How much does it take to retire?

My name is Alan, I am 40 years old and I never have to work again if I don't want to. The question is how do I know I can retire?  How do I know I never have to work again?  How do you know when enough money is enough money?  Do you have a target for how much you are working to save for retirement? Do you have a goal? A figure? Are you just working for the sake of working??? 

As an experiment ask some of your friends how much they think they need to retire.  There will be wide and varied answers!

Alan relaxing in San Diego on a dream trip to Comi-Con this year

I came across an incredibly simple formula for knowing when enough is enough. I will show you the straight forward maths behind calculating how much you need to invest to retire.

This was first written on the 26th of August 2019 and updated on the 15th June 2021.  I am now 42 years old now!  How time passes. We have reviewed and updated the article given everything that has happened since I wrote it in 2019!

Disclaimer: This is not financial advice.  Katie and I are not trained financial advisors, nor to we pretend to be one online.  Read our full disclaimer here. ​

How much do you need to retire?

Maybe you are 55 and nearing retirement and thinking "can I pull the plug on work early?" Maybe you are 25 and thinking "how can I set myself up now to not have to work till I am 68!?"  Wherever you are on the journey towards retirement;  there is some simple maths to help you plan. 

The simple maths of early retirement is based on the 4% rule or the 4% safe withdrawal rate.  This is a "rule" that was coined from the Trinity Study which looked at investment data from 1925 up to 2009 and worked out; based on different asset allocations and different withdrawal rates; if your money would run out in a 30 year retirement period. 

There are a lot of technical terms in that sentence which I am going to break down at the end of the article.  If anything doesn't make sense scroll down for a list of definitions.

The main assumptions behind the 4% rule are that if you have 50% of your portfolio (retirement investments) in bonds and 50% in stocks and shares and then withdraw 4% of this a year to live on then in 96% of instances you will not run out of money in retirement.  For example:

• If you want to live on £40,000 a year then you need to have invested and saved £1m.  4% of £1m is £40,000. 
• If you want to live on £20,000 a year then you need to have £500,000 invested. 
• If you want to live no £60,000 in retirement then you need £1.5M invested. 

The simple maths behind retirement is to take your current annual spending and multiply it by 25 (this is the inverse of 4%).  

If you currently spend £20,000 a year then multiply it by 25 and you will get £500,000 and this is the investment pot or portfolio you need to build in order to retire with that annual income. 

There are a lot of caveats and adjustments in these things but the general maths behind when you can retire is very simple.  People argue that it should be 5%,  3.4% or 3.2% safe withdrawal rate (SWR) but as a general rule of thumb this gives you a really neat and simple mathematical equation to work out how much you need to retire!​

Work it out for yourself now

The first step to working this stuff out for yourself is to know how much you are spending each year.  Do you track your spending?  Do you know where your money goes?  I wrote this article all about "what are you spending your money on?" which works to help unpack spending and decide actively where you want it to go!

Once you know your yearly spending then multiply it by 25 and that gives you the pot you need to save and invest.  

For Katie and I the maths was really easy.  We actually spend about £40k a year and have done for the last 4 or 5 years.  (Update: we spent a lot more in our first year of retirement travelling!) 

We kept our spending down by living in a 2 bedroom flat, driving a small car and not spending much on fancy clothes but we spend lavishly on trips and holidays!  We could probably lower this number if we wanted but we have a lot of fun together!

We spend £40k a year; so you just multiplied that by 25  to see that we need a portfolio of £1M invested to retire.  

If we reduced our spending by going on less lavish holidays and trips we could have reduced the size of the pot we needed and retired earlier.  If we decided to move to Thailand and live on £20,000 a year we could have retired with a pot of £500,000!

We ended up crossing our FI number in 2018.  This has created incredible opportunity and changed our lives.  Our first experiment after FI was coming to Hollywood to write a movie!  You can read about that here or continue on learning about the maths behind retirement!

Homework
Your Homework is to go away and look at the amount you currently spend per year or how much you think you might spend in retirement and come up with a FI number.  This is the number that you then need to have saved and invested to be able to retire. 

