Personal Finance

Using the 25x Rule to Create a Stable Retirement Savings Plan

The earlier you start thinking ahead and begin devising and implementing a savings plan for your retirement, the better. It is no easy task. There are so many things you need to take into consideration. It is why the “25x Rule” came into being – to help with this difficult conundrum.

What is the 25x Rule?

In essence, the 25x Rule is a tool that was created to estimate the amount of money you will need to save to give you a comfortable income when you retire. It works by calculating the annual income you aim to have as a result ofinvesting in a personal savings plan, and then it multiplies that figure by 25.

To give you an example of what this means, let’s envisage going for an income, after you have retired from working life, of £60,000 per annum. You then multiply that sum by 25, i.e., £60,000 x 25 = £1,500,000.



If your expectations are lower, the amount you need to invest is less. So, if, for example, you only expect to be withdrawing £30,000 per annum, then the 25 times rule suggests that the amount you need to invest is reduced to £750,000.

The 25x Retirement Rule of Thumb is a Generalisation

The 25x retirement rule is suited the those who consider themselves to be in the FIRE community. The initials stand for Financial Independence, Retire Early. Going by the 25x Rule is, however,very much a rule of thumb initiative that focuses you on goal setting, and it doesn’t take everything into account. Here’s what it omits:

  • Any pensions you may have
  • Any income from property lets of rentals, or a part-time job
  • Inflation

It also assumes that any stock investments in your portfolio will show an average annual return of 7%. So, as you can see, it is a bit “roughy and ready,” and it is more about targeting how much you need to invest rather than how much you might want to withdraw during your retirement years.

Here are some things you need to factor into your thought process when looking ahead to how much you will need to finance a comfortable retirement.

  • Will you be living in the same accommodation or will you move?
  • Are you planning a family?
  • What would you like to set aside for healthcare costs?
  • Will you wish to travel?

These are just a few of the considerations you need to bear in mind. Whatever the answer to such questions, the 25x Rule is a useful starting point, but remember, it is a generalisation.

The 4% Rule and How it Compares to the 25x Rule

As mentioned earlier, the 25x Rule focuses on how much you need to invest, whereas the 4% rule is a tool used to determine how much you would want to withdraw from your retirement investments on an annual basis.

It focuses on providing you with a steady income stream from your investment while at the same time maintaining an investment balance that will keep earning income throughout your retirement.

The 4% rule is more relevant to you if you are about to enter retirement and where your retirement investment plan has been in place for several years. Your concern at this stage is more about how much you can sustainably withdraw from your investment, and of course, with the 4% rule, that amount is 4% per annum.

If you’re IWR (Initial Withdrawal Rate) is 4% of a £1 million investment, your first annual withdrawal will be £40,000. The next year, you would take out a further £40,000, but with inflation factored in which if it was at say 3%, would mean taking out £41,200. The same applies year-on-year, and according to the 4% rule, your investment returns should amply cover your needs.

Understanding Your IWR and the Factors that May Affect it

Understanding the initial withdrawal rate and the things that may affect it is key. Let’s look at these factors one by one, starting with retirement age.

Your Retirement Age

As with the 25x Rule, the 4% rule targets a 30-year retirement, where the retirement age is 65. Even though life expectancy is constantly improving, a 30-year retirement span is above average for most people. However, if you are considering retiring early, you may need to think about downgrading the size of your initial withdrawal.

The founder of the 4% rule is William Bergen, an American financial consultant who published his theory in 1994. In practice, he found that the 4% rule worked for retirement periods of up to 35 years, but beyond that, problems can set in. This is where those in the FIRE community can be caught out.

His studies revealed that over the 51 retirement examples he sampled, approximately 10 of them were depleted within 50 years, and some within 40. But, when all is said and done, how long do you expect to live?

Market Valuation Calculations

P/E(Price to Equity) ratio is another important factor, and it affects how much it would be safe to withdraw in your retirement in varying P/E environments. A study undertaken using the Shiller P/E ratio found as follows. In times of high P/E, a safe IWR would be 4%. In lower market value situations, however, the IWR is more like 6%, although one year (1920) it passed the 9% mark.

Allocation of Assets

Whereas the market valuation of a portfolio is important when it comes to a safe IWR, it is the allocation of assets within the portfolio that is the critical factor, and indeed, some portfolios facilitate higher safe IWRs than do others.

In his 1994 studies, Bengen based his assumptions on a portfolio of two asset types – large Domestic Stocks and intermediate Treasuries. In a later study in 1997, he examined adding small-cap stocks and found that it increased the safe IWR from approximately 4.1% to around 4.25% in general. A more recent 2006 study returned a similar conclusion.

The Assumptions and Limitations of the 25x Rule

Having a good retirement savings plan in place is one of the most critical challenges in life. It will determine the comfort of your retirement, but where does that leave us with the 25 times rule?

In essence, it must be acknowledged that long term financial forecasting is difficult. Carefully made assumptions can easily change over time and significantly affect the outcome of any portfolio.

Concerning the 25x Rule, personal wealth professionals believe that it overestimates how much an individual needs to save, while the expected lifespan of an individual plays a huge and variable factor. Of course, there are no guarantees, and if anyone tells you any different, their judgement is suspect.


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