The 5% rule that has never failed

The 5 percent rule

I fixed it

Dear Investor Challenge

I’ve been saving and investing a third of my take home pay for quite a few years now, and even though I have nearly R7 million (R6 and 3/4 million to be exact!) invested, at my current savings amount of R15 000 a month, it’ll take me another 4 years to get to the R9 million I need to be able to retire spending the R30 000 a month I do now.

By then I’ll be 48, and who knows if I’ll still be able to go cycling through Europe, hiking in Patagonia or backpacking through Asia.

Surely there’s a way to speed things up a little?

Ms Impatient Saver

Thanks for writing in Ms Saver. Have you ever heard about the 5% retirement rule? Of course not, I just made it up. You’ve more likely heard about the 4% retirement rule. What this rule says is that if you were to retire today, you could withdraw 4% of your total nest egg this year, and adjust that amount for inflation for the rest of your life, and you’d likely never run out of money.

Now spending 4% in your first year is the same as spending 1/25th of your net worth, but I think both those numbers are stupid because a) I can’t think in percentages; and b) I have no clue how much I spend on anything each year. I know what I spend each month, but I can’t be bothered to multiply everything by 12.

That’s why I was happy to know that 4% per year = 1/25th per year = 1/300th per month. With this new information I wrote this blog post entitled The fantastically simple rule of 300, along with a fancy calculator you used in your link to work out how long it would take until you had your R9 million.

So what exactly is this new 5% rule?

Well unlike the 4% rule which says start with 4% of your total in year one and adjust up with inflation every year, the 5% rule says you take 5% of what you currently have each year, meaning your drawdown rate can go up or down every year depending on how the market has moved.

So if you start with R10 million, in year 1 you could spend R500 000. If the market climbed by 25% that year, and you were left with R12.1 million, in year two you could then spend just over R600 000, how fantastic is that! If on the other hand there was a major crash, and you ended up with just R5 million in year two, you’d have to cut your spending down to R250 000 and have to give up your bikini waxes.

Using the 5% rule, if you wanted to spend R30 000 a month, all you’d now need is 240 times that, which is R7.2 million. Happily at your current rate, you’d get there in just 11 more months!

If you had to follow that rule you would never run out of money, guaranteed. In fact it works for any percentage, even 50%, the only point to watch out for is that the 50% would become a very small number very fast, and that would suck, greatly!

To avoid that miserable scenario, it’s time to introduce a new calculator called cFIREsim. This isn’t one I built, which should be obvious because it’s insanely complicated. Fortunately it’s also insanely good at running historical numbers. What it does is take your retirement numbers and then pretend you retired every year from 1871 to now.

As it’s been programmed with the market returns as well as inflation for all of those years, it can show you what would have actually happened if you retired in each of those years, spending as much as you’d chosen.

Now yes, it is in dollars and not rand, which means if we’d like to run the numbers above we’d either have to convert, or else just pretend the $ symbol is actually a R symbol, as it makes no difference if you retire with R9 million spending R30 000 a month, or $9 million spending $30 000 a month.

You’re both equally likely to be just fine, though the $ based spender would probably be traveling the world first class while you recline with the livestock in the back. More proof that it’s not what you earn that matters, all that’s important is what you spend in proportion to what you earn.

So now, if we use this calculator to see what would happen to the young lady above using the new 5% rule for a 40 year retirement we get the following data:5 percent drawdown rate adjusted annuallyThe first thing to realise there is we have a 100% success rate, that’s great! You can also see that on average you’re likely to die over 50% wealthier than when you retired, and these numbers are adjusted for inflation, so you really will be that much richer. In the best case scenario you amazingly end up with more than 5 times the wealth, being able to spend a huge R140 000 per month!

But there’s also a problem. In one of the simulations you went through something called a Sequence of Returns Risk, also known as moerse kak luck. In this retirement year you would have ended up only being able to spend R116.7k a year,ย  just R9.7k a month. That’s 66% less than what you were planning to spend, likely an impossible task.

When I did my budget earlier this year I planned a barebones budget, and the best I could realistically do was cut 25%. We’re going to need another plan, and happily, I have one.

First you need to realise that bad times happen to the stock market far less than good times, so while it’s good to plan for the worst case scenario, in reality you’re unlikely to end up in one.

