Now that I am retired early and enjoying my first month without work, people are asking me for advice on how much THEY need to save to retire themselves. Many people don’t seem to know where exactly to start. Calculating the money needed for retirement feels like walking into a foreign casino to them – full of opportunity, but also fraught with risk.
With that in mind, I thought I would share the two SIMPLE “lenses” or tools that will help you understand what you might need. It will give you a decent sense of where you are at and won’t take you more than 10 minutes to use.
- 4% rule – Based on what is known as the Trinity Study, the 4% rule is the concept that in a typical 30-year retirement, one could withdraw 4% of retirement savings annually and be highly unlikely to risk running out of money. The 4% rule is a great starting point early in your planning – because it is such an EASY concept to apply. Just consider what lifestyle you want to have in retirement (spending) and multiply it by 25. If you want to retire early, or be more conservative, use a factor of 33 (3% withdraw rate).
- FIRECALC – This online calculator (firecalc.com) takes the root math behind the Trinity Study and lets you play with the details. It a simple and easy to use Monte Carlo analysis that utilizes historical investment returns back to 1871 to understand the probability behind your investment returns. History is, of course, no guarantee of future performance, but it is a good place to start with two World Wars, the Great Depression (and Recession), and periods of irrational exuberance included in the data set.
You simply input three key factors: 1) retirement spending; 2) retirement nest egg; and, 3) spending horizon (ie 30, 40 years). It then kicks out a graph that shows you how you would have faired for retirements starting each year over the last 100+ years. In this example, I’ve used a $1.5M nest egg with $60K in spending over 40 years: It shows that 85% of the lines stay above zero – meaning you don’t run out of money:
Notice that under the best of historical circumstances, the $1.5M nest egg grows to over $10M. The worst line leaves you almost -$1.7M in the hole. Obviously, budgeting in retirement is an ACTIVE process – we all need to adjust to actual market circumstances. Note that it also 20+ years until the best & worst possibilities start to really emerge. The fact is, the longer we live, the more likely we are to run into extreme bull or bear markets that leave us in the penthouse or the basement.
Additionally, FIRECALC is a terrific tool because it allows you to play with assumptions in a lot of different ways. Beyond the basic 3 inputs, there are tabs that you can use to add in your Social Security, your pension, different investment assumptions, and different spending philosophies. All of which are reflected in historical returns of those choices.
What is the right level of confidence or probability of success? That really depends on you. Because the tool his face is historical return, it can only be one lens on your decision know when to retire. For us, we look for a number of 90% or greater. Others, feel comfortable an 80% probability.
I really wanted to feature FIREcalc in this post, because it not only helps you get a sense of where you are at, but also allows you to LEARN what works best in planning your retirement.
To show my support for the tool and encourage others to use it (it is a user-supported, wiki-site), I will donate $2 for every MrFireStation.com visitor who comments to this post about their experience using it (for the good or bad), up to $100 dollars over the next week. 🙂 Should be fun to see …
Image Credit: Pixabay
- BTW: The 4% Rule and factor of 25 is fun to apply to fantastic “What If’s” too. A friend dreamed, wouldn’t it be GREAT to have enough money to live at the Ritz Hotel in Paris full time? Well, assuming that’s about $1K a night = $365K a year x 25 factor = $9.1M nest egg would be needed to achieve that dream.
UPDATE (5/18/16): I received 17 comments to this post and donated $35 to FIREcalc via PayPal today. Thanks to everyone that tried out FIREcalc – everyone said it was a valuable tool!