If you use four percent of your savings every year as a supplementary pension, you will never run out of money. This is what the Trinity Rule says, which researchers from the USA established 25 years ago. Practical examples show: It is more complicated than expected.
It is a given that the statutory pension will hardly be enough for any German in the future to maintain their current lifestyle. Anyone who is smart and earns enough should make private provisions, be it in stocks, bonds, raw materials or real estate. But how much money do you need for a peaceful retirement? The Trinity Rule says that 25 times your annual budget is enough. This rule was drawn up by researchers at Trinity University in San Antonio, Texas. So if you want to pay yourself 1,000 euros in additional pension every month, you would need 300,000 euros in savings. You pay out four percent of this every year, with this amount increasing every year according to the respective inflation rate so that you do not lose purchasing power. In theory, the researchers say, you never have to invest your actual capital stock because the returns on the remaining assets are sufficient to cover your payouts.
In theory, this is actually possible. After all, your assets would only have to generate a net return of at least four percent each year to finance the payments. In this context, net means less the inflation rate, taxes and possible fees, for example for managing the money. With the current tax rate of 25 percent withholding tax and 1.25 percent solidarity surcharge on withdrawals from your private portfolio and the current inflation rate of 2.2 percent, you would have to achieve a gross return of around 7.5 percent. This would be possible, for example, with a pure investment in Dax ETFs, because the German stock index has delivered an average annual return of 10.7 percent since its introduction.
However, such an investment in a single asset class is dangerous, because after all, in the Corona and financial crisis alone, the DAX has taken significant steps backwards several times in the last 15 years alone, which would significantly affect your capital stock. The researchers at Trinity University therefore tested several different portfolio variants for their theory. The best results were achieved by a mix of 60 percent stocks and 40 percent government and corporate bonds.
We tested this theory in practice. For our example, we assume that you want to pay out an additional pension of 1,000 euros every month, i.e. 12,000 euros per year. We will assume 1995 as the first year of your retirement. The payment amount increases every year by the inflation rate of the previous year. At the beginning of 1996 you would have to withdraw 12,228 euros from your savings. In 2024 we would already be at 20,056 euros. In addition to the pure payout amount, you also have to pay the taxes from your savings. We assume a constant 25 percent withholding tax and then a 5.5 percent solidarity surcharge. Anyone who goes to church would have to deduct church tax accordingly.
In order to finance these payouts, you must sell securities from your portfolio. So even though the value of individual stocks and bonds in your portfolio may increase each year, you own less and less of them. When the last share or bond is sold, the pension plan ends, regardless of the value of this security.
The table in this article shows how your portfolio would have performed under historical circumstances. The surprise: In practice, the four percent rule would not only have been enough to allow you to finance a comfortable retirement over the past 30 years, it would have actually increased your assets in the process. In the example, 300,000 euros in starting capital (or the equivalent in 1995 German marks) would have turned into around 500,000 euros today – despite all the payouts. In addition, there would still be enough securities left. During this time you would have had to sell around 80 percent of your stocks but only around a third of your bonds.
In order to keep the value of your stocks and bonds in a ratio of 60:40, it may even be necessary in some years to sell more of one asset class in order to use the money to buy back assets from the other asset class. This applies, for example, in years following a stock market crash, such as the financial crisis in 2009 or the bursting of the dotcom bubble in 2003. To simplify the calculation, we assume that you have only bought ETF shares in the German leading index DAX as stocks and only German government bonds as bonds. In reality, you should diversify your assets more.
Although our model calculation works surprisingly well, it has weaknesses. One is the starting year. Anyone who retired in 1995 could still enjoy additional payments and an increasing value of their savings using the Trinity Rule. This is not the case for other start times. Between 1995 and 2014, your assets would have increased despite payments in only eight cases. In ten cases you would have had to reduce the capital stock, sometimes more or less depending on the starting year. In two unfortunate cases, your money wouldn’t have lasted until today and you would already be broke.
This depends on the stock market development in the first few years of your retirement. Anyone who hits one or more years of crisis will have their capital stock dwindle sharply right from the start and then have difficulty recovering as payments increase. It was also difficult to get off to a start in the 2010s because, although stocks generally flourished, bonds sometimes produced negative returns – also poisonous in the early years of retirement.
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A second problem is the inflation rate. Over the past 30 years, it has averaged 1.8 percent. That is low and allows you to finance additional pensions and increase your assets with comparatively low returns. However, if it were to rise to an average of 3.0 percent – which is not entirely unreasonable based on experience from previous years – your assets would fall slightly. If it were to rise to an average of 4.5 percent, you would already be broke, despite the ideal starting year of 1995. Here, too, the starting point plays a role: higher inflation rates at the start of your retirement will cause your assets to melt away more quickly than later in your retirement.
A third point of criticism of the rule: It does not take extraordinary additional costs into account. Anything you cannot pay from your regular withdrawals will be ignored. A new washing machine, an expensive vacation or even care costs would have to directly attack the capital stock, reduce it and ensure that the money no longer lasts as long as planned.
There are several options to overcome all of these pitfalls. The easiest one is to start with more starting capital. You can either calculate with higher payouts to cover additional costs or save around 50 times your annual budget and then only withdraw two percent each year instead of four. Likewise, a paid-off home could change the balance in your favor because you will then have less savings in a deposit, but your annual budget will also be reduced by rent or monthly installments.
But all of this shows that the Trinity Rule sounds very simple in theory, but in practice it has many pitfalls. Financial experts and consumer advocates therefore only see them as suitable for people who have enough financial education to adequately deal with these traps. If you don’t count yourself among them, the rule is still not pointless. It will definitely give you an idea of how much savings you need to enjoy retirement. Because one thing is certain: If you save 25 times your annual budget and put it under your mattress, then the 4 percent rule will definitely last for 25 years.
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