Using rounds numbers for an example. Lets say inflation is 3%, you grew your pot of gold 8% over the past 12 months, or 8-3=5% net of inflation. Now you can draw-down up to 5% of the money without reducing the real value of your principal / pot of gold.

However your investment earnings will fluctuate – you will have good or bad years – yet you will want to have a constant life-style – so unless you want to live on cat food this year and caviar the next, you should seek to even out the $ you can extract each year. So people with too much time on their hands have looked at past market performance or done monte-carlo-simulations to see if you could predict a fixed draw-down rate at which you sustain your principal. I.e. can I define a percentage rate that I can take out of my investment once a year without gobbling up the principal after accounting for inflation?

The answer is that we don’t know. If I knew the answer, I could make so much money, I could hire Bill Gates as my pool boy.

However, using the analyses I described above, 2-3% seem too conservative – you end up growing your principal net of inflation, while 5-6% is too high – you gooble up your principal and will run out of money before you kick the bucket.

So I am not proposing eroding the pot of gold, I want to maintain it but not necessarily grow it more than really required.

Another way of looking at it is that if you are relying on draw down of capital for living expenses you are very vulnerable to adverse events. No thanks – I’d rather sleep soundly at night.

After looking at a bunch of data, I feel that a draw-down rate of 2-3% is too conservative, but 5-6% to aggressive. 4% or so seems right. I know, only 1% off from your value but over time it makes a huge difference.