This is one for the history nerds because this is actually the very first blog post I wrote on the ERE blog back on December 4th, 2007. As you can see, I started out presuming the correctness of the 4% rule. By the time I published the ERE book in 2010, I had become more cognizant of its limitations. It’s still useful as a rule of thumb though.

Financial planners generally agree that a 4 percent retirement withdrawal rate (a study has been done!) is safe for the long-term as it takes into account inflation, economic growth, and so on.

This means that you need 25 times (1.00/0.04 = 25) your annual expenditures invested in income generating assets such as stocks, bonds, CDs, and real estate to retire safely. Note that the home equity of your own house doesn’t count towards this goal as your house does not generate income!

Here’s an easy and fun way to figure out your annual expenditure

Day 1 5.50 5.50 5.50 2008
Day 2 45.00 50.50 25.25 9216
Day 3 0.00 50.50 16.83 6144
Day 4 …

Here the first column is all the expenditures you’ve had that day. For instance, on day 1 I spent 5.50 to see X-Men III. On day 2, I spent $45 on groceries and on day 3, I did not spend anything.

The second column is the cumulative expenditure. So on day 3, I had spent 5.50+45.00+0.00=50.50 in total.

The next column is the average daily expenditure. You find this number by dividing the cumulative expenditure by the number of days, so 50.50/3=$16.83 per day.

The final column is the average daily expenditure multiplied by 365 which thus becomes an estimate of my annual expenditure.

The more days you include in the table, the better your estimate of your average daily expenditures becomes. For an accurate estimate you need to carry out this exercise for a couple of months but even a few weeks would yield a reasonable estimate.

Needless to say, if your annual expenditure exceeds your annual after-tax income, you got a BIG PROBLEM.

Now, suppose your annual expenditures converge to about $7000. With annual expenditures of $7000 per year, you need 25*$7000 in savings to retire i.e. $175000.

So what is your number? Do you plan to increase your savings or decrease your expenses to meet it?

Originally posted 2007-12-04 02:06:00.