Then it’s time for the plan, the key is flexibility:

  1. First off, you need to be willing to make cuts. There’s always some fat in the budget, some unnecessary purchase or upgrade that can be put off, some cycling that can replace driving or even just staying home and becoming a 2 minute noodle gourmet chef for a brief period. All you need to do is be able to cut just 25% from your budget.
  2. You’re going to have to go back to work. Someone who has gotten into a position of being able to retire 20+ years before the average person, and do it comfortably, is someone who has useful skills. Now the good thing here is you don’t need a high paying full time job, all you need to do is make 25% of your budget. At your planned spending, you just need to make R7.5k a month, it should be a piece of cake for someone previously earning R45k. You could make that driving for Uber, or even as a barman on the beach taking in the great view as it frolics in the surf if you needed to. Even if it was the great depression and jobs were super scarce, you could offer to do your old job for just a 6th of the pay. They’d kick your replacement out so fast they’d lose a shoe. It’s guaranteed work!
  3. Keep an emergency fund. In all the major crashes, the bottom never held for long. A 3 to 6 month emergency fund will give you enough time to improve your situation using the points above.

So that’s the plan, when the shit hits the fan you can keep drawing half of your expenses from your investments, cut your costs by 25% and make the same amount of extra money.

Here’s how that looks in the simulator: Again a 100% success rate! Sure your average is marginally down but it’s barely noticeable. The above rules also aren’t cast in stone. If you can cut costs in half when the economy implodes then you don’t need to bother with a job ever again, and likewise, if you can get a job to cover half your expenses, you won’t need to bother with budget cuts!

If you’re still worried about an upcoming crash you need to remember that this strategy and the 4% rule have survived all major crashes of the last century, even the monstrous great depression, the worst economic downturn in the history of the industrialised world, where the markets lost 90%. That makes the 2008 crash look like child’s play in comparison. As long as we don’t have a situation worse that that we’re fine!

*For fun I ran the same scenario with a 6% drawdown, it had a 98% success rate and left you dying with around two thirds of your money left over. I prefer to grow my wealth even after retirement.

What kind of drawdown are you planning?

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24 Responses to The 5% rule that has never failed

  1. MoneyChief says:

    Are the results from cFIREsim applicable to South Africa?

  2. patrickza says:

    They’re based on the US market, so not exactly. Interestingly guess which was the only market to outperform the US from 1900? Yes it was SA: https://www.iol.co.za/personal-finance/jse-the-worlds-best-performing-exchange-since-1900-10659189

    So historically we’d be better off, but in future it’s anyone’s guess which is the reason I think global diversification is a safe way forward.

  3. Shane says:

    Great Article!! ๐Ÿ™‚ some good analysis work, did play around with the cFIREsim tool, quite rugged but cool.

    I know you mention of ways to make up extra money/ cut expenses for the “lowest” performing years of the market, one other way maybe to – just keep one’s lifestyle costs in check during the “highest” performing years and re-invest the access earnings during those years to contribute for the “lowest”performing years, obviously, hoping that the “lowest”performing years don’t hit too hard well before the “highest”performing years ๐Ÿ˜‰

    I would like to stick to the 4% rule though, just to be on the safer side, makes me feel more secure being able to take local and international holidays more comfortably.. and…covering above inflation medical costs, but it is definitely reassuring to see what historic market performance tells us, even though SA outperformed US from 1900, not sure if that will continue for the next 50/100 years!

    I am looking at diversifying some funds for the short term and seeing fixed rates @9% over 2 years at African Bank/Capitec, it does’nt seem like a bad option to park some short term money there, while investing the interests in equity on a monthly basis? what do you think of the option Patrick?

    I am off to Europe for a month of holiday in Aug, any advise or tips to save or manage my holiday more frugally seeing you are an avid traveler? Thanks again!

  4. patrickza says:

    Glad you found it useful. You’re right though, in the good times hold money back for the bad! Most people would call us totally boring for doing that ๐Ÿ˜‰

    I’m not the right guy to ask about holding cash as I’m allergic to large cash balances, but yeah 9% is pretty impressive.

    A month long holiday sounds great, where are you headed?

    The only tip I give everyone going overseas is to put your cash into a capitec account before you go and swipe it wherever possible. They are the ONLY bank in the country that has no exchange fees or spread. You get the spot rate for every swipe.

  5. Shane says:

    Thanks ๐Ÿ™‚ Headed to Netherlands and Germany (trying to catch the last of the summer ๐Ÿ˜‰ Yeah transferred the holiday money into Capitec already, that’s a good one, learnt it after a few trips we did in 2016 ๐Ÿ™‚

  6. Albert Viljoen says:

    I enjoyed the simplicity in the article but also the practicality it demonstrates for assisting in shaping our retirement strategy, not everyone has this chapter done and dusted.

