Retirement planning and financial independence are hot topics right now. But how much money do you actually need to retire early? In this article, I'm going to break down the numbers for you.
Base Assumptions
Personal finance is very variable. It depends on your needs, spending habits, lifestyle, and dependents. For this example, I'm going to assume that you're a single person with no dependents.
According to NerdWallet, the average monthly expenses for one person is around $3,700 a month or just over $44,000 annually.
The median household income in 2022 was roughly $74,580. Keep in mind that this number varies based on the number of income earners in the household. For example, if you're a single earner, your income might be closer to $47,000. If you have two earners in your household, it might be closer to the mid $70,000s. And if you live in a high-income state like California or New York, it could be closer to $80,000.
Inflation is an additional critical aspect to contemplate. The average inflation rate throughout the last 30 years has been approximately 3%. Yet, during the previous five years, it has fluctuated significantly, ranging from 1.2% to as high as 8%.
Retirement Assumptions
For retirement calculations, I'm going to make the following assumptions:
- You start investing at age 25 and retire at age 55 after investing for 30 years.
- You earn an 8% return on your investments.
- You start with $0 and contribute $500 per month.
- I'll assume an inflation rate of 3.5%.
- Your investments are in a Roth IRA with a 0% tax rate.
- After 30 years of investing, your portfolio would be roughly $708,000.
The traditional safe withdrawal rate is based on the Trinity study and is considered to be 4%. This means that if you want to retire with an annual expense of $48,000 (4% of $1.2 million), you would need about $1.2 million.
Let's see what FiCalc has to say about this.
FiCalc Analysis
FiCalc is a great tool for analyzing different retirement scenarios based on different investment strategies and market conditions.
I will employ the constant dollar method, which factors inflation into the withdrawal rate over time.
With my given assumptions and investment strategy, my success rate of sustaining withdrawals for 25 years is only 64% with a portfolio of $708k.
If I adopted the traditional safe withdrawal rate of 4%, my portfolio would need to total $1.2 million to achieve a 99.2% success rate.
This is why it's so important to understand your own personal finance situation and not just rely on general rules of thumb.
You can also play around with different portfolio allocations. For example, you could start at 100% stocks and transition to a mix of stocks and bonds by age 55.
Keep in mind that I didn't factor in Social Security benefits which could supplement your income from age 62 and a half onwards.
If you want more resources like this one, check out Whiteboard Finance University - it's an amazing community with tons of valuable resources for financial education and planning.
Barista Fire
Barista fire refers to retiring early but continuing to work part-time or having a side hustle to cover living expenses during retirement. This strategy enables individuals to retire earlier with a smaller nest egg and potentially reduced living costs.
Coast Fire
Coast fire is when you save enough money early on so that you don't have to contribute any more money towards retirement later in life. This allows you to take lower-paying jobs or work part-time without sacrificing your retirement savings goals.
If these concepts interest you, I highly recommend checking out "Die With Zero" by Bill Perkins - it's an amazing book that will help align your life philosophy with your financial planning and retirement goals.
I hope this article was helpful! Let me know what other topics you'd like me to cover in future articles.
Thank you for reading!
Alexandra, from Incorpo.ro