You might be thinking "Alan I don't need homework!" and I understand that!  But you need to know what you are working towards.  Most people sleep walk financially towards retirement and are left penniless.  If you want to create an extraordinary retirement then you need to have a target for what you are aiming at!

Alan working out how much money he needs to be able to retire!

Holy S*!T that is a big number

You might be thinking that £1M invested is a big number.  And it is!  If you need some motivation reaching it then I wrote an article just for you called the Insurmountable Mountain. There is also one major thing on your side and several other levers you can pull to get you there quicker!

The most powerful thing you have on your side is Compounding.  I will write another article soon about this but I am sure you know that if you start investing early and allow those investments to grow each year the interest starts to compound on the interest and your pot starts to grow exponentially.  I have started writing an article called "it's not linear" which will explain this further.  Coming soon!

Compounding over time is incredible, Einstein called it the 8th wonder of the world! If you are 20 and reading this article you have an unfair advantage.  If you are 50 it can still be done but it is going to be harder because we just don't have the same amount of time to save, invest and allow it to compound.  The earlier you start the better. 

​If you are 40 ish and reading this article you have time and your best earning years are in front of you.  You can do it. 

Compounding is so powerful.  You just need to get the money invested into the market and allow time to take it course. Katie and I have been developing articles to help you understand investing. 

We wrote a beginners guide to investing and then a whole series of articles on index investing starting with What is Diversification.  

State pensions

Depending on where you live you may receive a state pension at retirement age.  This is an important one to consider.  Remember to include this in your projections. 

If you get a state pension that pays out £10,000 a year for you and you need to live on £30,000 a year then this is reducing the amount of money that you need to save and invest yourself.  

It is a guideline not a rule

The 4% rule is often touted as a "rule" and a number that if you reach this you will never have to worry about money again!  This is not true and there are a lot of factors at play that you need to think about. 

The maths is simple but it is build on a whole host of assumptions that, if you understand, will help you to live a rich and happy retirement without worrying about money. 

I have found it more useful to think about it as a guideline that I have to work with or a target to reach.  Let me give you some examples:

• The stock market takes a tumble just after you retire, your portfolio gets cut by 25%!!  This is called sequences of returns risk.  so now your pot is cut from £1m TO £750k.  If you continue to live of £40k a year without adjusting your spending your pot might not ever recover and you might run out of money.  If you are flexible and either reduce spending that year or get part time work to cover the extra £10k gap then you will probably be fine.  Flexibility is key.  If you can't be flexible your chances of running out of money increase dramatically!
• You will never have to worry about money again.  This one is absolutely not true.  Even if you reach the magic FI number, you still need to check your investments, track your expenditure and manage your money.  Just because you reach the number doesn't mean you stop looking after the cash and spend willy nilly! 
• I can spend £40k inflation adjusted for the rest of my life and I will do that blindly never reviewing the numbers.  Some people treat this as a hard and fast rule and if they got to £1M then they just spend the inflation adjusted amount each year no matter what!  This will lead to a higher chance of running out of money.  You need to remain flexible and review the figures and what is happening. It is a guideline and not a fool proof rule!
• The main factors affecting the success rates of the 4% rule are:
  • How aggressive your investment strategy is.  From 80% bonds and 20% stocks which is really conservative all the way to 20% bonds and 80% stocks which is considered aggressive!  I am not sure what this makes me at 100% stocks and shares!!  
  • The time horizon you are retiring for.  The calculations were done on a retirement period of 30 years. Katie and I retired when I was 40, I hope I am going to live more than 40 years!! We need to be careful and just check the maths and sums each year to make sure we are still on track.   If you are retiring for 20 years you could increase this your spending to 6% and there is a high probability that your money won't run out! 
  • Portfolio success rate.  What percentage success rate are you happy with?  Do you want to have a 100% guaranteed success rate? (This doesn't exist!) or are you happy with a 96% chance of success, 85% or 75% success rate? The higher the success rate you want (or the more certainty you want over not running out of money) the lower you should adjust your withdrawal rate.  

This guideline is meant to give you a simple way of calculating how much you need to be able to step away from full time employment and how much income you will have without working.  It is not a set it and forget it forever strategy.  You still need to manage your finances, reassess each year and adjust where needed. 

