How much money do I need for my early retirement?

Early retirement to the country

A paddock of sheep is moved to more fertile pasture

Many people who are asked what they would do if they won the lottery, frequently say “I would quit my job immediately”, or “I’d tell my boss to get stuffed!” without realizing that the dream of early retirement is often closer than it appears. As I discussed in my post on reducing spending, the amount of money needed to retire depends to a very large extent on the amount of money you will need to spend each year.

If you MUST have an expensive annual holiday, or drive a brand new Mercedes Benz, then clearly you will need more money to retire. If however, you simplify your lifestyle by realizing that it is actually impossible to achieve meaningful happiness by spending money alone, your nest-egg required will shrink.

Needing less to retire on because you spend less every year has two specific benefits, namely:

  1. It allows you to save more money each year, and
  2. You reach your early retirement target more rapidly.

An example of the effect of a major reduction in spending:

Let’s say Bartholomew earns $100,000 per year after tax and normally saves a measly 3.7% of his annual disposable income. This, unfortunately, brings him exactly into line with the US national average, for September 2012 according to the Bureau of Economic Analysis’s Personal Income news release. Assuming he put his savings in a low cost investment such as index funds and obtained 7% per year, it means that poor old Bartholomew will save just $51,677.17 after ten years.

His annual expenses are $96,300 ($100,000 – $3,700) which means that after ten years he will have accumulated 53.66% of one year’s expenses. This means that in any given ten year period of work he could only afford a six month unpaid break, and also means he will be working for the term of his natural life.

Let’s compare Bartholomew’s position which is a fairly classic case of 9-5 until you’re 65, with Solomon.

Solomon also earns $100,000 per year after tax, but manages to save 50% of his wage. This means that for every year he works, he can afford to take an entire year off. Assuming he worked for an understanding boss, or for himself, he could literally only work every alternate year. The power of this fact makes considering small sacrifices like not having an iPad or not driving a brand new car all the more appealing. So after ten years, how is Solomon doing?

He has accumulated an extremely handy $698,340.19! Remember that the two have the same salary. In the same time Bartholomew saved half of one years living expenses, Solomon has socked away just under 14 years worth even if his nest-egg stopped compounding!

So how long will a nest-egg last anyway?

Of course, his nest-egg is not just stuffed under a mattress, and it continues to grow because of the power of compound interest. FireCalc is an amazing tool which shows how long a nest-egg would last by seeing how long it would last during all possible different periods of US stock market conditions from 1870 onwards. It looks at what would happen if you retired with a million dollars in 1870 compared to 2012 and everything (literally) in between. Of course, we could be embarking on one of the worst economic times we have ever seen and previous returns are not indicative of future returns, but this tool is a great way of seeing how safe your nest-egg would be during different times given varying annual expenses.

If you achieve a safety rate of 100% you can be fairly sure your nest-egg will be sufficient to fund your particular annual expenses even including interest and increasing spending as you age.

Back to Solomon – his nest-egg of $698,340.19 and an annual spending rate of $50,000 has a very high failure rate – it would last a 30 year early retirement just 36% of the time. Remember that this assumes that he would never work again in any form and would not continue to reduce his expenses after he finishes work. Normally, there are a multitude of spending categories that disappear after retirement such as work clothing, work functions, transport costs to and from work, and the cost of outsourcing work because you haven’t got the time to do it yourself.

Assuming he managed to continue to reduce his spending to $25,000 after he retired, his success rate rises to 100%. In none of the simulations did his nest-egg diminish to zero.

 

Early retirement - Solomon example $700,000 for a 20 year retirement spending $25,000

Solomon’s 30 year retirement

Planning an early retirement:

Clearly, the lower your expenses become, the quicker your early retirement time arrives. Similarly it allows for extending the working period to provide a significant buffer so that the chances of having a catastrophic nest-egg collapse much less likely. Any part-time work that can be added to the mix in early retirement will also lessen the necessity to actually draw on the early retirement fund and thus extend it’s life.

Also, depending on your age your nest-egg may only need to get you to your particular countries’ retirement age so that a state pension, superannuation, or 401k fund becomes available. In effect, you could plan to have two retirements, an early retirement up until say 65 and then a traditional retirement using the funds put aside from through traditional employment.

This revelation should cause you to think twice before you pick up a brand new set of jeans, or pick up a take away coffee – every unnecessary purchase is literally delaying your early retirement and tying you more to your job. For me, every year of work is currently resulting in me saving three years of annual expenses, meaning that my early retirement is certainly within reach at the end of the decade and hopefully I’ll be Free in Ten Years!

Related Posts Plugin for WordPress, Blogger...
If you enjoyed this post, please consider leaving a comment or subscribing to the RSS feed to have future articles delivered to your feed reader.

Comments

How much money do I need for my early retirement? — 1 Comment

  1. Pingback: Financial Independence: How to Retire in 10 Years | Club Thrifty

Leave a Reply

Your email address will not be published. Required fields are marked *