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I am trying to understand the formula of Financial Independence which is as follows here,

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I am trying to understand what does withdrawal rate mean here but I can't understand. Can someone please explain it?

Thanks.

  • 2
    did you read the paragraph after the formula? – mhoran_psprep Aug 25 '16 at 18:24
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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.

  • You're planning to live off the interest. Other approaches exist, where your gradually deplete your capital. The key on this one is to make sure that at your rate of withdrawal that the end of the money is some years beyond your life expectancy. The advantage is that this goal is more easily attained. – Xalorous Aug 26 '16 at 0:45
  • I did mention that alternative, @xalorous -- end of second paragraph -- but I prefer to consider that a fallback position if something goes wonky, rather than to plan on it. I do have the luxury of being on glide path toward hitting that goal. – keshlam Aug 26 '16 at 1:11
  • I wanted to stress the difference in time and investment required to reach the two goals is different. I like the saying that, "I want the last check I write to bounce." In that it signifies that the speaker planned their savings perfectly. – Xalorous Aug 26 '16 at 1:17
  • I want to leave some to friends,, if I can ... And I'm still slightly hoping for breakthroughs in medicine that will get us to older ages in good health. – keshlam Aug 27 '16 at 7:56
  • By that quote, I mean that I want to remain independent and save just enough to pay all my bills. The best I can expect to do for my kids is to avoid being a drain on their financial resources in my dotage. The whole last check bouncing is because I work so hard now to pay my bills on time, it's kind of a FU to the financial world if the last one bounces when they can't do anything about it. – Xalorous Aug 30 '16 at 0:30
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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.

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