STOP USING THE 4% RULE

What's up you guys, it's Graham here! So we have some pretty big changes for anyone who's investing their money, building wealth, and working towards financial independence. And that would be the end of the four percent rule and why we should stop using it according to the person who literally invented it to begin with.

See, for nearly thirty years, the four percent rule was known as the holy grail of making sure you have enough money invested to never have to work another day in your entire life. However, that was all until the other day when the inventor of the rule itself said it no longer applies and changes have to be made.

Now, of course, you might be wondering, "But come on, why does this even matter? How does this even affect me? I just came here for the cute turtle pictures and the three free stocks down below in the description when I deposit a hundred dollars on Weeble." And that's a good question! But truth be told, the math behind this video is probably going to be the most important calculation you're ever gonna have to make throughout your entire life.

This applies to pretty much anyone watching who invests their money. It's gonna tell you exactly how much money you need, exactly how much money you could spend, and what you need to do to never have to work another day in your entire life. And if you think I'm joking about this, just watch until the end of the video, and you'll see how this math can change the way you invest your money and why it's suddenly changed.

That is, as soon as you thank the sponsor of this video – it's called "this video doesn't have a sponsor." So if you wouldn't mind just smashing the like button for the YouTube algorithm, it’ll greatly help me out a lot. It helps out the entire channel; it even helps out the almighty YouTube algorithm. So with that said, thank you so much for doing that, and let's begin!

Alright, so here's why the four percent rule was such a big deal. It was invented back in 1994 and used as a method of calculation to make sure you never run out of money in retirement. Or basically, if you just want to have endless amounts of passive income forever, this tells you exactly how much you need and how much you could spend.

Now, to figure this out, the inventor analyzed every single year of stock market returns, and then he simulated what your money would have been worth had you retired that year and then lived off your investments for a 30-year period. Now, the goal with this was that if done right, you would never run out of money.

And in order for this to be a success, the calculation needed a few things to happen. One, they wanted to make sure you didn't spend too much money in the event your investments didn't do as well as you thought they would. Yeah, I'm looking at you, Denny's; I still have not made my money back on that one. And number two, they wanted to make sure you don't spend too little of it to the point where you can't possibly spend it all, so you gift it to your grandkids to then go and blow on first-edition Pokémon cards.

So in order to calculate how much money you need invested to live indefinitely without ever having to work another day again in your entire life, they simulated every single retirement year in history, from point A to point B, and then they projected how much would have been left over, assuming the worst-case possible scenario.

Which is really you retiring at the peak of the market and then slowly watching your investments just get decimated day after day, lower and lower and lower. Anyway, that sounds confusing, well, it is a little bit confusing, but here's a chart to help break that down.

Now, as you can see from the chart here, if you're a hundred percent in the stock market and spend only three percent of it per year, it's safe to say your money is going to last you indefinitely with a 100% success rate. That's because the market on average returns anywhere from seven to nine percent annually, two percent of that gets deducted for inflation, so effectively by spending three percent, that leaves you with a two to four percent buffer each and every year to let your investments continue to grow in value without you needing to do a single thing.

Now on the other hand, if you're 100% in the stock market and spend five percent per year over 40 years, you'll only have a 76% chance of not running out of money by the end of those 40 years. That's pretty much a one in four chance you're going to be completely broke by the end of the time frame, which is not a place you want to be between the ages of 70 and 90.

Now, this guideline is also known as the Trinity study, and from all of this research, the 4% rule was born. That means if you want to live off an income of $40,000 a year without you ever needing to work another day in your entire life or make any more money, you'll need one million dollars invested, and that will give you an 89% chance of lasting for the next 60 years without running out.

This calculation also works in reverse as well. For example, if you have a hundred thousand dollars invested, congratulations! You could effectively spend $333 a month adjusted for inflation each and every year in passive income, because that's how much your investments are going to be growing by every single year.

But now, according to the inventor of the rule itself, the four percent rule is no more. And instead, he recommends a change. He says that now he's no longer sticking to the four percent and that that number was treated too simplistically.

See, historically he took into account the worst possible case scenario in that you retired precisely at the worst moment possible in history, and the markets were like, "No, no, no, Graham, we're gonna punish you for retiring early, so here's a circuit breaker, here's a bankruptcy; say goodbye to your Tesla call options!" Or in a more realistic approach, this is someone who retired at the worst moment in modern history—that was October of 1968—just as the stock market peaked and runaway inflation had just begun.

However, somebody who retired at that time would still be okay if they just stuck with the four percent rule for 30 years. So that was basically taken with the worst case scenario in mind first and then readjusted backwards to make sure even if that happened you'd be okay.

But now he adds that during other times in history, when inflation is low and bonds are cheap, a new retiree would be able to spend much more and still be okay. Historically, he says the average safe withdrawal rate has turned out to be about seven percent, and at points, it's reached as high as thirteen percent.

Of course, the only way to know this is after the fact, in hindsight, at which point it's probably too late. Although given the current state of the market with low inflation and low interest rates, the four percent rule has now been changed to the five percent rule.

