Popular thinking about retirement is that people work hard for 40 years at their job and then in their mid sixties they can finally stop working and enjoy the remainder of their life thanks to some type of combination of Social Security, retirement account funds, and if they were lucky a defined pension plan. People picture retirees not doing much but relaxing and being with their family when their career through their job is over.
The recent FIRE movement which stands for ‘Financial Independence Retire Early’ is a different way of looking at retirement. Their new thinking is that once you have enough money and/or cash flow to pay your monthly bills for the defined future you are more than retired you are financially independent from employment and needing a job and paycheck.
You don’t have to wait 40 years to retire, you can replace your paycheck with other streams of income much faster. The new goal is not to leave your job and do nothing, it is to have enough money to do whatever you want to do.
The reason most people get trapped in employment for 40 years is they need the consistent paycheck to cover the expenses of having a family, large mortgage, new car payments, eating in restaurants, and taking nice vacations to relax and getaway. The FIRE movement’s goals is to create a life they enjoy that they don’t need to escape from. Their escape plan is to leave their job.
The answer to “How much do I need to retire?” starts with the question of how much money you need for the lifestyle that you want to live.
To leave your job you need either a large amount of capital that will be enough counting annual returns on that money to pay your living expenses for the rest of your life or enough cash flowing assets to cover your monthly expenses.
Example one for knowing your number:
If your monthly bills are $4,000 then you would need a $1,400,000 account that returned 5% a year to retire and live comfortably. 5% on $1,400,000 is $70,000 a year and over the $4,000 a month with an additional 2% growth rate. You would be able to live off the returns on your capital and not have to touch the original money letting it grow at 2% a year. Over time inflation will deteriorate the value of your capital so you have to hedge against inflation and allow room for your money to grow at about 2% a year in addition to your withdrawals.
Allows consider the dangers of inflation on your buying power in money saved for retirement:
With a 2% rate of inflation your buying power drops in half every 36 years.
With a 4% rate of inflation your buying power drops in half every 18 years.
With a 6% rate of inflation your buying power drops in half every 12 years.
If you double your rate of return on your capital then you would only need half as much. If you could achieve a 10% annual return you would only need $700,000 for retirement.
The problem is in this age of low interest rates it is very difficult to get a good return through Certificates of Deposits or Bonds that are 5% unless you go for high yield bonds or high dividend stocks. Even then you have to diversify to keep risk lower. Stock market index returns have averaged approximately 10% over the past 90 years but the returns have been irregular with several 50% draw downs and 10 year periods that were about flat as recent as 2000-2010.
To live off returns on capital you need the returns to be as high and as consistent as possible. Systematic traders and individual investors can achieve much higher returns on their capital over the long run but they would have to plan on irregular income patterns with drawdown months and strong earnings years to balance out their cash burn rate.
You have to consider how much money you have and the speed at which you will spend it to see how long it will last you. If you spend $50,000 a year on living expenses $1,000,000 would last you 20 years if you made no returns on it.
Example two for cash flow:
Another example is monthly cash flow covering your living expenses. If you own assets that make money like book royalties, a website, a business, or software as a service and receive payments from them each month that is greater than your monthly expenses then that is another way you can make the math work for an early retirement from a job.
A pay check from an employer is just a stream of consistent cash flow they give you for giving them your effort, time, and knowledge. You just have to replace it with other forms of cash flow.
The key with cash flowing assets is the effort you have to put in to keep them up to date, relevant, and adding new assets. Different streams of cash flow require different levels of effort.
The starting point is quantifying how much your monthly expenses are and considering how much less you will need without the expense of a job with meals away from home, commute expense, and cost of clothing, etc. Also how much more you will need to over medical costs without your employers plan you will have to take on the full expense of buying your own plan. You will no longer have to save for retirements as you will already be retired you just have to grow your savings and earnings at the same pace as inflation.
They more you like to spend the longer it could take you to retire. The quicker you can build a business or a portfolio of great value the quicker you can retire.
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This blog is for informational and educational purposes only. Please seek the advice of a professional before making any financial decisions.