In the last post, I revealed my exact plan for reaching financial independence. I outlined my current progress, my assumptions, and a forecast on when I will reach the goal. If you haven’t read it, go have a look!
To have my basic expenses covered for the rest of my life I need an investment portfolio of €300K.
At a 4% yearly withdrawal rate I will be able to get €12K yearly without exhausting my porfolio.
The moment I reach €300K in my investment portfolio, I can dance the happy dance and declare my goal accomplished! I can with a high level of certainty withdraw money and my portfolio will not exhaust for the rest of my life.
I calculated the size of my investment based on my basic yearly expenses of €12K and the 4% rule. The 4% rule is also known as safe withdrawal rate. It is a conclusion of the Trinity study – an influential 1998 paper by three professors of finance.
If history is any guide for the future, then withdrawal rates of 3% and 4% are extremely unlikely to exhaust any portfolio of stocks and bonds. In those cases, portfolio success seems close to being assured. – Trinity study
I did my own calculation and reached similar results based on the numbers below:
- Annual return rate on investments: 9-10% (in the last 26 years, DAX ETF has an average yearly return rate of 9%. This compares with around 10,1% for the S&P 500; assuming the dividends are reinvested)
- Average annual inflation: 2-3% (calculated from 1913; 3.22% for the US and bit less than 3% for Germany)
- Taxes on income from stock: 15% for the US and 25% for Germany where I live currently (these are long-term capital gains rates — which are lower than ordinary income tax rates but still need to be taken into consideration)
When I remove inflation and taxes from the annual return on my investments, I am left with anything from 4 to 5% of my portfolio which is safe to withdraw. To be extra cautious, I stick to the lower number – 4%.
There will be years when the market will be declining (bear market) and I will need extra cash for emergencies. This is something I can’t predict at the time being. It will require course corrections due to the uncertainties in the market and the lifestyle.
The calculation is a very simplified, but it will do for now. It makes me wish I had super powers of sneaking into the future, but I will have to be patient and see if time proves me right.
Upwards and onwards!