or two a week does not kill me. But it reduces the risk that my assets will be used up due to a temporary weak return.

Just as well, I can adjust the withdrawal strategy itself. With the SWR strategy, I always deduct a fixed amount of money from my assets . Instead, I could only withdraw a fixed percentage of the assets. This strategy is called Dynamic Withdrawal Rate – or DWR for short . With a DWR of 4%, I take a fortune of $100,000 also $4,000. Shrinking my investment next year, but for example, to $80,000, then I take only 4% of the new sum, ie $3,200.

From a purely mathematical point of view, the risk of bankruptcy is excluded in the case of a PWR. Because even if my assets shrink to one euro, I always take only 4% of the assets, so still have 96% left, even if that should only be a few cents. At the same time, however, this is the disadvantage of this strategy: The withdrawal amounts can be too small to cover my expenses. In reality, therefore, a mix of SWR and DWR is probably useful, in which I take dynamically within a certain upper and lower bound. For example, I could always get four percent of my current assets (that would be equivalent to a DWR), but not less than $10,000 and not more than $20,000 a year. I would have added a bit of SWR to a DWR base.

And last but not least: who says that I generally earn nothing more besides, as soon as I am financially independent? Maybe I start a project, make fun of my own company or programm here and there times a website or software for a customer, so I also have a small active income – of course, purely on a voluntary basis.

In my opinion, it is therefore not so crucial whether four, three and a half or even only two percent represent the “correct” withdrawal rate. Much more important is a meaningful withdrawal strategy and that I can respond flexibly to changing life situations (and portfolio levels). Then the 4% rule gives me a solid rule of thumb on how much money I need to be financially independent and never have to go back to work.

Because one thing is certain: If you have saved 25 times your annual expenses, you can calm down your boss’s notice on the table. Even if the stock markets collapse tomorrow and there would never again interest or other capital gains: Even without any return and 2 percent inflation your accumulated assets would already be sufficient for about 20 years. More than enough time, then, in which you first relax, put your feet up and you can look in peace for new opportunities. In the vast majority of cases it should come as far as not at all. Then your money will last until the end of your life and you will never have to worry about your job and earned income.

1 Small example complacent? Suppose you have invested $1000 and take from this fortune per year $50. Now comes Case 1: Here you will achieve a return of 30% in the first year and in the second year of -10%. Your assets grow in the first year to $1250 and falls in the second year to $1075. Now we turn the tables: In case 2, your yield in the first year is -10%, in the second +30%: Then your assets shrink first to $850, grows in the second year but only to $1055. This risk of an unfavorable order in the return distribution is called in the financial world Sequence of Return Risk(SOR). When saving a sum of money, rising and falling prices affect you unfavorably at the beginning, while the depreciation or retirement phase is the other way round: Here you benefit from rates that rise at the beginning and then fall later.

[1] Such a procedure, where a strategy is applied to past data, is also called backtesting.

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