I am trying to understand the formula of Financial Independence which is as follows here,
I am trying to understand what does withdrawal rate mean here but I can't understand. Can someone please explain it?
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The definition I use for financial independence is 99% confidence that, at a specific estimated spending rate per year (allowing for estimated inflation, and budgeting for likely medical emergencies, and taxes on taxable investments), the money will outlast me.
This translates to needing an average annual return on investment which covers the average yearly spending. For my purposes, that works out to my relying on being able to draw only a 4% income from the money each year, which should give me good odds of the money not just being sufficient but being able to deliver that rate "forever". (Historically, average US stock market rate if return is around 8%.) That is overkill, if course, I could plan on the money just barely lasting past my 120th birthday or something of that sort, but the goal us to be pretty sure not only that I won't run out but that I will have some cash unexpected needs.
Which in turn means that I estimate I need investments 1/.04 times the yearly spending estimate to declare the "forever" independence/retirement, or 25x the yearly.
From that, I can calculate how much longer, at a given savings rate and rate of return, it'll take for me to reach that target.
Obviously you need to adjust all these numbers to reflect your opinions/understanding if the market, your own needs, your priorities and expected maximum age, and the phase of Saturn's moons. But that's the basic rationale.
Or you can pay a financial planner to give you this number, and a strategy for getting there, based on the numbers you give him or her plus some statistical analysis of the market's overall history.
In this equation the withdrawal rate is the percent you must pull from your savings to meet your expenses. For example if your savings is $100,000 and you need $10,000 annually for your living expenses then your withdrawal rate would be 10% (where 10k is 10% of 100k). To complete this formula, you need to know how much savings you need to be financially independent before you can use this formula to find out how long it will take you.