Also known as: SWR, The 4% rule
Safe withdrawal rate
The percentage of a portfolio that can be withdrawn each year so that the money will probably last the whole planned horizon. Four percent is the figure most often quoted.
Once you stop working and start living off what you have saved, a question appears: how much can you withdraw each year without running out? The safe withdrawal rate is an attempt to answer it with a single number.
The best-known answer is four percent: in the first year you withdraw 4% of the portfolio, and in later years you only raise that same amount by inflation.
Where the number comes from
It comes from a study that tested historical returns on American shares and bonds over thirty-year periods. It looked for the highest withdrawal at which a portfolio survived even the worst of those periods, and the answer was roughly four percent.
That is also where the rule in reverse comes from: the wealth you need is about twenty-five times your annual spending, since 1 / 0.04 = 25.
- : the portfolio value needed
- : annual spending
- : the withdrawal rate
A worked example
You need €1,500 a month, that is €18,000 a year.
| Withdrawal rate | Wealth needed | Change |
|---|---|---|
| 3% | €600,000 | +50% |
| 3.5% | €514,286 | +29% |
| 4% | €450,000 | : |
| 5% | €360,000 | −20% |
The gap between 3% and 4% is €150,000: years of extra work. Choosing the withdrawal rate is therefore the most expensive decision in the whole plan.
Why it is not a guarantee
The order of returns. Two portfolios with the same average return can end up completely differently depending on when the losses arrived. A fall in the first years of withdrawal is far more dangerous than the same fall fifteen years later: you are drawing from an already reduced base.
The length of the horizon. The original study assumed thirty years. Someone who finishes work in their forties needs to cover fifty and over a longer horizon a four percent withdrawal is considerably riskier.
The Slovak context. The model accounts for neither tax on returns nor health insurance, nor for the fact that a portfolio built differently from the one in the study will behave differently.
What to do about it in practice
Those who want more certainty choose a lower rate: 3 to 3.5%. Another approach is flexible withdrawal: in years when the market falls, spending is trimmed temporarily. That does more for the resilience of a plan than any precise percentage.
It also helps to hold two to three years of spending in cash, so you never have to sell into a fall.
Work out how the wealth you need changes with the withdrawal rate in the FIRE calculator.