If you have been working for any number of years than I am sure that you have given the idea of retirement at least one or two thoughts. It is something that we all hope to achieve one day because it seems to be the perfect set up.
Waking up in the morning with no worries in the world because you know that all of your financial obligations are taken care of, and the only things that you have to stress over is how to spend more time with your family members.
Or maybe you are traveling the world, visiting every country of your choosing. Marking everything off of your bucket list before coming home to do some relaxing before your next great adventure.
But what if it’s having the freedom to leave the crappy job that you’re at now without a worry that you won’t be able to make your mortgage payment this month, or the month after that, or the month after that.
All of these scenarios sound pretty good right?
Now let’s just take one moment and try to figure out how to get you from where you are now to where you want to be, which is financial freedom.
What exactly will it take?
Is it even a possible goal?
Well I am here to tell you that it may be a little more possible than you may think. This is because most people think that they needs millions upon millions of dollars to be able to retire for their day job and not have to worry about ever getting another one in the future.
All it takes is a little math, knowing where you have to go, and setting up a plan for how you’re going to get there.
In this article, I will be taking you through the math of exactly how to calculate your financial freedom number and also a few tips and tricks you can do to reach that number even faster than you may have thought imaginable.
However, before we even bring a the amount of money that we will need in retirement into the equation, we’re just going to assume that you want to retire somewhere in the next ten years.
(Optimistic am I right?)
I truly am a believer of the FIRE movement.
Which is an acronym for “Financial Independence, Retire Early”.
This movement is all about people who are taking the steps necessary to leave the rat race of the 9-5 and begin taking control of their lives and their finances.
We are taught in school to study hard so that we can get a high paying job. Once we are at that job, we are taught to work hard so that we can get a nice bonus or raise, and then work harder to get another and another and another.
The thing is, your bonus or raise will always be directly correlated to the amount of hours that you put into your job. You are never building something (other than an employer sponsored 401(k) possibly) that will guarantee that you can one day leave the job in search for something that makes you happy.
In the FIRE movement, we are all about finding ways to build wealth and live our lives with the passive income that we have built over the years.
Not all of the people who subscribe to the party believe in a passive income in the form of actual cash flow as their retirement source, some of them believe in investing as much money in the stock market and building a nice sized nest egg that will allow them to fund their expenses through that channel.
I will be talking about the investment channel through the stock market in this article.
So how much money do you think you really need to retire and live a life that is not burdened on the worries of where your next paycheck will come from, how many hours you have to work to get it, and the stresses that come along with working a job that you hate?
You want to have the ability to live on this money for the rest of your life, never having to contribute to it ever again.
What is a realistic number for this amount of money to be?
Is it 3 million dollars?
Is there even an amount of money that would let you do this?
When I first got started on my FIRE journey, I was skeptical if their was ANY amount of money that I could save in my 20s and 30s that would allow me to live until I am well past 80 years old. I just didn’t think the math would allow it.
So, is it possible?
Well, in short, the answer is yes. Definitely yes.
I can’t answer exactly for you what this number will be because I don’t know your personal lifestyle habits or where you plan to live, but I can assure you that the number is probably a lot less than you think.
In order to calculate this number you have to take into account the amount of money that you wish to spend in retirement. This number should be large enough to allow you to live comfortably. Depending on how frugal you are will determine how large you will need your nest egg to me.
Quite obviously, the less money you spend per year = the smaller nest egg that will be required and the faster you will be able to achieve FIRE.
So, how is all of this even possible?
the reason for that, simply, is compound interest.
Compound interest, often referred to as the eight wonder of the world, is the science of making your money make money for you. You are sort of building this snow ball (but instead of a snowball, its more of a huge wad of cash) that continues to get bigger and bigger as it rolls down the figurative hill towards retirement.
Compound interest is what turned common people like you and I into millionaires, and millionaires into mega-billionaires like Warren Buffett.
and, the craziest thing about compound interest is that it stares us in the face almost every day but few people actually take full advantage of its capabilities. It is hard to see the streets of gold and the end of the murky alley because it is just too far in the future. However, I assure you that if you can stick through the early years of slow growth than compound interest will work in your favor and you will start to build wealth that you never thought possible.
