Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / The 2 Percent Rule That Works Better Than 4 Percent
Transcript
- Lucas: So the 4 percent rule is basically gospel in early retirement circles. You save up 25 times your annual spending, pull out 4 percent in year one, adjust for inflation, and your money lasts 30 years. That's the Trinity Study — 1998, three professors, a portfolio of 50 percent large-cap stocks and 50 percent intermediate-term government bonds. Luna: And everyone just ran with it for almost three decades. But the world has changed. Bond yields are not what they were in the 90s. Lucas: Right. And that's the problem. The Trinity study assumed a bond yield around 6 percent. Today the ten-year Treasury is yielding maybe 4 percent on a good day. So the same math that gave you a 95 percent success rate back then now gives you something closer to 80 percent. Which is fine if you have flexibility. But if you're 35 and planning to live another 60 years — 4 percent starts to look risky. Luna: So what's the alternative? I've seen people argue for 3.5 percent, 3 percent, even 2.5 percent. But then you need way more savings. It feels like moving the goalposts. Lucas: It is moving the goalposts. But the alternative is a portfolio that fails in your 40s. And look — there's a specific case I want to drill into today. A couple I know, real people, let's call them Mike and Jenna. Mike was a product manager at a mid-tier tech company in San Francisco. Jenna was a UX designer. Combined household income around $260,000. They saved aggressively for 12 years and built a portfolio of about $1.5 million. Luna: Which is impressive. But $1.5 million in San Francisco is not exactly mansion money. Their rent alone was probably $4,000 a month. Lucas: Exactly. Their annual spending in San Francisco was around $85,000. That's a 5.7 percent withdrawal rate on $1.5 million — way too high for a 50-year retirement. So they did something radical. They moved to Medellín, Colombia. Their rent dropped from $4,000 to $800. Their total annual spending went from $85,000 to $30,000. Now that $1.5 million portfolio supports a 2 percent withdrawal rate. Luna: Two percent. That feels almost too conservative. But you're saying it actually works better than 4 percent in this context? Lucas: It's not just about the number. It's about what the number enables. At 2 percent, your portfolio failure rate in historical simulations — including the worst periods like 1929 or 1966 — is essentially zero. Not 5 percent, not 1 percent. Zero. Over 60 years. You can ride out any market crash, any inflation spike, any sequence of bad returns. Luna: But you're also drastically cutting spending. That's not just a withdrawal rate hack — that's a lifestyle change. Some people don't want to move to another country. Lucas: Totally fair. But the principle applies even if you stay in the US. You could move from San Francisco to Boise, Idaho, or to a smaller city in the Midwest. Your spending might go from $85,000 to $55,000. That's a 3.7 percent withdrawal rate on $1.5 million — still better than 4 percent. Geographic arbitrage isn't the only tool, but it's a powerful one. Luna: Let's talk about sequence risk specifically. If you retire and the market drops 30 percent in year one, your 2 percent withdrawal on a $1.5 million portfolio is $30,000. After the crash, your portfolio is $1.05 million, but you're still only taking $30,000 — that's now 2.86 percent. Still safe. With 4 percent, after the same crash, you're taking $60,000 from $1.05 million — that's 5.7 percent. Much more dangerous. Lucas: That's exactly the math. And it's why I think the obsession with 'the' safe withdrawal rate misses the point. The real question is: can you structure your life so that you need less money? If you can, you don't need to gamble on historical averages. You can just win. Luna: But what about healthcare? That's the big unknown for early retirees. If you move abroad, you might lose access to good insurance. Lucas: Mike and Jenna actually found that their out-of-pocket healthcare costs in Colombia were lower than their premiums in the US. They pay about $150 a month for a private plan that covers most things. Back in San Francisco, they were paying $900 a month for a high-deductible plan. So again, the math works in their favor. But you have to do the research. Not every country has the same quality of care. Luna: And you have to consider currency risk. If the Colombian peso crashes, their dollar-denominated portfolio grows in peso terms, so that's actually a hedge. But if the dollar weakens, their purchasing power drops. It's a two-way bet. Lucas: It is. But over a 50-year horizon, currency fluctuations tend to mean-revert. Plus, they keep maybe 20 percent of their portfolio in Colombian peso-denominated bonds or local real estate. That balances things out. But you're right — it's not a set-and-forget