The age old advice is to work hard, save for 30-40 years and then retire when you have at least a few million in your retirement account.
However, many people are beginning to realise they aren’t willing to wait that long to enjoy their Golden Years. Chances are, if you retire when you are between ages 60 and 70 the Golden Years aren’t going to be a large part of your life either.
The majority of your life will be spent working your 9 to 5 job (more likely 8 to 8), not seeing your family and only having fun at the weekends. I am not sure what to call these years, maybe the Dull Years.
The idea with early retirement is to spend as little time as possible in these Dull Years and more time in the Golden Years.
I think most of us will agree, if they won the lottery and had a few million in the bank they would certainly quit their job and either spend more time with family or go traveling.
The reality is you don’t need several million in the bank to retire, you don’t even need a million.
The amount you need in your retirement fund is largely based on what your expenses are. Earlier in the week I taught you how to create a budget you will need this to continue, so if you haven’t done so go do that now!
Now I want you to take your budget, look down your expenses and work out which ones you are still going to need in retirement. Travel costs for commuting can go as can some food costs if you buy lunch out when you are at work.
There also a few age dependent ones as well, which will depend on when you are likely to retire, such as whether you are still paying off a mortgage or have nursery costs.
Next I want you to go through your short term monthly savings and work out which ones you are going to keep. I assuming you will still want to go on holiday so saving up for that will likely still be on your list.
Let’s assume you are going to retire within the next 10 years and we will base the expenses off of that.
Once you have your monthly figure (e.g. £2,500) we are going to multiply it by 12 to get the yearly cost (e.g. £30,000).
Then we are going to multiply it by 25 to get our retirement fund. Why 25? Studies have shown that if you withdraw 4% of your investments the first year and then increase the initial withdrawal with inflation each year then your retirement fund will never run out. Assuming of course it is all sensibly invested.
So my retirement figure in the above example is £750,000. If I had £750,000 invested now then I could quit my job today and will have enough money to last me the rest of my life.
Don’t believe me let’s look:
Monthly Expenses: £2,500 Yearly Expenses: £30,000 Retirement Fund: £750,000 Retirement Age: 35
Now the S&P has returned on average, with dividends reinvested, 12%, so I am going to assume this will continue to be the case.
I am also going to assume that inflation is going to average about 3% (currently for the UK in 2019 it is only 1.8%).
Finally for simplicity sake I am going to take a full year’s worth of expenses at the start of each year.
If you manage to live to the ripe old age of 100. Due to inflation your expenses would have grown to £204,899.48 a year and your retirement pot would be a staggering £598,183,598.87.
If you play with the numbers a little you will find that as long as you get returns of at least 7% then your pension pot will never run out. Although it will start declining in value once you get to 84.
Now obviously this is a very simple example and reality the stock market has both positive and negative returns over the years. Inflation as well can vary quite a lot with a range of 0.37% to 24.21%.
Excluding the great depression of 1931, one of the worst times to retire in recent years would have been the year 2000.
The burst of the dotcom bubble saw 3 consecutive years of negative returns (-9.1%, -11.89%, -22.1%) before it went back up again. So lets have a look how this would have played out if you were to retire then.
As you can see below the story isn’t great in this case. Assuming 20% return in 2019 (currently on course for 23%) and only 7% return and 3% inflation in the years following. You would run out of money by age 63.
If you truly wanted to whether the storm you would have needed a £980,000 starting fund to see you through the downs and get you through to your 100th birthday.
This interestingly works out at a starting withdrawal rate of 3%, which some have suggested is a safer option than the 4% currently recommended.
In which case the multiplier to work out your retirement pot is 33.
Really it is up to you how safe you want to be in retirement. If you start to see your retirement pot decline then you could choose to lower your withdrawal amount or get a part time job to make up the difference.
If you only ever take up to 4% of your retirement pot a year you should be fine but you will in some cases have a few lean years where you will have to replace your retirement income with some part time work.
Alex started Pursuit of FIRE in 2019 to try and help people reach financial independence. He has spent nearly a decade working as a software developer in the finance industry and now is looking towards early retirement so he can spend more time with his young family.