The 4% rule has been discussed endlessly in the FIRE community over the years.
And for good reason. It’s important to know what returns we can expect from our investments to keep everything humming along in the wonderful world of early retirement.
The 4% rule has been covered from all angles, with people suggesting it’s too optimistic or too pessimistic.
Well, today I want to share another point of view. I think much of the debate actually ignores the most important factor when it comes to financial independence and living off your wealth. And I’m calling it: Your flex rate.
A warmup to today’s topic
Everyone has their own personal flex rate. And it’s unbelievably powerful, yet for some reason, goes mostly ignored. In this post, I’ll explain:
— What the hell your flex rate is, and why it helps maximise your long term freedom while ensuring you don’t run out of money.
— Why lack of flexibility is causing unnecessary fears, leading to more wasted years in the workforce, giving up freedom to an unsatisfying job.
— How being adaptable can be a million-dollar skill up your sleeve (or at least half-a-million).
— Why we have more control than we think over our long term financial independence.
— How to adapt this ‘flex rate’ factor to your own situation using a nifty calculator.
On top of that, you’ll even get some ranty vibes coming through (it’s been a while!). So, get comfy (maybe grab a coffee?), because this is a meaty post. Let’s get into it!
Throughout this blog, I’ve been a big proponent of people remaining flexible with their finances, before and after reaching financial independence.
In my view, it’s a core pillar of financial strength (and personal strength for that matter), both of which are at the heart of this blog.
It’s also the reason why I have zero financial fears in my life, despite the Strong Money household not being ultra-wealthy, still having a pile of property-related debt, and having no qualifications to fall back on. I did have a forklift ticket, but it’s expired 😉
And while I understand the fears around leaving full-time work, there are people in the FIRE community who are millionaires or multi-millionaires, have hit their ‘number’ and are still worried about running out of money. As if somehow they’ll be forced to watch their accounts evaporating and their lifestyle disintegrating into rags and breadcrumbs like a slow-motion train wreck, as they look on helplessly and unable to do anything about it.
Well, dear readers, I have excellent news! This fear is completely unwarranted, and the power to control your financial independence is back in your hands. Until recently, I could only offer simple calculations and some logical principles to help you achieve this. But not long ago I stumbled upon a calculator which had exactly the thing I wanted to calculate!
Basically, how does my portfolio fare if I’m able to reduce spending or increase income by a certain amount when the market goes down?
Why the 4% rule causes concerns
The reason there are fears around living off a portfolio of shares (and the 4% rule in general) is we don’t get a guarantee.
Sometimes markets go through long periods of horrible returns. So anyone who is living off a portfolio will see their portfolio value and dividends cut (sometimes drastically) at various times.
This means you won’t get a perfectly rising and guaranteed income stream from your investments every single year (regardless of asset). One inefficient solution for this is to work longer and save more money.
An alternate solution, which I’ve heartily recommended in the past, is to simply be flexible with your spending in retirement, along with being willing to earn a little income should the situation call for it.
Intuitively, I knew this had to have a massive effect on the long term certainty of a portfolio, but I couldn’t ‘prove’ it. Until now.
The Post-FIRE Retirement Calculator
A site called Engaging Data has created a calculator with the catchy title of… “Rich, Broke or Dead? Post-Retirement Calculator: Visualizing Early Retirement Success and Longevity Risk.”
Rolls off the tongue, I know. Here’s a sneak peek.
But seriously, this calculator is fantastic. It helps put our wealth and life into proper perspective. It does this by letting you play with different inputs and timeframes to see whether you’ll end up… Rich, Broke or Dead.
Now, I know that’s a little morbid. But including mortality is actually the healthiest possible way to consider our long term future, because investing and life aren’t that different. We’re dealing with probabilities.
Go to this page to check out the calculator. You might want to play along as you read this, or just save it for later 🙂
Anyway, the reason I like this calculator so much is because it has the sweet function of adding a ‘flexibility’ component. Meaning, if you’re able and willing to reduce your spending (or make some income) when the market takes a hit, you can add this in and re-calculate your ‘success rate’ based on different levels of flexibility.
You can account for future possible income streams, like part-time work, superannuation or pension payments. You can even account for future expenses over certain time periods, and lots more.
Alright, enough of the explanations. Let’s run through some actual examples so you can see what I’m getting at, and why this is super exciting for the FIRE crowd.
Example 1: Standard retiree, no flexibility
We’ll begin with a standard example (if there even is one?) of someone who retires with $1 million portfolio. By the way, for this and other examples, I’ll be using the following inputs/assumptions:
— Portfolio of 95% shares, 5% cash.
