This is the final part of the Financial Independence Series:
We began by defining what financial independence means to you, identifying your passions, priorities, and key values. I presented various approaches to achieving independence, from taking mini-retirements to embracing the “Barista FIRE” lifestyle, illustrating the diverse paths available to reach your goals. We then started looking at the numbers a bit closer by setting up your budget. Once we established your budget, we delved into financial strategies, discussing the importance of emergency funds and investing. Naturally, with all this talk about financial independence, you’re probably eager to ask, “How much do I need to retire?” and “When will I be financially independent?”. Let’s address these crucial questions in this post.
How Much I Need To Retire? - The 4% Rule
In 1994, financial advisor William Bengen published his research about retirement savings. He sought to determine the optimal withdrawal rate from an investment portfolio to ensure one wouldn’t deplete their savings in retirement. After examining various withdrawal percentages against historical market returns, Bengen concluded that with a portfolio containing at least 50% in equities (stocks), one could safely withdraw an equivalent of 4% of the portfolio value annually, adjusting for inflation, without running out of money.
To simplify, if you know your yearly expenses, multiply them by 25 (since 25 x 4% = 100%) to estimate the total portfolio size needed for retirement. If you’re working with monthly expenses, multiply them by 300, which led to another popular term, “Rule of 300”. This “4% Rule” or “Rule of 300” gained even more traction when the Trinity Study in 1998, conducted by three professors at Trinity University, reaffirmed Bengen’s findings.
Let’s put Bengen’s research into practice with a straightforward example. For the sake of simplicity, we’ll use rounded figures. Assume you’ve determined an annual budget of $50,000, which also reflects the amount you’d like to spend annually during retirement. To determine the portfolio size needed, you can use the following formula based on the 4% rule:
Annual Budget x 25 or Monthly Budget x 300
Using the formula above for the 4% rule we would have the following
$50,000 (Your Budget) x 25 = $1,250,000
There you have it, if you need $50,000 a year to be financially independent, you will need $1,250,000 in your portfolio to achieve this with the 4% rule. This ballpark figure serves as a solid starting point for most scenarios. However, let’s dive deeper into the nuances of the study.
For starters, the 4% rule carries a success rate of about 95%. This means there is a 5% probability that you might outlive your savings. I used FireCalc for these calculations, utilizing a dataset that spans back to 1871. This tool simulates portfolio performances over diverse market periods. For my assumptions, I took a portfolio composition of 75% stocks and 25% fixed income.
It’s also important to note that Bengen’s research was predicated on the portfolio lasting a span of 30 years. Extending this duration to 40 years brings the success rate down from 95% to 85%. Yet, tweaking the withdrawal rate from 4% to 3.5% boosts the success rate to an impressive 97%. For those considering early retirement and potentially longer retirement durations, it’s essential to factor in these scenarios.
One thing I’d like to highlight from my analysis is that the portfolios that didn’t make it often started during extended periods of stagnant or negative market growth, notably during the stagflation period of the 1960s to the 1970s. Monitoring your portfolio, particularly during its initial years, can be instrumental. This proactive approach allows for timely adjustments, enhancing the likelihood of your portfolio’s sustained health. It won’t eliminate the risk of depleting your savings but will mitigate it.
Below I have a few scenarios that I put on a table for you to take a look at. As always, past results do not guarantee future performance. 100% doesn’t mean that its impossible to not outlive your portfolio, it just means we haven’t seen anything happen that would cause the failure yet. If you are looking for more specific scenarios then I recommend hopping over to FireCalc to test out some scenarios there.
| Number of Years | 3% Withdrawal | 3.5% Withdrawal | 4% Withdrawal | 5% Withdrawal |
|---|---|---|---|---|
| 20 | 100% | 100% | 100% | 92.5% |
| 30 | 100% | 100% | 95.1% | 74% |
| 40 | 100% | 97.3% | 85.8% | 59.3% |
| 50 | 100% | 94.2% | 75.7% | 46.6% |
How Long Do I Need To Save To Be Financially Independent?
Now that we know how much we need to be financially independent, I am sure we want to know how much longer its going to be until we reach it. A FIRE calculator that I have created here will give us an estimate of how long it will take based on the scenario you have provided.
Lets continue with the previous example where your FIRE number is $1,250,000. We will assume you are earning $75,000 to make things easy. Since your annual expenses amount to $50,000, you’re left with savings of $25,000 each year, representing a 33% savings rate. If you save $25,000 per year, it will take approximately 21 years to reach your FIRE number with the assumption of 8% returns on average(This is the average return for the S&P500).
Now, this timeline might seem lengthy to some and surprisingly short to others. Remember, everyone’s perception and journey to financial independence is unique. One’s prolonged timeline might be another’s perfect fit, given their contentment with their current spending and saving habits.
If you noticed, I mentioned not only how much you are saving but also the savings rate. That’s because the savings rate is very powerful when it comes to how long it takes to retire. This is because when you are saving more, it also means you are spending less and theoretically spending less during retirement. Using the same example above, lets say we are saving 50% of our income, our budget is now $37,500 instead of $50,000. If our retirement spend is now $37,500 we only need $937,500 instead of $1,250,000 to retire! So we are now saving more AND spending less. Using this 50% savings rate example we can now reach our FIRE number in 15 years. To illustrate the impact of different savings rates on your retirement timeline (assuming an 8% ROI), I’ve provided a table below.
| Savings Rate | Years to Retire |
|---|---|
| 6% (Average in the USA) | 45.2 |
| 10% | 38.3 |
| 15% | 32.6 |
| 20% | 28.5 |
| 25% | 25.3 |
| 33% | 21.1 |
| 50% | 14.3 |
| 75% | 6.6 |
What Are We Doing?
As we imagine with everyone else, our spending and savings rate has fluctuated throughout the years. We swing between 40-50% savings rate which puts us on track to reach financial independence in approximately 18 years. Our savings rate was higher when we didn’t have kids(unsurprising). However, we found that with our investments compounding we can let off the gas down to low 40% and only extend our timeline by just a year.
With the info from this post in hand, you’re all set to figure out your FIRE number and gauge when you might reach financial independence. As we’ve touched on in other parts of this series, it’s pretty normal to bounce between different phases. After crunching the numbers and seeing the timeline to reach your financial goals, you might want to revisit your budget. Maybe you’ll tweak a few things to save a bit more or, on the flip side, you might feel you’re on track and decide not to rush things. Remember, the road to FIRE isn’t always straight. As you journey forward, stay flexible. Adjust and adapt as life throws its little curveballs.