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.
The 4% rule explained
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 a 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 very simplified, but it will do for now. It makes me wish I had superpowers of sneaking into the future, but I will have to be patient and see if time proves me right.
Upwards and onwards!