In my last post I mentioned our FI number is $750k. I figure now is a good time to tell you how we got that number, and how you can figure out yours.
A long time ago in a college far, far away, three finance professors at Trinity University completed a study that would attempt to define “safe withdrawal rates” for retirement portfolios. Basically they wanted to know what to tell retired people who were asking, “How much of my money can I spend every year without having to worry that I’ll run out before I die?”
There’s gotta be a shorter way to ask that question…. but I got nothin.
Anyways, moving on.
So the professors looked at every 30 year period in the history of the stock market and started running the numbers. What they found was that the amount of money you could spend was highly dependent on the year you retired. If you retired right at the end of a bull market, things might go downhill fast, but if you retired right during the lowest point of a recession, you’re looking at some good times ahead. It’s impossible to know what the future holds however, so what they did was look for the minimum. AKA what’s the safest amount to withdraw starting year 1?
Turns out if you start out spending just 4% of your retirement portfolio, then proceed to withdraw ever increasing amounts based on inflation, your money will last at least 30 years. But wait, 30 years is too short! That’s what you’re probably thinking right? I want to be retired for 40-50 years, not 30! The good news is there isn’t much a difference between saving for 30 years and saving for a million years. We’ll get into how to make your money last longer later, but first, let’s do the final calculations.
Turns out the math is really simple. If you want to reverse engineer this 4% number, you would multiply your annual spending by 25, and there ya go. In my case, my family’s spending on essentials is $30k a year. Multiply that by 25 and you get the $750k number I mentioned earlier. Sure living with just the essentials sounds less than glamorous, but I plan to keep making money after retirement. Also, I’m not beholden to this number. If we decide we need a bit more, we’ll save a bit more.
I think of it the same way I do running. When I go out for a long run, I plan for a distance I know I can do and have done several times in the past. It helps with the mental battle early in a run, knowing you’ve done it before. Then, if you get to your goal and feel like you can do more, go right ahead! Same with our savings. If we get to $750k and feel like things are great the way they are, I’ll keep working, feeling secure knowing I can walk away from the work place as soon as I felt like it.
Many conservative types start to sweat thinking of relying on this number, and instead choose to multiply their spending by 30-50. Maybe it’s for the same reasons I listed above. But what we all have to be remember is how conservative the 4% number already is.
You see when they completed this study, they wanted it to be a sort of control number. By that I mean they assumed no adaptability of the retiree. They also assumed you’d maintain a portfolio of half stocks, half bonds, which isn’t gonna help you grow your money. So thanks but no thanks, we don’t have to be mindless drones. During your early retirement you can harvest the good times and go lean during the bad. You can put 70% or even 80% in stocks instead of 50%, and offset the risk by continuing to earn money as well, there’s no law against working after you retire. Just do what makes you happy. If you can save a million bucks before 40, my guess is you’re a smart cookie. So don’t spend all your savings when the market is dropping like a rock, okay?
One final note before I go. I think it’s important to recognize how big an impact your spending has on your FI number. Every $1 in additional monthly spending requires $300 more in total savings before you can walk out of the office forever.
So start cutting the fat. My guess is many of us could easily spend $500 less this month, and every month from here on out. Just look at your spending, find the parts of your budget that are both unnecessary and not bringing you a lot of happiness, and drop it. If you can save $500 every month, then you just lowered your FI number by $150k. Reducing how much you spend is truly the most important thing you can do to reach financial independence.