— Healthy, non-smoker.
— Investment fees of 0.3% per annum.
— Retirement age of 30.
— Retirement period of 70 years.
— $40,000 spending, adjusted for inflation (4% rule)
There are countless variables, but this is what I went with. Feel free to choose your own inputs after reading through my examples. So, given the above, how does the long term picture look for our early retiree?
In this case, a 4% withdrawal rate had a 85% success rate. (link to this example)
This chart is overwhelmingly green, meaning wealth is intact or higher than the starting balance. You can already see that as this retiree ages, their chance of dying (in grey) is much higher than the odds of running out of money. Here, we see the overwhelming (and slightly disturbing) likelihood of ending up either rich or dead.
But the red slice is where our early retiree runs out of money in a handful of cases. This is what causes anxiety among many people. Because with a crappy stretch of returns, it’s technically possible to deplete a portfolio to zero.
Well, that’s assuming we stubbornly increase our spending every year with inflation, regardless of what’s going on. Has anyone ever actually done that? I doubt it.
And we’ll also completely ignore any superannuation, inheritance, and the government pension, which by itself is enough for most retirees (ourselves included), and would kick in around the time those Broke scenarios do.
So, in my view, we’re already being painfully pessimistic. But we’ll roll with it anyway! Let’s see how we can improve this outcome.
Example 2: Minimum Flex (25% flex rate)
Suppose our early retiree manages to squeeze a little flexibility into their plans, to the tune of 25%.
What does this mean? With spending of $40,000 per year, this flex rate amounts to $10,000. Maybe they reduce spending for a while, or earn some part-time income.
Our retiree decides to start being flexible when their portfolio falls to 80% of its original balance, adjusted for inflation (noted as ‘flex threshold’ on the calc). Basically, if the portfolio is 20% lower than where it needs to be for their given spending and withdrawal rate, this is where the flex rate kicks in.
I’ll use this threshold for each example. I chose this level because it’s probably where a retiree would start getting nervous, and when they might consider tweaking something.
Alright, here are the updated results:
Finding: With a 25% flex rate, our early retiree basically never runs out of money with a 4% withdrawal rate. (link to this example)
(I’m using the ‘spending flex’ input for overall flexibility. It doesn’t matter where the $10,000 per year comes from – the outcome is the same. This is more useful than ‘extra income’ because that requires a fixed time period. You’re more likely to earn extra cash and spends less when the market is down, which fits better with ‘spending flex’.)
How long do you need to be flexible for? Just until your portfolio is back on track and above the 80% threshold again. Realistically, you’d likely do it until your portfolio can sustain your spending once again based on your chosen withdrawal rate.
Okay, so a little flexibility gives a much better outcome. We’re feeling comforted now. But what if you have even more wiggle room? After all, many of us have a decent amount of optional expenses in our lives. Plus, more importantly, almost everyone I talk to either plans to work part-time after reaching FI, or is open to the idea.
Example 3: Medium Flex (40% flex rate)
This is where things get interesting. As it turns out, a higher level of flexibility actually enables you to live off more than 4% of your portfolio. Take a look:
Finding: With a healthy flex rate of 40%, our early retiree can live on 5% of their portfolio, essentially forever. (link to this example)
Here, the starting portfolio is the same – $1 million. And annual spending begins at $50,000. A flex rate of 40% would mean this person needs to have wiggle room of $20,000 per year.
That’s a decent chunk of change. But one person working just 15 hours (2 days) per week at $25 per hour would earn $20,000 per year. So it’s not difficult to achieve, if they wanted to keep spending the same. Side note: as of August 2021, the median hourly wage in Australia was $36 per hour.
Example 4: Maximum Flex (55%+ flex rate)
Alright, let’s kick things up a notch. As our flexibility increases, so does the amount we’re able to spend from a portfolio when things are going smoothly.
Finding: With a flex rate of 55% and above – should we all that Arnold Flex? – our early retiree is now able to spend from their portfolio at a seemingly ludicrous rate of 6%. (link to this example)
Now, because of the bigger withdrawals from the portfolio, this likely means part-time work would become more frequent than earlier examples. But the point remains: the more we can flex our income and spending when the market is down, the 4% rule becomes increasingly and unnecessarily conservative.
Because our early retiree is spending $60,000, they need to create $33,000 of flex. Let’s say they cut spending by $6,000. Now they need $27,000 of part-time income.
That’s starting to sound like a bigger hurdle. But I’d say the majority of people who hit FI and retire early could still comfortably manage this.
