4% Rule - what is it.....and how does it work...

I couple of people have asked about the 4% rule....

Well there is a belief if you only draw down 4% of an asset base (i.e. say $1m) that asset base would last to for infinity so long as they asset base is solid and of a good quality.

For example lets say you have an asset base of $1m...drawing 4% plus say 2% inflation this is what can be drawn down:

Year 1 - $40,000
Year 2 - $40,800
Year 3 - $41,616
Year 4 - $42,448
Year 5 - $43,297

The underlying assumption here is that the asset will grow more than 4% to ensure that inflation is covered. So thus the need for good quality assets.

On the flip side if one want to determine what asset base is needed for drawing an income which is indexed to inflation. You simply divide the income by 4%.

So for example to get a :

$25k income you would need $625k in assets
$50k income you would need $1.25m in assets
$100k income you would need $2.5m in assets
$200k income you would need $5m in assets

You get the picture...now...

 

Depending upon the situation, that drawing may be taxed or untaxed eg $40k from rent (taxed) or about $35,500 net vs $40k in retirement phase of a super fund (untaxed).

 

Yep....not an issue for people on the verge of 60...or more if Abbott has his way...

But hey I consider Super money as play money anyway....

 

IMO it's confusing just posting an arbitrary rule, without any reference as to where the data comes from.

- 4% was known as the "safe withdrawal rate"
- it came from the Trinity Study on retirement portfolios
https://en.wikipedia.org/wiki/Trinity_study
- it refers to a diversified portfolio of stocks and bonds, not property

 

The following may be of interest,


A Crowdsourced Financial Independence and Early Retirement Simulator and Calculator

http://www.cfiresim.com/input.php

 

I will work on quality property also...just need the asset to be good quality...and diversified across more than 1 state! No mining or small regional towns.....

 

LOE portfolio structuring 101.

 

Nope....unlike LOE...this is based on hard assets with no debts.

 

Thank you sharing Sash

 

Hi @sash

To clarify, is this based on a portfolio that is all paid off and has absolutely no debt?

Thanks

-Tyrone

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Start small. Be consistent. And watch massive change take hold.

 

Good stuff Sash, at 46 (9 years from now ) I am now tracking at PPOR unencumbered, $2.3m family trust diversified stock portfolio yielding grossed up 4.5% and $1.3m SMSF. Trust income will be streamed to 2 beneficiaries so very tax effective (That is if I decide to "retire" at that point). Will then apply the 10% rule on distributions (ie. Min 10% of income being added back into capital base each year) and then the portfolio really starts to compound.... This is all doable now with no growth in salary / business performance, despite the outlook being very good on both counts, so this is a realistic baseline.

Once you have achieved a debt free capital base large enough and live within your means and reinvest some of the income back into the capital base you don't have to worry about much

 

Sounds good Falcon. Well planned strategy.

Who assisted in formulation of the strategy? Accountant, planner, lawyer, taxi driver?

 

The specifics are all mine Piston. Those are baseline numbers so trying for more, but i'd still be satisfied. We had my fathers 70th a few weeks ago, and it was a wake up call for me that all of our days are numbered. So it kind of crystallised what I am trying to achieve. Rather than chasing huge headline numbers / goals, first get to a defensible beach head, a "fortress" position if you like that is de-risked as much as possible, which is what above is. The "F.U. Money" position

(warning, language )


From there, further business expeditionary actions (of which there will no doubt be some) will be using other peoples capital, or very small amounts of ours so downside risk limited, avoidance of directorships etc while still the opportunity for cream and some fun. BUT, the point is I wont have to do this anymore if I don't want to.

 

Doesn't matter...but income is worked on the hard equity or cash component only hot on gross assets or anything with debt.

 

Ditto....I am following a similar strategy where via offsets I am retiring debt at arounf 180-200k per annum...

 

Are hard cg assets with low debt a bad thing when everyone else is paying its way?

 

No Rixter....the 4% rule works only on quality assets which are paid off completely. We would usually exclude stuff with debt as that is more like your LOE strategy.

The reason you only pull out 4% is because inflation indexation is covered. Note that for this to work...the assets would need to be good quality. Originally this was based on shares, bonds...but it will also work with OZ resi in the major cities - i.e. Sydney, Perth, Melbourne, and Brissie as they are pretty much global cities and have consistent demand.

 

When you say drawing 4% is that in the form of a loan? How are you referring to drawing? dividends?

 

Nope the 4% is drawn on asset growth only...albeit some years the growth may only by 3% others 7%...but over it balances out.

If a loan is attached it is your LOE strategy...this could happen in parallel...as a supplement but not entirely. I feel that the LOE strategy in the current environment and is its viability is now under review...

 

But how does it work with property ?

Why shares it is easy to sell off 4% of them for living expenses.

With property, as they say, you cannot sell off a bedroom for living expenses.