Up until now I’ve claimed that I’ll be able to retire by 35, and pretty much asked that you take my word for it. Some of you are decent people who will take a man at his word. Others of you are ruthless savages who demand that I back up my unconventional statements with “objective reasoning”, “quantitative data”, and “logic”. We’re in the 21st century – I thought we’ve moved past this as a society. Whatever.
In order to follow along with the doctoral level math I’m about present, I’d recommend that you have the following items handy: graphing calculator (TI-89 or newer), protractor, compass, Cheetos (this is going to take a while and I don’t want you getting hangry), and an open mind. All right let’s do it, gang!
STEP 1: Calculate your total annual expenses. This includes anything and everything you spend your money on.
STEP 2: Multiply your annual expenses by 25. The result is your “nest egg”, or the total amount of money needed to fund your retirement.
STEP 3: (We’re almost done.) Determine how much money you save per year. This number includes money put in checking accounts, savings accounts, and any other investments (IRA, 401k, real estate, etc.)
STEP 4: Divide your nest egg by your annual savings – the result is the amount of working years required to get you to retirement.
STEP 1: Art Vandelay lives on $28,000 per year.
STEP 2: That makes his next egg $700,000 ($28,000 * 25).
STEP 3: Art’s take-home pay $60,000, so he quickly finds out that he saves $32,000 a year ($60,000 – $28,000).
STEP 4: Taking the total amount needed to fund his retirement divided by his annual savings, Art determines that he has 22 working years remaining. Unfortunately, Art is already 93 years old so he can’t retire until he’s 115. Good for him.
At this point in time, I’m not comfortable publishing my personal living expenses and salary (although I’ve previously mentioned that I save 60% of my earnings). I will tell you though that the result of this retirement age calculation has me working an additional 10 years, which lines up nicely with my desired retirement age of 35.
Why this Math Works
I would argue that most people have no idea why the typical retirement age is 65. The answer isn’t complicated – it’s the age at which the average retiree’s investments/savings can cover his living expenses such that it’s no longer necessary to exchange time (working hours) for dollars (salary/hourly wage). Life expectancy in the States right now is 79, so it may be easier to conceptualize retiring at 65 as the point at which savings/investment will last 14 years. This is depressing for a number of reasons but we won’t get into that now.
“So, asshole Mark, how do I know when I have enough to last me 14 years of not working?”
“Great question, asshole friend.”
There is a magical concept known as The Safe Withdrawal Rate. It’s an idea that suggests you can spend 4% of your nest egg each year, and your nest egg will last FOREVER (not just 14 years) if you have your money invested in the market. The magic behind this idea isn’t magic at all – there is simply a 100+ year trend that suggests the market will grow more than 4% year over year, so by spending less than 4% year and year, your money replenishes itself indefinitely. Abracadabra.
NOTE: The 4% rule explains why I asked you to multiple your yearly expenses by 25 – you could have divided your expenses by 4%, but dividing by percentages is for nerds.
Assumptions I Made
1. Current net worth = $0
Net Worth = Assets – Debts.
Assets include things like money in checking and savings accounts, retirement accounts, stocks, bonds, and real estate. Debts include borrowed money (college, automobile, mortgage, credit cards, gambling).
Chances are your net worth is not exactly $0. Hopefully your assets outweigh your debts so you’re closer to retirement than the calculation suggests. To bring this wrinkle into your retirement age calculation simply add your current net worth (even if it’s a negative number) to your nest egg before dividing by annual expenses.
2. Earning and spending stay constant each year
We unrealistically assumed that you’re going to make and spend the same amount year after year. Most members of the working class receive a regular (annual, bi-annual) compensation increase. However, we also commonly observe an increase in spending with those same individuals. So depending on your financial habits, it may or may not be accurate to assume that you’ll save the amount each year.
PRO TIP – to accelerate your journey to retirement, maintain your present spending levels even when you experience an up-tick in your earning.
This Calculation may be Conservative
1. Returning 4% is for chumps
As I explained earlier, the 4% rule is founded on the principle that the market will grow more than 4% each year. What I failed to explain was that this principle is based on the growth of traditionally stable investments like the U.S. bond market (because interest rates are so low, bonds don’t increase in value by 4% any more). I would argue that I can do significantly better than 4% growth by investing in simple index funds and purchasing cash flowing rental properties. Perhaps, my investments will return 5% each year. This means I only have to multiply my yearly expenses by 20 to get my nest egg.
2. Retiring doesn’t mean I’ll stop making money
As I stressed in my last post, retirement does not mean I’m going to stop working, it just means I’m no longer financially obligated to exchange my time for money. It’s my belief that I’ll earn money in some facet after I retire. So it may be reasonable to assume that I’ll be adding to my nest egg even after I retire which will allow me to retire even earlier!
I hope you find this information as encouraging as I did when it was first introduced to me. I find it liberating to know that the amount of years that I’m obligated to work is derived from things that are well within my control. Early retirement is not a privilege reserved for the high earners – its attainable by anyone with the discipline to live below their means and who has a basic understanding of personal finance.