So let’s talk about how compound interest can work for you
Before we go into the calculations of how to find your freedom number and using compound interest as a tool to help you retire early, I want to explain how it works.
I recently finished a book called Financial Freedom by Grant Sabatier and he explains how you actually need less money to retire at the age of 35 then you would if you were retiring at 65.
If you want to check this book out for yourself, use this link.
Going back to how you can retire with less money than you thought possible.
The idea behind this is that if you choose to retire at the age of 35 with the freedom number that I will calculate for you shortly, then you will have 30 extra years of compound interest working in your favor rather than against you.
Did lose you?
Well, let me explain more.
Let’s say the average stock market return is somewhere between 7-8% adjusted for inflation. With the tips that I learned from Grant Sabatier’s Financial Freedom, I learned that you should strive to withdraw no more than 4% from your investment any given year of retirement if you want to be the most effective.
This gives you 30 years of compound interest working for you because you are never touching the principal of the money that you have invested and the money that you earned over the 4% that you will withdrew will start accruing compound interest on it as well, growing your entire nest egg even larger.
The 30 years of withdrawing less than what you earn will allow the compounding effect to work in your favor so greatly that you would probably end up having more money than if you chose to retire at a later date.
So at last, let’s learn how to do this.
Calculating Your Freedom Number
When thinking about your freedom number, keep in mind that this is the number that you will need to have invested in order to able to live on for.. well.. forever.
We don’t want to make the assumption that you will day at the age of 85 or some other calculation like that because we want you to have this money as long as you may need it. Even if it until you are 125 years old.
So if we assume, as we did earlier, that you want to withdraw no more than 4% from your portfolio in any given year then that will be your starting point.
Moving forward, the next point is calculating how much money you will truly need or want to make you happy and comfortable in retirement.
You can figure this out by calculating how much you already spend on your monthly expenses and buffering a little bit if you feel that you are a little tight. The best way that I have found to do this is to take a look at your spending habits for the last three months and add up everything that you have spent money on and average it out. If you are a budget freak like me and keep all of your expenses in a spreadsheet, then all you have to do is multiply this by 12 to get the number that you will need annually.
When calculating your expenses from your credit cards or bank statements, try to take out any large one time expenses, as they will cause your numbers to skew in the wrong direction. You still must be careful in including all the necessary expenses because you want to make sure that you indeed have enough money when you are finally ready to take the plunge into retirement.
For me, my monthly expenses are $4,000 and I feel that I can live comfortably on this amount when I am in retirement, however, when I am retired I would like to have $5,000 a month coming in. This leave me with a margin of error in case something funky happens in the stock market one year like we are experiences because of this pandemic that we are in today.
Multiplying $5,000 by 12, then I would like $60,000 a year after taxes from my portfolio.
To do this with your personal number, simply follow the same steps as me but add your expenses where my $5,000 is.
After that you will divide that by your desired withdrawal rate.
A simple equation to visualize this is:
$60,000 (annual expenses) / 4% (withdrawal rate) =
This finally leaves you with your freedom number, or the nest egg that you must save up in order to consider yourself financially independent.
My nest egg is:
Before you come at me with knives and pitch forks because I just spent this entire article telling you how you didn’t need millions of dollars to retire, I want to put this number into perspective.
While $1.5 million may seem like a lot of money, let’s compare this number to the number that a general retirement calculator would give you for the amount of money that you will need to have saved upon retirement.
I searched online for a random retirement calculator and found one that looked similar to the one below.
I put in my desired retirement age and the amount of money that I will need annually when I retire and told it to give me my freedom number.
This is what I got:
This calculator says instead you will need $8,000,000.
What a difference.
So which one would you rather have to save in 10 years?
$1.5 million or $8 MILLION??
Now I know $1,500,000 still sounds like an impossible number to achieve, but if you break it down into manageable goals, then you can be there before you know it.
By utilizing money-making opportunities that I have talked about in past blog posts, you can be on the fast track to financial freedom as well.
Thanks for reading!
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