How many years until I can retire?
This question is an interesting one. Let me give you the perspective as a member of the Financial Independence Retire Early (FIRE) community. I certainly can’t speak for everyone, but generally we believe that financial independence (FI) and the ability to retire early are essentially the same thing. So the question to us is really: how much money do we need to be financially independent?
What is Financial Independence?
According to the FIRE community FI is when you have enough money to cover living expenses indefinitely. Saving and investing 25x of your living expenses is considered a good rule of thumb for a financial independence number. At this point you have enough money invested to cover your living expenses and retire for the rest of your life.
To understand the number of years it takes to retire first requires us to analyze how much we are spending and earning. Once we know these two things we can calculate how long it will take us to retire. So let’s start!
Understanding Expenses: Breaking Down Lifestyle Costs
When determining your FI number it’s important to know how much you are spending to sustain your current lifestyle. To do this you will need to track your expenses, ideally for a few months. Doing this meticulous tracking of your finances is usually uncomfortable for the first time because it feels a little unsettling having an honest look at what you spend your money on, but I promise it is very helpful information that you will appreciate having. If you don’t want to do this, try and make your best educated estimate on what this might be.
A useful aspect of tracking your finances is that you know where the money is going. You might be surprised at first how much money is going to say food, entertainment or subscriptions. You will start to ask yourself how you can reduce this. Do I really need cable tv, do I need to spend so much money while shopping, should I eat out less? These questions start to be asked and this is great! You are starting to think about your finances; being money conscious is being money wise!
Not tracking your finances or having an idea where your money is going is like ignoring the leaks in a ship that you are sailing on. The more leaks you have the slower the ship goes. If the leaks are too bad the ship starts to sink. So it’s important to keep leaks in your finances at a minimum so you can get to your destination, the island of financial independence, as soon as possible.
Understanding income: What Should Be Included
Now since expenses are tracked, the other part of the savings rate equation to consider is your income. I personally don’t like to include anything outside the income I earn from my job. Doing this allows for a more conservative estimate of what my savings rate is. It also forces me to save more than I otherwise would. Including other sources of income in the calculation could make me ease up to not be as focused as I should be when perusing FI. Additionally the only income considered is my after tax income.
Savings rate calculation and how much time is needed to reach financial independence
Now we are finally ready to calculate our savings rate. To do this, subtract your monthly income by your monthly expenses to get your monthly savings. After this divide the monthly savings by your monthly income to get the savings rate.
Savings rate is really interesting, because it dictates how long you need until your FI number is reached. Increasing the savings rate just a little can make a huge difference in how much faster you can reach FI. To see a powerful illustration of this check out the tool from this website: https://networthify.com/calculator. It is a tool that illustrates very well how a small difference in saving rates can have a massive impact on the number of years to FI.
Assumptions
The calculation on the number of years required for FI assumes that all of income (after taxes and expenses paid) goes straight into the stock market. The yield depends on how much you think the market is expected to yield over the coming years. The most common yield estimate for the stock market is usually 7-10%. I personally think this estimate is too high, so I stick with a much lower 5% yield for my estimates for the journey to FI.
The final amount needed for FI also assumes that 4% is a safe withdrawal rate (SWR). This particular SWR is backed up by the trinity study.
It’s worth noting, the 4% rule is not to be considered a hard rule, it is to be used as a guideline. This is because the market fluctuates year to year, but on average the market return of 7% allows for 3% to be taken off due to inflation leaving the remaining 4% to be used for living expenses. Some years the market returns less than others, those years it’s required to withdraw less than you usually would in order to prevent your portfolio from diminishing.
Some people believe that 4% rule is too high. Some even go as low as 2.7% (https://youtu.be/1FwgCRIS0Wg?si=weuITETHLESBQiE1). Whichever SWR you use, it is your choice; that is the beauty of personal finance.
