When Are You Financially Free?

Many people approach the doorstep of financial freedom with a pile of assets that looks something like what you see below ... a complicated mess of numbers and dollar signs that represent their retirement savings. What’s more, these investors don’t have any idea if the assets they’ve gathered will cover their future expenses.



What you really want is something like this ...



... a steady flow of income streams pouring into your checking account to cover every expense upon arrival.

But how do you go from a random pile of accounts to a steady stream of paid bills?

Understanding the 4% Rule

The most likely “rule of thumb,” one that serves as the ever-flowing financial faucet, is a clear understanding of the 4% Rule1. Also known as the Trinity Study, this influential paper was penned by three finance professors at Trinity University in 1998. Their goal was to determine safe withdrawal rates from stock and bond portfolios.

The study originated from work done by Bergen in 1994, and it has been back-tested over the past two decades by Pfau (2010) and Pye (2010). While it has been criticized many times, it still stands as the best study ever done on the issue.

The Trinity Study used historical data on stock and bond returns over a 50-year period from 1926 to 1976. Thus, it included the worst economic period in American stock market history.

Key elements of the study included:

·       Portfolios used a mix of stocks and bonds (cash in CDs--money markets weren’t counted)

·       Stocks were represented by the S&P 500 Index, bonds by an index of five-year U.S. Treasury bonds

·       Portfolio structure was approximately 50% stocks and 50% bonds

·       Four percent (4%) referred to what was withdrawn in the first year

·       Subsequent withdrawals were inflated, based on current inflation rates

·       Some years of withdrawals were done while total portfolio values had sunk

·       Portfolios had to last 30 years.

Before the study was conducted, experts generally considered 5% to be a safe amount for retirees to withdraw each year. The main outcome of the Trinity Study, however, stated that “a person has sufficient savings in assets if 4% of his / her assets are sufficient to cover a year's expenses.”

The study explicitly affirmed:

“For level payouts, 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 during any of the payout periods. In those cases, portfolio success seems close to being assured.”

"For payouts increasing to keep pace with inflation, they stated that withdrawal rates of 3% to 4% continue to produce high portfolio success rates for stock-dominated portfolios."

To clarify, 4% of assets must cover all spending that is not accounted for by other reliable income streams. These streams include pensions, annuities, and / or social security.

Additionally, “all spending” must include taxes and every instance of discretionary spending. To apply the 4% Rule effectively, you must have a strong understanding of your annual spending, including emergencies and an expected average tax rate.

Applying the 4% Rule

The study emphasized that the 4% Rule should not be used as a matter of contract, but rather as a form of continuous planning. In other words, you should monitor the rule over time with respect to your financial picture, and adjust it to be more conservative if necessary.

Also, the study suggested that it was a good idea to have other contingencies in place in case your retirement extends beyond 30 years. Contingencies should include at least one of the following:

·       Complete home ownership with the home asset not counted into the withdrawal rate

·       Mortgage pay-off in the early years of retirement

·       Three percent (3 %) as the rule if you are very conservative

·       Exclusion of counting into the formula: incidental income from side gigs, inheritance, sale of assets with uncertain outcomes.

For example, let’s say that you want to be able to spend a total of $80,000 per year in the first year of retirement and increasing for inflation over another 30 years. Also, assume you and your spouse have social security income of $50,000 per year. At a tax rate of 20% that increases total spending to $100,000, a nest egg of $1,250,000 would have you covered. [Calculation: ($100,000-50,000)/.04 = $1,250,000)] 

What to Do Next

If you’re sitting there thinking, I’ve got the funds, now what?, there are a few questions you might still need to answer:

·       What investments do I use to ensure a strategy like the one in the study?

·       How do I set this up from my investment accounts?

·       What do I do if we hit a 3-year skid like in 2008?

Not meaning to overly simplify this, but the authors in the study used a combination of low-cost (fund fee under 0.2%) S&P 500 index funds like the ones available at Schwab, Fidelity, Vanguard, and a myriad of other fund companies. In addition, they used actual U.S. Treasury bonds found at these institutions and others. In today’s environment, the bond portion could be addressed with a short- and intermediate-term, investment grade, low-cost bond fund for the portion of money you would draw in the first 10 years.

