What is retirement? What is Financial Independence? I always think, what would I do if I get retired? Will there be no work? I like working and I enjoy my career and I like building products and businesses and working with Startups. Retirement is not about having Million Dollar and still not being fulfilled. However, retirement is all about having options. It’s been about being able to say “NO”. Its been about having the F-You Money and Freedom it provides. It’s about having a choice. How much do you need for retirement?
If you read my earlier post about reading, you know, I am an avid reader and love listening to audio books on audible and you can find me with my Kindle Reader immersed in reading. I came across the book The Simple Path to Wealth written by JL Collins and my perspective about creating wealth and retirement has changed. He has beautifully outlined the simple roadmap to Financial Independence and a Rich Free Life. From his book, I learned that you need to have your assets created so that you can withdraw and live a rich free life and which is really obvious. So, I started digging more to understand what is that we need to have in assets for retirement. What is the safe withdrawal rate for retirement and what are the things you should do to test at your specified number?
There are tons of articles, blogs, and books available out there on how to figure out the required retirement wealth. I have been going through different blog sites and reading several books and checking which one is best suited for me. Here is how it looked like. What I meant was, you didn’t miss much. It’s all same everywhere. I will try to put some highlights what I learned and walkthrough strategy built upon the most data-driven, and academically well-researched approach for foundation out there.
What Is It That Matters in Retirement Strategy?
What I learned that, at the heart of the retirement calculation, it is important to understand how much you can take out what you need for as long as you would need without running out. This is very tricky and each variable you introduce could be very sensitive if you go wrong about having investments grow at 4% or 5%. This is very small change over a period of 10 years but it would be huge over the period of 50 years.
For Year 10: 100k USD growing at 4% would be worth 148k USD vs 163k USD growing at 5%, whereas for Year 50: 100k USD growing at 4% would be worth 711k USD vs 1.15 million USD growing at 5%.
Exactly, this is the reason many experts want to focus on the strategy of the perpetual draw. With this calculation, one can determine how much he can take out or withdraw without eating into the principle of the total invested nest egg. There is nothing more horrible watching your total nest egg shrink as you grow older and hoping your nest egg outlast you as you age.
So, it is better to keep enough to live off withdrawal rate. This sounds great, right?
Trinity Study: Academic Research
There are various Early Retirement Ninjas who have done work for us. Trinity Study is the great-grandfather of retirement research, for inspiration. The Trinity Study was a research paper published in 1998 and updated in 2009 by three professors at Trinity University. They looked at portfolios of stocks and US Government bonds over 30 years (i.e. 1926-1956, 1927-1957, etc) data for which they had data, and concluded that a withdrawal rate of 4% each year would likely to take you through the retirement without your portfolio going down to zero.
Of the all available data points, a 4% withdrawal rate (indexed automatically to inflation as defined by the Consumer Pricing Index) would have successfully carried the family over 30 years period.
4% is the nice starting point based on the research and historical data. There will always be risks, but only two failure points (1965 & 1966) of the data set of all these samples. It is actually a worst case scenario in the 65 year period covered in the Trinity study. That’s pretty great.
The time period, the Trinity Study used was calculated i.e.1926-1995, and the compound annual growth rate was 10.6%. The most recent years were worse. From 1996-2015, the compound annual growth rate was 8.2%.
What I understood is that, in most cases, the people owning the portfolio could have taken out 5, 6, 7% per year and done just fine. Most of the time taking only 4% meant at the end of the days, we would be left with buckets of money on the table for our heirs. However, many believe that most people don’t like to think too hard.
The negative trending years are only appearing on the back end of a full retirement period when retirees will have much less need rather than at the beginning of the period. That understates how much negative impact they could have for a retiree like you and me if we were to retire into a period that looked like the 2000s. Another important point is that with the current medicines and increased mortality rate, there is great chance that we will live longer than the 30-year retirement timeframe the Trinity professors studied. This is especially true if we are aiming towards early retirement like me and as the readers of this blog.
It was concluded that 4% is more appropriate withdrawal rate, the inflation-adjusted rate that we can draw on our net worth with reasonable confidence that it will not deplete the principle. Withdrawing 4% or less annually is as near a sure bet as anything in this life can be.
How Much Do I Need to Retire and How To Calculate?
With our foundation in place, we can now get right into calculating how much we need to retire. Let’s see a couple of real-life scenarios:
Just take the annual spending level, and multiply it by 25. That’s how much, you and I would need to retire, at the most. A $30,000 (approx. 275,000 SEK for people living in Sweden) spender like me needs $750,000 (approx. 6,8 million SEK). So, I need to work towards that, plus to consider various safety margins in the lifestyle.
Different people have different expense structure when they retire. People may think of traveling to dream destinations, spend time in luxury hotels. People get older, wiser and more likely to break and need comprehensive medical care. Some people may support their parents when they grow old and contribute to their medical care. It all depends on where you live and how you live.
Most folks find they can actually decrease their net spending in retirement, even if they want to do things like traveling the world. They have the flexibility to take advantage of last-minute deals or off-peak specials when everyone else is at their workplace reporting for duty.
For some folks with kids and parents, expenses are a bit on the higher side. Then, just take that pre-tax number and divide by a 4% withdrawal rate. If you expect to need $50k a year, you would take $50k/0.04 = $1.25 million nest egg.
Check your expenses and figure out what is the right target for you.
What is your target range? It all depends on where you are living and what is the rate of return on your portfolio. Share your numbers in the comments and let me know what are your thoughts.
There are many big brains in this retirement space, I would like to mention four who helped much of the content in this article.
- The Trinity Study professors who have created excellent work which is at the center of intelligent conversation around retirement and safe withdrawal rates today.
- The Simple Path to Wealth by JL Collins and his blog provides valuable information regarding good finance and wealth creation
- Wade Pfau of RetirementResearchers.com who writes excellent, very much detailed and complex retirement articles
- Mr. Money Mustache, one of the most interesting bloggers in personal finance.