What do you actually need to retire on?

Last week I wrote about how my net worth is now $950,000, and how I was feeling about it. Do come and join me on Insta where I tell the same stories but with a lot fewer words, and with photos of Barbies. What’s not to like?!

This week I want to talk through what the limitations of my net worth are. Not because I’m ungrateful or want to scare off people who are much earlier on in the journey, but because there are impacts to how we organise a portfolio which means that net worth doesn’t necessarily tell the whole story in terms of what I need to retire on.

So let’s go back to basics. The FIRE approach to early retirement takes as standard the 4% rule: basically, you need to save 25 times your annual financial requirements, then you will be able to withdraw 4% each year in a way which will keep you going for at least 30 years.

Yes ma’am! Photo by Precondo CA on Unsplash

There has been a huge amount of discussion on this in the FIRE community and outside. The 4% rule comes from the fairly standardised view of return on investment in the stock market. The S&P500 for example has an annualised return rate of 7.5% over the past decades. So if you assume inflation gobbles up 3%, you’re left with 4% that you can withdraw before impacting on the capital.

Right now, there are commentators noting that the 4% rule might not work as well in future, as the stock market goes into a period of instability (or, you know, total global apocalyptic meltdown). Others point out that, on balance, the markets always right themselves eventually. At the point of drawdown though the issue is this – if you are retired and you need to spend out of your portfolio, you can’t wait for the market to resettle, and you can’t withdraw based on an average. So if you need to take money at a challenging time when the markets are down, you will either only be able to take out less, or it will diminish your capital.

As an aside, if you are new to this journey you really don’t need to know everything about the stock market but you might want to explore a little – I love Paula Pant’s recent basics guide.

Enjoy yourself! Either by talking about the stock market, or by planning your fantasy life when you retire. I know which I prefer… Photo by Jay-Pee Peña 🇵🇭 on Unsplash

(Side bar – I do my financial planning in GBP£ but calculate my net worth in US$ because it looks better. I know, I know, the games we play with ourselves…)

The reason this matters is because it has a significant impact on how much you need to save in the first place. I worked on the basis that I need £30,000 per year to live on – there are a lot of assumptions and years of budgeting behind this, but broadly, it works. Which? have a fascinating annual survey of how much retirees spend annually, and they calculate that £31,000 per year is enough for a single person to have a ‘luxury retirement’. But this assume the person is older, without the need to financially support children or their own elderly parents. It also says that spending on food and drink dramatically decrease and let’s face it – that’s not going to be me.

To withdraw 4% and have this be £30,000 per year in retirement, I would need to save 25 times that amount. So 25 x 30,000 = £750,000 ($975,000), which is very close to where I am. Using a more conservative approach would suggest using the 3% rule instead, or saving 33 x 30,000 = £990,000 ($1.23m).

There are lots of caveats to this in terms of how you do your planning and what it means, but it is also a stark reminder of where the mindful money aspect comes in to play. It sounds obvious, but the more you want to spend in the future, the more you have to save now. This also means looking at paying down debt, or paying off your home: basically balancing your expenditure with your planning.

Gather up your courage and do your calculations. Big Shaq is with you!

That means that the first and most important step is to know your numbers. Next week I will walk through my portfolio and some of the challenges in calculating an early retirement age, especially around accounting for defined benefit pensions, and deciding how to treat buying a house vs renting, as well as understanding what each of these options means in your planning.

Until then, I hope you enjoy working through some of your numbers. I’d love to hear from you, here or on Insta, about how it’s going and whether there are any more hacks and ideas I can help with.

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