- A withdrawal rate is the quantity of money, expressed as a percentage of the initial investment, which can be withdrawn per year for a given quantity of time without depleting your portfolio. In other words, the rate represents how much stocks, bonds, mutual funds, etc. you sell each year from your portfolio without going broke.
Your withdrawal rate therefore translates to a dollar amount you are receiving from your portfolio. Let’s give an example illustrating this concept.
If I have a million dollars worth of a portfolio and I have a 4% withdrawal rate, that means I am selling 4% of those stocks, bonds, etc. in a given year. Therefore, I am receiving a total of $40,000 a year from my portfolio.
- The withdrawal rate is not set in stone, you can decide what you want it to be each year, however, we recommend you keep it relatively constant, if possible for most years, and update based on inflation or market conditions.
- The withdrawal rate is important because you want a withdrawal rate that provides you a comfortable income amount per year, but also ensures the money in your portfolio does not run out a few years later. The withdrawal rate also give you an indication of how much money you should have in your portfolio in the first (which should have at least 50% in stocks) before you start withdrawing money.
- Most studies have shown that a withdrawal rate of about 4% will probably make the money last around 28 years or more. Of course this assumes that you are not making additional investments if your portfolio.
So if James and I wanted to retire tomorrow with a portfolio that provides $100,000 a year with a 4% withdrawal rate, than we would need $2,500,000 in our portfolio ($100,000/.04=$2,500,000). I am also adding that we would continue to find ways to keep investing and growing that portfolio so we are not just withdrawing and limit our money to only lasting a few decades.
Assuming a 4% withdrawal rate and you keep growing your portfolio, what is your ideal income and how much worth do you need in your portfolio to “retire”? Do the same excercise I did in the above paragraph, just switch the $100,000 to your ideal income.