The 7% Rule

"7" by darren131 is licensed under CC BY-NC-ND 2.0

By now, everyone should have heard about the 4% rule, especially if you are someone who is pursuing FIRE (financial independence, retirement early).

The 4% rules simply states that if you withdraw 4% annually of a certain amount of money, usually 25 times of your annual expense, then you don't ever have to work if the money is invested in the stock market, which returns about 7% annually with inflation accounted for. The 4% rule is very safe and conservative because it leaves about a 3% cushion for any dips in the stock market.

As an example, let's say that my annual spending was $20,000 on average, I would need $500,000 as a nest egg in the stock market. We get this number dividing $20,000 by 0.04 since we are using the 4% rule.

However, I think for a more realistic percentage, I should use the 7% rule, which is the average annual return of the stock market since all of my investments are in the stock market.

The reason I will use a 7% is two folds. One is because it tricks me into saving and investing in the long run by breaking down a massive goal into smaller milestones. Let's face it, $500,000 is a lot of money and I feel like I'm climbing Mt. Everest. I will also include an annual expense of $8,000, which would be my expense without any housing costs. This is to account for the frugality side of me.

Below is the break of my financial milestones:

$8K/0.07 = $115K - First FIRE milestone (by June 2021)

$8K/0.04 = $200K - Second FIRE milestone (by December 2022)

$20K/0.07 = $286K - Third FIRE milestone (by 2024)

$20K/0.04 = $500K - Fourth FIRE milestone (by 2029)

The second reason I want to include a 7% rule is because I view life as a flexible thing. I may decide to move to a cheaper place, or buy a property and rent out the spare bedrooms, or maybe spend a few years as a monk some years down the line so I don't even have the need to pay rent or mortgage. Just a thought.

I know the 7% rule is risky since the stock market will not return 7% annually, but on average it will. There will certainly be a time when a recession hits and the market dips. When that happens, I will invest more into the market or withdraw a smaller percentage from my nest egg.

My ultimate goal is still $500,000. But giving myself some slack is good so I'm not so much focused on a huge number, and the 7% rule certainly does that for me by giving me several milestones along the way to FIRE.