Assumptions

There are some assumptions behind this simple maths that I wanted to unpack for you:

1. Your spending won't change in retirement.  The math is based on the fact that your spending won't change before and after you hit financial independence or retire.  In a lot of instances people's spending can actually go down in retirement taking into account geo-arbitrage, going on holiday during low season and not having to commute.  A more accurate way to predict how much money you need to retire is to create a budget for spending in your retirement based on what you want to do and then multiply that by 25 to get your total FI number. 
2. Low fees. The Trinity study was based on stocks and shares data and did not include management fees for investing into those funds.  If you are paying high fees to a fund manager these numbers don't stack up!  For a 50% Bonds and 50% stocks portfolio you have a 96% chance of success with no fees.  If you pay 1% fees then this goes down to 84% and if those fees creep up to 2% your chance of success is only 65%!!  Fees and keeping them down is so important which is why I invest in Vanguard index fund.     Katie and I wrote an entire article on the impact of fees on your investments here!
3. You will never earn any money again.  The study assumes you will never earn any money again and won't be willing to get work in a down year.  The interesting thing that I have noticed is that most people that have the energy and attitude to get to FI have developed the skills to make more money in the future if they need to. 
4. You won't be flexible in a downturn. The study assumes you will spend the same amount every year not matter what happens in the market and that you won't be flexible and reduce spending if needed. 

Why I am happy with 4%!

I am using 4% to calculate the amount of money I need to retire on and I am confident and happy in this prediction. 

In the two years since I have written this post I even more comfortable with 4% as our investments have grown well and we are now 1.5 times our initial goal.  

Here's my ideas why 4% is plenty for retirement! 

• I don't plan on never earning money again.  I have some skills and if the market takes a dive I can get a job or earn some more money for a year or so until it recovers.  My flexibility means I can have a higher safe withdrawal rate with better success rates. If I need to I can always go out and get some work and earn £10k for the year to make up a gap.  I am sure I could serve Starbucks coffee and make £10k! 

Why Alan is happy with a 4% withdrawal rate

• I am flexible.  I could just move to another country with a lower cost of living!  If I moved to Thailand for half the year or Poland I could MASSIVELY reduce my living costs and wait for the market to go back up a bit! My flexibility means I am not stuck spending 4% even if the market goes down.   If you aren't flexible and you MUST spend 4% a year then your success rate goes down.  The less flexible you are the lower SWR you should use.  I am flexible so 4% is low!
• I am comfortable with stock market volatility.  I am not going to sell my shares if they go down!  In fact if the stock market goes down I usually end up buying more as they are on sale!  One month our portfolio went down by £70,000.  Yes seventy thousand pounds in one month!  Did I have a hissy fit?  Did I sell everything and run away?  No, I bought some more stocks and kept my cool! I am comfortable with volatility.  This means I can have a more aggressive investment strategy which affords me a greater success rate for my portfolio. 
• I am an aggressive investor. I currently have 100% of my money in stocks and 0% bonds.  In traditional circles this makes me very aggressive which means over the long run I can expect better returns and a higher success rate for my portfolio.  If you aren't comfortable with such an aggressive portfolio then you might need to choose a lower safe withdrawal rate!  The interesting thing is that the rest of the world sees this as an aggressive and risky strategy and I see it as the safest thing I can do with my money over the long term. 
• The guy that came up with the 4% rule just wrote an article saying it should be more like 5%!  I found this SUPER interesting to read.  He argues that markets have been returning far higher for the last 20 years plus and a SFW of 5% is possible.  If you are geeky like me you can find his new article here. 

I am more than comfortable with 4% as my safe withdrawal rate.  Actually, I think it is a little conservative if anything and I could easily do 5% and be fine!  4% gives me all the safety and security I need over the coming years. 

Update 15/06/2021: I am going to speak to Katie about upping our SFW to 5% and see how she reacts! 

Will you run out of money?

One of the things that I found most interesting about the Trinity study is the amount of money you can expect to have left at the end of your 30 year retirement period if you spend 4% and adjust for inflation each year!