For example, Mrs SMA earns slightly more than this herself from a 2 day per week government admin job. No special qualifications on her side either.
A couple would find it easy to earn $30,000 as the work can be spread across two people. $15,000 each = $300 per week = 2 days work at minimum wage (or 1 day each for well-paid work).
At this point, you’re either on board with my line of thinking, or you think I’ve lost the plot. Hopefully it’s the first one! But to show you I’m not just spouting magical numbers from some ivory tower and throwing down unachieveable challenges, let me share my own situation.
Our own scenario: Flex AF
After 5 years of FI (or semi-retirement or whatever you’d call it at this point), I’ve been surprised from others and our own experience how simple it is to earn decent income doing enjoyable things.
It helps that work is naturally more enjoyable when it doesn’t take up too much of your time and energy.
Over the last couple of years we’ve ended up earning income in the ballpark of our household spending – $50,000 – with modest amounts of part-time work.
This effectively gives us a flex rate of 100%, before we even consider cutting our expenses (which we could certainly do). So, yeah, flex AF!
And we’re not alone. I’ve heard from many others in the same boat. You reach FI (or get close to it), then begin pursuing things which interest you while enjoying a generous dose of freedom and leisure, creating part-time income to the point where your investments are just kind of sitting there in the background!
At that point, the idea of running out of money becomes a source of comedy. Since you barely end up needing it in the first place! Okay, let’s summarise these findings.
Flex Rate results
Here’s a table with different flex rates, what it means in dollar terms, and the withdrawal rate it works with.
It’s a good way to highlight the value of flexibility in action.
We can also put a tangible value on our flexibility. Having $20,000 worth of flex in your situation is essentially the same as having an extra $500,000 of shares as a backup plan.
On our FI journey, finding ways to spend less comes with a multiplier benefit of say 25x, given we then need less investments to live on. And after we reach FI, our flexibility comes with the same multiplier benefit, given it’s the same as having a higher level of investments.
The higher your flex rate, the more ‘backup value’ you have in reserve. A number that’s unseen, but very real.
What this means for the FI community
You might have already guessed what this implies, but let me spell it out anyway…
Depending on your personal flex rate, it’s entirely possible (and totally reasonable) to pull the pin on full-time work even sooner. Yes, you can confidently ‘retire’ with less than 25x your annual spending saved up!
Maybe you even pull the pin once you’ve reached 20x or just 16-17x (which equates to a withdrawal rate of 5% and 6%).
This can shave years off a typical FI journey, resulting in more freedom, for more people, sooner. That’s something which excites me tremendously!
Of course, after jumping this mental hurdle, you may seriously consider the idea of semi-retirement, a fantastic option for so many reasons I outline in this post.
All possible, once we get past our fears of not having enough money. And seeing how we can comfortably navigate the seemingly scary future, through a few simple decisions and a willingness to flex our financial muscles from time to time.
Some will say that a scenario involving part-time work or spending less means your FI plan isn’t solid enough. They’ll suggest it means you’re retiring too soon, without enough savings.
With a warm inner glow, you can ignore these comments. It means you’re a sensible human being who values your life and freedom more than giving up your best years in order to chase the slippery slope of greater safety and security.
It also means you can smile and scroll past the next article you see on “Why the 4% rule is not safe enough”, and how it should be 3%, or 2%, or whatever overly conservative and pessimistic nonsense is being blurted out.
Because, at the end of the day, you know that while you can’t control the market, you are in complete control of your personal actions and how you manage your income and expenses for the remainder of your life. And that, as we can see, is what truly drives a successful outcome.
Flex rate applied in other ways
If you read enough investing websites and chat forums, you might have noticed something. Investors who focus on living solely off dividend income don’t seem to have this fear of running out of money.
Why? Because dividends fall during recessions. So the investor naturally receives less income from the portfolio and has to make it up in other ways (spare cash, reduced spending, earn income, etc.).
In this way, there’s a form of forced flexibility built into the strategy, and because no shares are being sold, the investor knows the portfolio will never hit zero.
That doesn’t make it a magical strategy, but it does offer a built-in level of psychological certainty that often goes overlooked.
Investors living off rental property income are in a similar boat. When rents take a hit, or they have an extended vacancy and unexpected repairs, they simply adapt and live off less income for a while, until things get back to normal.
The power in maintaining a healthy flex rate applies across the board, regardless of your chosen investments. You go with the flow and adapt.