What matters is that you are investing in thousands of pieces of the U.S. economy through stocks and high-quality bonds. Therefore, you’ll benefit from dividends, interest, and appreciation from several companies, industries, and government entities.

In practice, once you’ve activated your investment portfolio, you should set your dividends and interest payouts to add to cash over time. This will cover approximately 2% of the 4% draw. Then plan on selling investments a couple times of year to make up for the other 2%. 

In order to pace yourself, draws should be made monthly. If you draw fully in January at 4%, you may run out of funds by August.

Maintaining a cash account with at least one year of your spending outside of your investments for emergency expenses also makes good sense.

If another three-year slump occurs, like the one encountered in 2008, don’t panic. As a sensible investor, you know it’s unwise to attempt to time the market or move funds out of your stock investment portfolio in a downturn. Instead, rely mostly on your cash account and bonds while waiting for stocks to recover.

From 2008-2011, U.S. Treasury bonds in total averaged a 6% return2. This amount would have sufficiently covered your draws during that period. During other treacherous stock market periods, like the early 1970s and the early 2000s, the same index averaged 7% and 9%, respectively.

In conclusion, a fixed chunk of money sensibly invested across low cost, diversified stocks and bonds is one of the soundest retirement strategies you can employ.

It’s safer than relying on a job, which requires a decent economy, refined job skills over time, and a solvent company able to pay numerous employees.

While the 4% Rule may be challenged and improved over time, it still stands as the most robust calculation today of what a retiree can draw. If you have set aside the funds and invested wisely over the years to build your ever-flowing, cashflow faucet, it may be time to start enjoying your financially-free years.



1.     Wikipedia, The Free Encyclopedia. Trinity Study. Retrieved on March 11, 2019, https://en.wikipedia.org/wiki/Trinity_study.


·       Cooley, Philip L., Carl M. Hubbard, and Daniel T. Walz. "Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable." AAII Journal 10, no. 3 (1998): 16–21.

·       Scott, Jason, William Sharpe, and John Watson. "The 4% Rule—At What Price?" (PDF). Stanford University (April 11, 2008). Retrieved May 29, 2018, https://web.stanford.edu/~wfsharpe/retecon/4percent.pdf.

·       Collins, J L. "J L Collins - Talks at Google – The Simple Path to Wealth". Reddit. Retrieved May 29, 2018, https://www.reddit.com/r/financialindependence/comments/8e1tly/jl_collins_talks_at_google_the_simple_path_to/.

·       Collins, J L. "My Talk at Google, Playing with FIRE and other Chautauqua connections". J L Collins. Retrieved May 29, 2018, https://jlcollinsnh.com/2018/05/11/my-talk-at-google-playing-with-fire-and-other-chautauqua-connections/.

·       Scott, Jason S., William F. Sharpe, and John G. Watson. "The 4% Rule: At What Price?" https://web.stanford.edu/~wfsharpe/retecon/4percent.pdf.

·       Fonda, Daren. "The Savings Sweet Spot." SmartMoney (April 2008), pp. 62-63. (Interview with Ben Stein and Laurence Kotlikoff.)

·       Prospercuity LLC. "The 4% 'Safe Withdrawal Rate' Rule Of Thumb." Tipster®. http://www.prospercuity.com/swr.htm.

·       Pfau, Wade. "Trinity Study, Retirement Withdrawal Rates and the Chance for Success, Updated Through 2009." Retirement Researcher (October 29, 2010). https://retirementresearcher.com/trinity-study-retirement-withdrawal-rates-and-the-chance-for-success-updated-through-2009/.

·       Cooley, Philip L., Carl M. Hubbard, and Daniel T. Walz. "Portfolio Success Rates: Where to Draw the Line." Financial Planning Association (2011). https://www.onefpa.org/journal/Pages/Portfolio%20Success%20Rates%20Where%20to%20Draw%20the%20Line.aspx.

·       Pye, Gordon B. "The Effect of Emergencies on Retirement Savings and Withdrawals." Journal of Financial Planning 23, no. 11 (November 2010): 57-62.

·       Pye, Gordon B. "Retrenchment Rule." Retrenchment Rule (2012). http://gordonbpye.com.

2.     FTSE U.S. Government Bond Index, 3-7 years, as reported by FTSE fixed income indices, 2018, FTSE Fixed Income LLC.