Meaning that you would be safe to spend one percent more per year in retirement and still have money left over by the time you reach that big "like" button in the sky. If anything, he says that now four and a half percent is the new worst-case scenario and seven percent could be saved for the average 30-year retirement.

Now that, of course, relies on low inflation, and all of this is in hindsight after the fact. So what happens over the next 10 years could absolutely change this. However, not everyone is happy about this, and right now there's quite a few rebuttals against this.

One is from the popular finance blogger Financial Samurai. He's very outspoken in his claims regarding the legitimacy of spending four percent per year, and he says it was established at a time where the 10-year bond was five. So he says that now, with 10-year bonds yielding just below one, instead, you should aim to spend just point five percent every year. Uh yeah, you heard me correctly—not five percent, point five percent.

And he even lays it out for you in a nice chart that I'll put up right here. So if you want to go and retire off forty thousand dollars a year, you're gonna need eight million dollars invested. Now, to be fair, I'm not sure if he was just having a really bad day that day, but him saying that caused a lot of criticism and backlash from people who say that he's lost his mind.

There have never been any periods of time where the stock market has returned so little over a 30-year time span, and to be fair, they're right. But that also doesn't stop people like Karen— I mean Susie Orman—from telling people that if they want to retire, they're going to need five million dollars. Her reasoning is that that's enough to raise a family and live a very middle-class lifestyle in a high-cost of living area while still having money left over to go on vacations every year and have a little bit left over in case something comes up or the markets go down.

Now obviously both five million and eight million dollars is a pretty ridiculous number to come to, especially if you don't spend a lot of money or you're planning to retire off forty thousand dollars a year. Aspiring for five or eight million dollars is pretty daunting.

So I think in all fairness here, I'm just gonna break down my own calculations completely independent from anybody else, and I'll give you my thoughts from someone who makes YouTube videos from home all day.

So first, in order to do this, we got to take a look at what's called the rolling 30-year return of the S&P 500. This is pretty much just the average return that you're gonna get over any 30-year time frame, and by looking at this, we're going to be able to figure out the best and worst-case scenarios for your money.

We're going to start off with the chart that goes back the furthest, and it goes all the way back to the good year of 1872. This one found that a 20-year stock market has never produced a negative return ever in the entire history of the market, adjusted for inflation.

Even in the worst-case scenario ever realized in history, over 20 years, that return worked out to be 0.5% adjusted for inflation. However, this was, like I mentioned, during the 1960s when inflation just went crazy and the likelihood of that happening again is slim to none.

But during any other time, however, the average return was more like six percent annually with a best-case scenario of 13. Now another chart found that on a 30-year rolling period, the worst-case scenario was an 8% annual return before inflation, and the best case was nearly 15% before inflation.

And a third chart shows the worst possible 30-year rolling period was a 4.3% return after inflation again; that would have been during the 1960s. However, with the unlikely chance that the worst-case scenario ever happens in history at the precise time that you decide to retire, and on top of that, you never want to work another day in your entire life ever again, then according to all this data in the entire history of the market, over any 30-year period, you would actually be okay at five percent.

Although my only big critique here is that if you want to retire early and have longer than a 30-year retirement, then you're probably safer to aim for more like a three to four percent withdrawal rate. Because you need that money to last you longer; that way, even if the market didn't return as much as it did historically, you would still be able to budget appropriately to make sure you're okay.

But let's be real, the biggest thing to keep in mind for almost everybody watching is that none of this matters that much if you're okay being flexible in your spending. It's not like you have to spend five percent of your portfolio every year; otherwise you're a failure, and it doesn't mean you can't scale back to three percent per year if you just can't find anything to spend money on.

Instead, the metric we should use is that it's okay to spend three to six percent of your portfolio annually if you're willing to cut back on your spending in the event the market goes down or your investments don't do as well as you thought they would.

For example, if the market goes down 10% next year, then hey, maybe that's a sign that you should not be buying a first-class ticket to Paris, and maybe you should postpone staying at the Ritz Carlton. As long as you have flexibility in your spending, chances are you're gonna be fine whether you're spending three percent or five percent.

Now this one also assumes that you're never going to make money from working ever again in your entire life, and again the likelihood of that happening is slim to none. So in the event you retire and take time off, but then wait a second, the markets aren't doing that well, there's nothing stopping you from, ooh spooky, going back to work and making more money.

Or you could just make YouTube videos; the possibilities are endless! And again, all of this should really just be used as a rule of thumb. By understanding the math behind this and how it works, you're going to be able to better budget, save, and invest your money.

Just take the amount of money you want to have in retirement, then multiply that by 20 to 33, and that's how much money you will need to have invested if you want a 30-year retirement. Just multiply that number by 20 to 25, and that's approximately how much money you'll need.

Now, if you need this money for more than 30 years, or if you're an immoral vampire who intends for this money to last you for many centuries, then you should probably multiply your spending by 33, and that should be enough to last you for a long time.

So there we go! We got a full-on history lesson here, we got a math lesson combined with investing, and me then pestering you to hit the like button. So if you guys enjoyed this video, it would help me out a lot to hit the like button. And also, if you want, get your three free stocks down below in the description when you deposit a hundred dollars on Weeble because those three free stocks are totally free and they could be worth all the way up to $1,600!

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