Jacob became financially independent at age 30 by reducing his expenses and saving and investing 75% of his paychecks to provide enough passive investment income for the rest of his life. He no longer works for a living. He blogs about how to reach financial independence and many other things on Early Retirement Extreme.
Often times the number, that is, the amount of money to retire is just thrown out there. It used to be that people said they needed $1 million to retire. Now many say they need several millions.
However, what you really need to find out is how much money you need to be comfortable and satisfied in retirement. Some people, like rock stars and sports stars seemingly need a lot of money to get their budget to hang together but most need much less.
If we compare satisfaction and comfort to eating, then comfort is the state of not being hungry and satisfaction is not being miserable having to eat whatever is on the plate. It is clear that not being hungry does not require a lot of money whereas not being miserable can easily require a lot of money given that some will be miserable if they are not drinking champagne whereas others happily drink water.
It is also clear that some savvy shoppers will pay much less whereas others pay much more for the same things.
Therefore people need different amounts of money for their retirement because their wants and their ability to satisfy those wants are very different.
Making the Calculations
To determine how much retirement saving is needed, tally up your annual expenses. Much investment research has been done on how long a portfolio will last for a given withdrawal rate. For example if the portfolio is $600,000 and $30,000 is withdrawn over a year, the withdrawal rate is five percent. If the portfolio is $300,000 and the $30,000 is still withdrawn, the withdrawal rate is 10%.
To retire without running out of money, the withdrawal rate needs to be low enough to avoid depreciating the portfolio below zero. Nobody wants to run out of money in retirement. Typical retirements last up to 30 years. Here it has been determined that the safe withdrawal rate is four percent.
This means that your savings must be 25 times your annual expenses in retirement. That is your number. For example, if you spend $20,000 each year, then your number is 25 x $20,000 or $500,000.
If you have not or predict that you will not meet your number, you must either save more or spend less. Notice how spending less can be much more effective in making more. Reducing expenses by $2,000 over a year would mean needing to save $50,000 less. Since it could takes years to save that amount reducing expenses is often a good strategy since it may not take years to learn ways to reduce one’s budget.
Starting your retirement fund early, such as opening an IRA in your 20′s will help you get there faster so that you’re not playing catch up later on.