  7. patrickza says:

    Thanks Albert, there are probably hundreds of ways to retire successfully,
    and likely thousands to do it unsuccessfully. One of those thousands
    would be buying that 4×4 you once owned ๐Ÿ˜‰

  8. Ros Brodie says:

    Holiday savings tip: get an AirBnB with a kitchen and save on eating out. If you’re organised enough, make a packed lunch and enjoy in a park. Also allows you to eat more healthily.

  9. patrickza says:

    Totally agree Ros, a bonus is also doing your laundry free at the airbnb

  10. Andrรฉ says:

    My advice would be to avoid August ๐Ÿ˜ Is crazy busy everwhere in Europe and right now INCREDIDIBLY hot! Seriously thought, if you can avoid a spread on your withdrawal or swipe it’s a good start. Avoid restaurants where possible and you will find food to be similar to SA. Parts of Europe are are cheaper of course. We’ve been doing the campervan thing last two months and will keep going until October..In France we find overnight stops are cheap or even free and much more abundant than Italy for example But then again France is very busy right now.. We’re lucky that we get to use a family camper for free and our only expense is day to day. As a result we can easily contain our total expense . Enjoy your holiday!

  11. Andrรฉ says:

    Great article thanks ! For us this makes a lot of sense as we still have income ability if needed. At the moment we’re aiming for 2-3% but who knows ๐Ÿ˜‚

  12. Shane says:

    Absolutely, that’s part of the plan. Couldnt agree more Ros. Also doing a part of the trip in a caravan we got to use. ๐Ÿ™‚

  13. Shane says:

    Thanks Andre, we’ve booked to leave, so can’t turn back ๐Ÿ™‚ Yeah a heat wave in Europe , who would have thought! A campervan surely makes the trip cheaper. What’s a good budget guys, I’m working on a R25000/month for the two of us? Based on our last few trips, Whats your experience of a frugal budget? Obviously comes with a lot of dependencies!

  14. Andrรฉ says:

    Tough one this. Even camper live is around ZAR 25K per month total cost on average. I’m hoping this excludes your accommodation? The thing is that with ZAR 25K you can live VERY well in SEA for a month in comparison and we usually tend to go to cheaper destinations.. In Western Europe the single biggest expense is accommodation and even on the budget side its tough to get something under 50 Euro per day. The average in popular areas is probably 3-4 times that. If you find something cheaper transport cost might negate the saving. The only way for us to travel Western Europe affordably long term is by camper. We make use of free stops where possible and
    avoid restaurants completely – this way we can easily keep our daily food and drink cost under 15 Euro – it helps to have a fridge and can prepare meals. But you really don’t need a kitchen. Breakfast and lunch is easy diy and most grocery stores have many freshly prepared food options. Other tips. Take very good shoes as you might do a lot of walking Visit the tourist office in the area first thing and get info on local transport options (for example a time limited sharable tram or train pass) and local attractions. Sometimes you can get discount vouchers and some good tips. Look for self guided walking tours and download apps with audio guides for walking tours in advance. Download an online map (maps.me or Google) . Consider renting bicycles for sightseeing – if you use Airbnb especially in Netherlands you should ask the host. We also find it very useful to have a local sim but you can find WiFi freely available in most places.

  15. Shane says:

    Thanks Andre, some very cool tips in your message. Yes, we have some family and friends accomodation and the caravan for some part, hence the lower R25k/month budget including accomodation. Cycling is definitely on the cards in Netherlands and some good walking too.

    SEA is really cheaper and awesome, will do Vietnam and Cambodia next year to make up for the expensive holiday. But we have the US west coast road trip holiday in April-May next year, which is not going to be cheap by any standards before that! Dreading the dollars already ๐Ÿ˜‰

    You are right…Accomodation and travelling is definitely the biggest costs usually, food one can get away with if you avoid restaurants and eat local stuff.

  16. Andrรฉ says:

    Damn – sounds like loads of good travelling in your future! Vietnam is by far the cheapest destination we’ve been to in SEA (with parts of Indonesia on par). Pity about the expensive Visa though. In 2013 we bought a 125cc bike in HCMC and rode two-up all the way to Hanoi. Some dangerous, crazy fun times =) The US will be a shocker for sure. Been there a few times but in 2012 me and the wife did a 2 month stint with 4 weeks West (California, Arizona, Utah, Nevada). Then the ZAR was (only) 8 to USD and we found accommodation once again the biggest challenge. This was the first time we used AirBnB and it was good value back then in major centers. Especially San Francisco and LA. Things might be different nowadays bit if you are planning on getting a rental car dont book it with the US agency if possible. Its state dependent but in the US CDW is not included and has to be added afterwards. If you however book via the UK agency for the same supplier it has to include CDW by law. Best value I could find at the time was with alamo.co.uk at $29 per day for 25 days if I remember correctly. If you want to chat you can find me on https://shareforum.co.za

  17. patrickza says:

    Thanks Andre, yeah you and your wife are some of the youngest retirees I know, plenty of ability to go back to work if you feel like it.

