One of the first questions that started to rattle around in my head once I started down this path was – “How much do I need to retire?” How much money do I have to have to be able to stop working for the man and start drawing in my free time. But how few of us actually save for retirement? And of those, how few have a concrete number they’re shooting for? I can tell you it’s very few because most of us don’t actually know how much we need for retirement.
So, without further adieu, I’d like to discuss the current method of determining how much we need to retire early.
How Much Do I Need to Retire? – The Calculation
Step 1 – Determine your monthly spending
The first step to getting your “FIRE number” or whatever you want to call it is to start tracking ALL you expenses. And if you’re wondering what in the world FIRE stands for, then prepare yourself for quite the rabbit hole and go read about it on Dave Ramsey’s website. In order to know how much you need at the end of your working days, you need to know how much you actually spend. My number is different from your number which is different from your parents number. Everyone’s number is different. But we can’t know how much we need at retirement without knowing how much we need today.
Track all expenses then subtract any investing or other expenses that you don’t anticipate having at retirement. [For example, you might be paying a mortgage with 10 years left but plan to retire in 20 years. In that scenario, you might be living in your home mortgage free and have a much lower number to retire.]
Step 2 – Determine your annual spending
This one is pretty simple. For most of us, we just take the monthly and multiply by 12. But I bring this point up to point out that things like your credit card annual fee or Amazon Prime membership are one-time annual expenses that may be overlooked if they didn’t occur during your monthly spending analysis. So factor these annual membership expenses in as well.
Step 3 – Determine your multiple
The 4% Rule
Most people recommend taking your annual spending and multiplying by 25 to get your number.
For example, if you spend $4,500 a month, your equation would look like:
4500 * 12 * 25 = $1,350,000
You might hear people refer to this as the 4% rule which is the least conservative measure recommended. It’s 4% because another way of calculating this number is to divide your annual spending by 4%.
(4500 * 12) / .04 = $1,350,000
[ .04 = 4% ]
Hence, the 4% rule.
Now, some people will tell you that 4% is not conservative enough. So if you’re really wanting to protect against the worst case scenario in the markets, you probably want to use something closer to 3.5% or a 28x multiple.
4500 * 12 * 28 = $1,512,000
(4500 * 12) / .035 = $1,512,000
And even then, some might argue that the true conservative figure is 3% or 33x multiple.
4500 * 12 * 33 = $1,782,000
(4500 * 12) / .03 = $1,782,000
Whatever number you use is not as important as getting a number in your head and devising a plan on how to get there. If you’re in charge of your household retirement planning, it’s on you to become an expert on money and how to grow it safely. I recommend reading some books on the subject including one I just finished – The Richest Man in Babylon. I share my favorite 5 lessons from this wealth building book here.
How Much Do I Need to Retire?
We have a tendency to want to over complicate things. Especially when it comes to our finances. Luckily for us, planning for retirement is as simple as taking our annual spending and multiplying it by 25 or 28 if we really want to be conservative. As far as how to get to that number quickly, I personally recommend using index funds which I speak to in depth here. But at the end of the day, if you’re saving money and buying any kind of appreciating asset, you’re ahead of most people… which unfortunately isn’t saying a whole lot as 1 in 3 Americans have less than $5,000 saved in retirement.
Last but not least, make it a game. Have a weekly budget meeting with your spouse. Get a scoreboard up. I’ve been amazed at how much my wife has gotten into planning for the future with me because we’ve made it a game that we both want to win.