If you have $1,000,000 and plan to retire early on it, how much can you actually spend each year? Spend too much and you risk running out of money before you run out of time. Spend too little and you shortchange yourself for decades.
Is there a withdrawal rate that is safe enough to last forever? There is. It is called the 4% rule.
What the rule says
Assume inflation runs at 2%. If your portfolio compounds at 6% a year, you can withdraw 4% of it every year without your capital shrinking.
The arithmetic
Take $1,000,000 again. The S&P 500 has compounded at roughly 9% a year over the last two decades. Apply Buffett’s margin of safety and discount that to 6%. Here is what happens:
- One year later your portfolio is worth $1,060,000.
- You withdraw $40,000, leaving $1,020,000.
- Adjust for 2% inflation: $1,020,000 ÷ 1.02 ≈ $1,000,000.
Your purchasing power is exactly where you started.
In other words, you spent $40,000 and your $1,000,000 did not shrink by a single dollar. That is the 4% rule.
Why you must not interrupt compounding
The rule only works because of compounding. That is why you should never interrupt the process unless you truly have no alternative. Compounding earns money for you while you do nothing — and the 4% rule lets you spend from it for the rest of your life without ever running out.