I was thinking maybe my pot would stay the same? Maybe it would increase slightly?  The Trinity Study did some analysis which you can see in Table 4 on their paper here if you fancy. 

If you retire with $1M in your portfolio and are 100% in stocks and shares what do you think the average (median) amount of money you will have at the end is?

Everyone is worried about running out of money! If you are invested I think the opposite is true. 

You would end up with £10,075,000!!!  

Yes that is TEN MILLION!

4% could actually be a little bit low if you are flexible, invest 100% in index funds and manage your money well! 

Has this helped?

I would love to know if this has helped!!  Please tell me.  Write in the comments, email me, message me through the site and tell if this has helped you set a target.

If you haven't done it yet then sit down with a friend, your partner or your family and have a discussion about how much you want to spend in retirement; multiply that number by 25 and there you have your retirement target! 

​You can't hit a target you can't see!

I really want to know if what I am writing is of value to you.  It has helped me immensely in my life and writing this has actually helped me clarify my own thinking and increase my confidence in my own numbers! But the really important thing is has it helped you?

Scroll down to leave a comment or press like and share on Facebook.  Below is all of the definitions of the terms above if you need them. 

Definitions

When you are talking finance there is a new vocabulary you need to learn.   It is just like learning a new language.  When you first read something in a new language you spend your time looking up words and deciphering them; this gets easier over time if you stick with it.  I have spend the last decade learning the language of finance (I am still no expert) and I am going to work to put what I have learnt down and make it simple here:

• Asset allocation - this is the split of your investments between different asset classes.  For example you might have 50% in stocks, 25% in bonds, 20% in property and 5% in cash.  It is where you have decided to allocate your resources or money to get a return.  It can also be used to refer to where you investments are at a more granular level such as the split between technology, blue chip companies and other industry sectors
• Safe Withdrawal rate - this is the amount of money you can safely withdraw from your investments each year to live off without depleting your funds and running out of money! There is a lot of debate over what a safe withdrawal rate for retirement actually is.  4% is the average used by most people. 
• Trinity Study - this is a study done by three professors of finance at Trinity University on withdrawal rates and whether or not your retirement funds will outlast you. 
• Conservative, Moderate or Aggressive Investors - This refers to how aggressive you are as an investor and how much risk and volatility you are willing to take. Conservative investors tend to hold more bonds and cash in their portfolio and aggressive investors hold more stocks and shares. On this scale I am an aggressive investor holding zero bonds, little cash and nearly all stocks and shares in index funds. 
• Portfolio - The amount of money you have saved and invested between different asset classes.  The size of your pot.  
• Sequence of returns risk - this is the risk that you retire at the wrong time just before or after a recession and your portfolio is cut massively.  This means that the size of your pot might not sustain your spending at the start of retirement and is more likely to fail or run out.  For example if you tried to retire in 2008 just after the financial collapse you might fall foul of the sequence of returns risk and run out of money. 
• Success Rate - The success rate of your portfolio in relation to the 4% rule is whether or not you run out of money before the end of your 30 year retirement period.  If you run out of money the authors of the report deemed it a failure and if your money survived the 30 years they deemed it a success!
• Vanguard Index Funds - Jack Bogle was the founder of Vanguard and created the index fund which allows you to invest in all publicly traded companies in a given market at a very low cost. This is the company that Katie and I invest all our money with. 

What next?

Katie and I have been working hard on other resources to help you get to grip with your finances and start working towards an incredible retirement.  Here are some places to go next:

1. We did a follow up article to this answering all the questions in the comments below and more.  You can find the 4% Q&A here
2. We have built the Rebel Finance School to help people take control of their finances and work towards financial independence.  You can find out more about Rebel Finance School here and when the next one is going to run
3. We wrote an entire set of articles on index investing which you can go through to help you start to invest your money.  They start with What is Diversification here

The whole purpose of these articles is to help you take control of your finances and to enable you to start working towards financial independence.  

The extraordinary belongs to those that create it

No one is going to hand you an extraordinary life you have to build it yourself.  However there are people that will help you along the way.  This is Katie and my effort to help you build the life of your dreams. 

​Start by working out your retirement goal and taking steps towards making it happen today!