Regular retirees are applying this strategy all the time without the need for a fancy calculator. Hell, everyday people are doing it too. When their situation changes due to job loss, health issues, whatever.
Humans have been adapting to their environment forever. Why would that change? To twist a Naval quote, you’re just a monkey with some savings.
Look, there’s probably a subset of the FIRE crowd who are drawn to financial independence due to the desire for safety and security. That’s fair enough. But in many cases, these people are still driven by a subtle and nagging underlying fear of not having enough money.
So, despite my best attempts, they may not absorb this message. The walls of their cocoon of worry are too strong to hear outside voices.
Why isn’t flexibility spoken about?
In my view, two reasons:
1– Because it’s not very sophisticated. It’s not intellectually stimulating, so the finance nerds aren’t really interested in it.
Far more exciting to debate future returns using market history across all countries and time periods, scraping together questionable data from 200 years ago.
Then plug all that into a spreadsheet with 127 columns and proceed to model 2,304 different asset allocation portfolios, tweak it using dozens of indicators and market valuation metrics, elaborate tactical and rebalancing strategies, testing various factors against each other, all in an effort to come up with the optimal answer to present to you.
But in all seriousness, the more likely reason this angle isn’t covered is…
2– Because it’s not the answer people want. Even if it’s the best answer, having to take action personally (and – gasp! – maybe make a few small changes every now and then) is not the solution people want.
It’s like saying the answer to staying in good physical shape is to remain active, keep a careful eye on your nutrition, and adjust your approach based on results.
Funnily enough, I’m suggesting you do the financial equivalent of this (not a coincidence). So, even if these are the best solutions, ain’t nobody wanna hear that shit!
Give us the pill, the secret diet plan, the magical exercise routine, the guru with all the answers. But for the love of god, don’t give us a simple logical answer!
So there it is. How to secure your finances and prolong your investments forever in one simple factor.
On the FIRE journey, the most important factor is your savings rate. In retirement, the most important factor is your flex rate.
Flexibility really does equal freedom. It allows you to retire with more confidence and greater peace of mind, knowing you have far more power over your situation than many assume.
It almost doesn’t matter what the market does. With a healthy flex rate, you’re moving with the environment. It’s a way to be prudent and conservative without working year after year until you finally feel safe (hint: you never will because you’ll keep moving the target).
By taking charge this way, you create a titanium layer of financial strength that can see you through the worst of times. And in doing so, you basically guarantee a happy and prosperous future, backed by your own ability to adapt and go with the flow.
Then, you can get back to the real business of enjoying your freedom, rather than worrying about the future!
If this is all too complex, forget the numbers. Here’s the short version:
— If the market falls, spend less, earn some income, and you’ll be completely fine.
— The more flexible you are, the less you need to retire.
— The more you can flex in the bad years, the more you can spend in the good years.
I’m not saying this gives you a concrete mathematical formula to work from either. Complete certainty is an illusion.
Rather, the overall principle and the overwhelming value in flexibility is what’s important. And after preaching it for a number of years, I’m glad to have found some numbers to back it up.
If you’ve ever wondered why I seem hopelessly optimistc around early retirement and almost dismiss the idea of being financially fearful, now you can see why.
While some may quibble with returns or the finer details in practice, the concept is solid. Take an adaptive approach, and you can maintain a healthy level of wealth and maximum freedom at all times… while in the worst cases, still being in a position of mostly-retired.
More importantly, that freedom comes much sooner than slogging it out another decade for extra cushion “just in case.” Here, the benefit is front-loaded, when your life is most precious. Because, as the calculator reminds us, those future years aren’t guaranteed.
If you know someone struggling with fears around the 4% rule, or think more people need to know the power of flexibility, please share this post with them.
Thanks for reading!
Here are some resources you may find useful on your wealth building journey:
Sharesight: A great portfolio tracking tool for share investors, and free for up to 10 holdings. It tracks all dividends, franking credits and capital gains, which is incredibly helpful at tax time. Saves me a lot of time and headache!
Mortgage broker: My personal broker of 10 years is More Than Mortgages. Highly rated and award winning, Deanna and her team been super helpful over the years and can assist with anything home loan related, including refinancing and debt recycling.
My book: After 5 years and hundreds of articles and podcasts, I decided to distill everything down into an easy to follow book. Designed as a complete roadmap to achieving financial independence and retiring early in Australia. Available in paperback, ebook, and audio.
Just so you know, if you choose to use these resources, this blog may receive a financial benefit at no extra cost to you. Thanks in advance if you do. And to be clear, I only ever recommend things I use myself and genuinely believe in 🙂