    I’m enjoying following your trip on youtube and facebook. I particularly like it when your facebook friends ask you what the hell your secret is that you can stop work and just travel full time!

  18. Brandon Ellse says:

    Hi Patrick,

    So I’ve looked a comparison of debit/cheque/credit cards and their costs for overseas travel and it seems to me that it makes the most sense to swipe you Capitec card wherever possible and use a Virgin Money Credit Card for cash withdrawals (it’s R25.22 flat for ATM withdrawals). Does that sound right to you?

  19. patrickza says:

    It’s not quite that simple. Virgin charge you R25.22 + 2.75% conversion fee. Capitec charges a fixed fee of R55.48, so the crossover point is R1100. Lower you should use Virgin, higher Capitec. Just beware if your Virgin credit card goes into negative for cash reasons there’s usually interest charged from day 1 not 55.

    An even better way to get cash is to try draw at a mastercard machine with your Capitec. On their fees page they say that should be just R7 a time. I do that locally, but I’ve never tried while traveling, and I don’t know if it’s something done overseas commonly. It’s probably worth asking about when you swipe.

  20. Brandon Ellse says:

    Hi Patrick,

    To my understanding, the charge for withdrawing cash from a Virgin Money Credit Card has always been a flat fee. Well at least for the last 5 years. I’ve used it on several overseas trips to draw cash. It currently charges a flat fee of R25.22. http://www.virginmoneycard.co.za/the-deal/
    You’re quite right about the interest charge from day 1, so I typically load cash on the card before I leave.

    That’s interesting what you say about the Mastercard machine. I’m not quite sure what an International Mastercardยฎ card machine looks like to be honest. It doesn’t mean an ATM with a MasterCard logo on it.

  21. patrickza says:

    The 2.75% isn’t a withdrawal fee, but whenever you switch currencies it’s applied as a kind of spread, so you definitely don’t see it, but if you convert the foreign cash amount received to the amount you paid you’ll see it’s not the spot rate. If they have it there for swipes you can bet it’ll be there for withdrawals too.

    I think they mean a mastercard till-point like when you withdraw cash at PnP/checkers etc.

  22. Shane says:

    Thanks Andre, love the travels ๐Ÿ™‚ yes SEA is definitely a good cheap holidays, we also hired a 125cc bike when we travelled for a month in Bali last year , its so easy to travel and see the country. (Just, got to get used to the traffic and hundred other bikes ;).

    Yes we need to plan our local travel for the US (first time for me, flights booked) trip, so the car rental link is really helpful, thanks! I was wondering though if they rent a data card and GPS as well. (We did a months cross country road trip in Portugal in 2016 and we could hire a data router and GPS with the car, which made the travel , internet and maps so much easier).

    We plan to do a few days in New York with friends and then drive from LA (south) to Seattle (north) on the entire West Coast over the month. Hopefully that will be cool! With Airbnb stays included. need to check out the road trip routes and which cities must we cover.

    Seems like you guys love your travels too. I would love to chat more about the US trip we are planning, I tried going onto the link, https://shareforum.co.za but do you have a sub link to this page, if so, under which topic? Is there any other way to communicate, do you have an email/travel blog/ what’s app (I’m pushing it ๐Ÿ˜‰ that you have that I can reach you on?

    Keep well and safe travels! ๐Ÿ™‚

  23. Shane says:

    Apologies for my late reply to your message, only saw your message now!

  24. Andrรฉ says:

    I’m sure all the car rental places will offer GPS as an option. Nowadays Google Maps makes things much easier but you need data. (You can also route off-line with maps.ME and free wifi is EVERYWHERE). Last time I took a little Garmin 40 with with a 12V adapter and pre-loaded it with the latest North America maps. This might be cheaper than renting a unit as a cheapie Garmin (perhaps 2nd hand even or a loaner) + USA maps could be under 2k total cost. Then you might also get away without constantly needing data on the move. Nowadays we usually get a local data sim wherever we go and carry a LTE mifi router and dual-sim phone. T-Mobile is your best option in the States I think. After a few months in Europe I’m a bit gatvol navigating the pitfalls of local sims and is looking at options for proper international travel sims (Project Fi is very appealing). Anyways, this year we started travelling full-time and you can find me on Instagram https://www.instagram.com/andre.du.toit/. From there you will find a link to YouTube as well.

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