strategy. Luna: So for someone listening who's thinking, 'I don't want to move, but I want a lower withdrawal rate,' what's the alternative? Just save more? Lucas: Save more, or earn more during retirement. That's the other angle. The 2 percent rule doesn't mean you never work again. It means you never have to work for survival. Mike still does freelance product consulting — maybe 10 hours a week, brings in $20,000 a year. That's discretionary income. He can stop anytime. That's the freedom. Luna: So the withdrawal rate becomes a floor, not a ceiling. You live off 2 percent, and anything you earn is gravy. Lucas: Exactly. And that changes your relationship with work entirely. You're not negotiating for a raise because you're scared of being fired. You're choosing to work because you enjoy it. That's the real endgame. Luna: Speaking of choosing what you enjoy — I want to take a quick second here. If today's conversation gave you a useful frame for thinking about your own numbers, and you'd like to support the show staying ad-free and independent, the simplest way is a coffee. Honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: Yeah, we keep the show free because of that kind of listener support. No sponsors, no agenda. Just the math. And it genuinely helps us keep going. Luna: Okay, back to the 2 percent rule. One thing I want to push on: isn't a 2 percent withdrawal rate just a way of saying 'save an enormous pile of money'? It's not really a rule, it's a luxury. Lucas: It is a privilege, no argument. But the principle scales down. If you can get your spending to $40,000 a year, you need $2 million for a 2 percent withdrawal. That's a lot. But if you use geographic arbitrage and get spending to $30,000, you need $1.5 million — still high, but achievable for a dual-income tech couple in their 30s. And the point is: the 4 percent rule is no longer safe for long retirements. So you need to either save more, spend less, or earn something during retirement. The 2 percent rule is a target, not a gate. Luna: What about someone who's already retired on 4 percent? Should they panic? Lucas: No. History shows that if you retired in 2009 with a 4 percent withdrawal, you're probably fine because the market had a huge run. The danger is retiring right before a crash. So if you're already retired, you can adjust. Cut spending in bad years. Have a variable withdrawal plan. That's what we covered in episode 70. The 2 percent rule is for people planning a 50-plus year retirement starting today. Luna: So it's really about the starting point. The first five years determine everything. Lucas: Exactly. Sequence risk is concentrated in the first five to seven years. If you survive that period, your portfolio is usually robust enough to handle anything. The 2 percent rule is insurance against a bad starting point. Luna: And what about inflation? The Trinity study assumed 3 percent inflation. We've seen 9 percent recently. How does 2 percent hold up? Lucas: A 2 percent withdrawal rate is so low that even with 9 percent inflation for a year, your real spending power drops but your portfolio is large enough to absorb it. The historical worst-case for a 2 percent withdrawal over 60 years is still a portfolio that ends up with more real dollars than you started with. It's essentially fail-proof for any historical period. Luna: That's pretty powerful. But I'm still stuck on the 'you need a huge nest egg' part. For a typical listener who's not a tech executive, is this episode just aspirational? Lucas: I hope not. The median household income in the US is about $75,000. If a couple saves 20 percent of that for 30 years, earning 7 percent real, they end up with about $1.2 million. That's $24,000 a year at 2 percent. Not luxurious, but possible if you're willing to live in a low-cost area. And Social Security adds maybe $20,000. Suddenly you're at $44,000 — pretty comfortable in many places. Luna: So the math works for average earners if they're disciplined and patient. But it requires a different mindset: spending less is more powerful than earning more, because it lowers the withdrawal rate. Lucas: Exactly. Every dollar you don't spend is a dollar you don't need to earn and a dollar that stays invested. That's the core insight. The 2 percent rule is just a way of making that concrete. Luna: Alright, so to wrap: if you're planning a retirement longer than 30 years, don't rely on 4 percent. Consider 2 percent as a safer target, and use geographic arbitrage or side income to get there. Start with your spending, not your savings. Lucas: Well said. And remember — the goal isn't to live on as little as possible. It's to design a life where you don't need a high withdrawal rate. That's the real freedom. Luna: Next time we'll talk about how to actually invest that $1.5 million portfolio for a 2 percent withdrawal — because asset allocation matters a lot at that level.