The 4% rule

Acronyms are rife in finance. It seems every year there are a few new ones to add to our lexicon. During the GFC (see another one!), we were introduced to NINJA loans (loan to those with No Income No Jobs or Assets) and over the last few years I’ve heard about retirees adopting the SKI lifestyle (Spend the Kids Inheritance).

I recently read an article about the FIRE (Financial Independence, Retire Early) movement.
It’s about a growing subculture of young folks – mainly tech workers earning big bucks – who are radically reducing expenses, investing their surplus and building a portfolio large enough to live off.

The example I read was about a 28-year-old living in San Francisco earning $165,000pa. Instead of buying an expensive property to live in, he rents a shared room in a 5-bedroom house. Instead of a fancy car, he uses his bike to get around the city. Instead of eating out, he eats rice and beans 5 nights a week. By doing this he saves $78,000 a year and allocates it into an investment portfolio towards his $800k retirement goal. By then he can relocate to a cheaper city and live off the interest to focus on his passions and exploring philanthropy.

It’s an interesting strategy – and it got me thinking because as it’s not a million miles away from our investment philosophy at FFBD. My own investment plan is to accumulate and own quality businesses and hold them for long enough to replace my employment income with a completely passive income.

The FIRE movement works out their Financial Independence (FI) number (how much you need to retire) then follows a financial theory called the 4% rule (which is the theorised ‘ideal’ withdrawal rate from a portfolio without needed to draw on savings).

OK I hear your argument…Robbie – are you nuts! – I don’t have a $78,000 surplus to invest each year. Well, neither do I.

But obviously, it’s a question of priorities. What do I value more? No matter what your income is, every financial decision you make (big or small) is either going to advance or delay your financial independence.

Buy a house or rent one?
Drive a Camry or Wrangler?
Private School Fees or Public?
Holiday in Bali or Peru?

Our mantra at FFBD is – spend money on things you value, and don’t waste money on things you don’t.

The great thing about investing for income is that it is scalable. Maybe we don’t all have the income to be able to save a retirement lump sum in a few short years. But instead of trying to replace your living costs, or after-tax income, perhaps a good starting place is to build a smaller passive income.

• A portfolio with a passive income of $2,000pa could cover flights to the Gold Coast each year
• A portfolio with a passive income of $5,000pa could cover school fees
• A portfolio with a passive income of $10,000pa could allow you to move to a 4 day work week.

If you don’t know where to start – just give us a call.