The 4% safe withdrawal rate and why Financial Independence looks different for therapists.
Updated: Mar 7
A while back I posted my guide to becoming a wealthy therapist.
I wasn't sure how people would take it, but the guide got a lot of attention and became my best performing post, which was pretty cool!
After posting it I got a follow up question which I thought would be fun to answer here.
Question: What about the 4% rule?
This looks great - I love all things personal finance. I do have a question though - how do you feel about the 4% rule for retirement drawdown? I see you listing 10%.
The Simple Answer: The stock market returns 10% a year.
CP is asking about the following statement from my guide:
"Okay, so I'll run you through my numbers (roughly).
I live with a family of 5 on 50k a year. I feel like I live like a king. I invest conservatively in a Stock Index which matches the average return of the stock market.
If you google "what's the average return of the stock market?" google says 10%.
50k is 10% of 500k. That means if I can have 500k invested in an Stock Index it will give me (on average) 50k per year.
So If I can get 500k I can basically live on my investments FOREVER."
I used 10% because the stock market as a whole returns 9-11% on average. That's a long term average. Typically long term average is 30 years. So the stock market as a whole might return 20% for a decade, then 0% for a decade and then 10% for another decade. Which means that over that 30 year period you money has grown 10% a year.
That's the simple answer. But CP is asking a deeper question: how much money do you really need for financial independence.
Which, in my opinion, is much less than you'd think.
What is the 4% rule? The safe withdrawal rate.
For those who don't know the 4% rule is known as the safe withdrawal rate of personal finance. Basically, if you invest conservativity in a index which tracks the US stock market, you can expect to pull 4% forever. This comes from all the research on retirement as well as the research on historic stock market returns.
For example, if grandma needs 40k a year to live her life, well 40k is 4% of 1 million. So once her portfolio of stock indexes reaches 1 mil she can retire, spend 40k a year, and still leave a cool million to her kids.
Upon learning that you could pull 4% forever, some people realized this applies at any age. Your portfolio doesn't care if you're 65 or 25. If you need 40k a year to live then your "enough number" is 1mil regardless of how old you are.
The people who realized this started the Financial Independence/ Retire Early (FI/RE) movement. The movement teaches people to run their numbers and change their lifestyle so they can reach their financial independence number as quickly as possible.
The thing people miss about the 4% rule.
People often try to make the 4% rule "safe." They read the articles and say, "okay sounds good. I'll just put it down to 3.5% to be safe."
I think that means they don't understand the 4% rule. 4% is the safe number!
Not only has there been tons of research on how safe the 4% rule is, remember the stock historic returns are actually closer to 10%. So there's a strong likelihood that your money will actually grow much faster than 4%.
So how do I feel about the 4% rule? I like it. A lot.
Lowering the 4% rule to 3% is like putting your money in the bank and then hiring a private security company to guard the bank.
Most people would be like, "Dude. It's the bank."
If you were going to retire now, and never work another day, I'd use the 4% rule.
But if you're young I think the idea of never working again isn't realistic.
The thing people miss about financial independence.
I used to work geri psych at this hospital, and one day they hired a new PRN social worker to run groups. She was a middle aged black woman. Maybe mid 40s. We got to talking and she mentioned she'd retired from being a social worker for the state. I couldn't believe she'd retired so young.
"Really?" I gasped. "Shouldn't you be on a beach in Jamaica somewhere?"
"I was," she replied, "I took my family and we went on cruises for six months with my pension. And then I got so bored I couldn't stand it. Which is why I'm here. I had to go back to work."
Studying early retirees, I've seen this again and again. Many people who reach financial independence young don't want to sit around doing nothing. You have to do something to fill the time. Oftentimes this leads to paid work of some sort.
What this means is if you're comfortable acknowledging that you'll work some you should factor this into your financial independence number.
Could you make 20k a year working PRN at the local hospital?
If so, then your FI number from above drops from 1mil to 500k.
That's where my 500k number comes from.
But there are two other things which make this number right for me.
The magic of compounding.
First, what makes the 4% rule so strong is that most of the time the market returns more than 4%. The market returns 9%-11% (averaged over 30 years).
But even at 4% 500k compounds a lot over the years.
This means that if you had an emergency you could pull from that money and your money would continue to grow in the background. For example say you had an emergency in year 5 and needed to pull 20 grand.
Well if you run the numbers your money would still grow by 4 grand. And even if it didn't, you'd still have 608k in the bank which would keep growing next year.
What a private practice therapist' salary?
Second, we therapists, if we go into private practice, can have quite lucrative part time jobs. Seeing 20 clients a week it's quite possible to make over 100k in private practice. See 10 clients and you can make over 50k, which is more than enough to cover your expenses (if you spend 40k a year).
When I add up all these factors:
The 4% rule...
the magic of compounding...
a commitment to work part time...
the likelihood of returns higher closer to 10%...
the fact that part time work can cover expenses...
It seems to me that if you can get to 500k you reach a kind of financial escape velocity where the chances of ever going broke or having serious financial trouble goes to 0%.
If your car breaks down?
Your passive investments make 20 grand a year, so just pay the 2 grand to fix your car and move on.
Have a large medical bill?
Well, you make 10 grand more a year than you need, so just pay the 10 grand and your investments are still growing.
Need to stop working for a year?
No worries, your investments probably can cover you for the year anyway and you'll still have 500k in the bank.
What this means for you!
Now, I'll be the first to admit, this is my subjective analysis. Your expenses might be much higher. So the 500k number might not work for you. That being said, I think this has three big implications when calculating your enough number.
First, calculate your FIRE number.
The first thing is to simply run your numbers. Find your financial independence number. The easy way to do that is to take your yearly spending and multiply by 25.
Second, factor part time work into your FIRE number.
If you retire young, you'll probably make some money. Factor that in. As a therapist your probably have a high part time rate. See how much of your expenses your part time rate covers.
Third, calculate at what point do you reach escape velocity?
At some point you reach escape velocity where it's nearly impossible to fail. I've given you the variables I look at, but what about for you? What are the variables you need to consider? Factor all of that in and see what your 'escape velocity' number is.
Forth, remember why this is important.
Typically people fall into one of two camps.
Either they don't care about money and spend assuming everything will be okay or people stress over every dollar and can't enjoy the money they have.
Our goal is different. Our goal is to make enough money so we don't have to think about it any more.
Don't lose the bigger picture.
Jordan (the Counselor)
-You Finished! Congrats! Thanks for reading! 10 points!-
More on the 4% rule
The 4% rule, withdrawal rates and how much can I spend anyway?
A lot of what's discussed in this post is connected to the ideas of Coast Fire and Barista Fire. Check out the linked articles to learn more.
If you liked this post, consider reading this next. I think you'll like it ;) It's about how to become a wealthy therapist.