If you’re pursuing financial independence and early retirement, you’ve probably heard about the 4% Rule: When you’re calculating whether your investment portfolio will cover your cost of living, assume a 4 per cent withdrawal rate.
CampfireFinance has a good summary of why the 4% Rule works, at least in theory:
The 4% Rule is based on two financial averages.
First, the 4 Per cent Rule says that your stock portfolio will grow at an average rate of 7% annually. Second, because the average rate of inflation is 3%, you can safely withdraw 4% of that growth, leaving 3% behind to keep up with inflation.
Because you’re only spending the average incremental growth from your portfolio, in theory you should never run out of money.
However, Paula Pant at Afford Anything has done the maths — and if you invest in rental properties, you’ll be able to withdraw 6% instead of 4. This means you’ll get a bigger monthly payout after retirement, and you might even be able to retire earlier than you expected.
Here’s how she explains it:
If you’re retiring on index funds, you might plan your retirement on the 4 per cent withdrawal rule.
But if you’re retiring on rental properties, you could use the equivalent to a 6 per cent withdrawal rule.
This holds true even if total returns on the two investments are the same.
Why? Two reasons: (1) the returns on a rental property bias towards an income stream rather than capital appreciation, and (2) rental properties don’t hold the same risk of withdrawing the principal.
Her full post covers why rental properties bring in more cash flow than index funds, why rentals are lower-risk investments than equities, and how you can get started with rental properties even if you don’t have a lot of money to invest. (Spoiler alert: look for single-family homes in the Midwest. They’re still affordable!)
If you’ve started investing in rental properties as a way to create passive income and/or retire early, let us know if you think the 6% Rule is accurate—and whether we should all start buying up rentals in addition to putting our money in the stock market.