The Only Number that Really Matters

ultimate retirement numberI’m constantly crunching numbers in my head, on spreadsheets, online calculators…you name it. You could say I’ve been borderline obsessive about this whole FIRE (Financial Independence Retire Early) concept, ever since I discovered it.

Being an engineer by education, although not by profession, has wired me to solve problems. It’s in my nature to try and figure out how to fix something that seems to be working inefficiently.

There’s nothing more inefficient than working 50+ restricted (high quality) years, to generate 10-20 unrestricted (low quality) years. By quality, I mean physical, mental and emotional health. Of course this assumes all those issues can be avoided during younger years.

If your work places no restrictions on your freedom to do what you would like, or makes up for that lack of freedom by enhancing your happiness, then this isn’t a problem you need to fix.

Unfortunately in my case, as I’m sure can be said for many others, work restricts my freedom considerably.

Which is why I continue to work on solving this puzzle. Looking at every angle, and testing potential solutions.

The Trigger Number Solution

If I had to come up with a number that would “trigger” my financial freedom, what would that number look like?

There are a number of triggers that can be used, some are more effective than others.

Age Trigger

I’m currently chasing an age target. My goal is to retire from traditional work by the age of 45. I believe that’s the optimal trade-off age. At that age, I get a 50% discount off my freedom.

If successful, it would mean that I worked 25 years in a traditional working environment, in exchange for 25 years of high quality freedom. Assuming of course I’m fortunate enough health wise.

Unfortunately an age target alone does me no good. It’s not an effective trigger without the finances to back it up.

Net Worth Trigger

Net worth is an attractive number to use since it’s generally going to be the most inflated. It’s wonderful to run scenarios on net worth, especially if the value is a healthy sum.

Who doesn’t like running compound interest calculations into the future on net worth? Makes FIRE seem that much more achievable.

Unfortunately using a net worth target as a trigger can be very deceiving. Without examining the components of my net worth carefully, I can find myself far short of what is needed to FIRE.

Passive Income Trigger

Another approach is to use my passive income target as the trigger. This is a useful approach because it’s tied to my spending level. As long as my passive income can cover my yearly expenses, I should be able to claim true financial freedom.

This is my preferred trigger, and the one I’ll use to determine an absolute number for FIRE.

The Only Number That Really Matters

When I look at my assets, I immediately need to disregard both my primary residence and my traditional retirement funds.

Even though my house is now fully paid off, its value has no direct impact on my trigger number. It does however have an indirect impact since having a paid off house lowers my passive income needs.

My traditional retirement funds will also have no direct impact on my trigger number. They’re reserved for retirement after the age of 70. Indirectly, they help my trigger number by relieving me of the need to save for traditional retirement in addition to funding my FIRE years.

This leaves me with funding my FIRE fund. The value of this fund is the only number that really matters, especially if I’m serious about financial freedom prior to the traditional retirement age of 70.

Calculating The Number

A number of factors and assumptions have to be taken into consideration when evaluating the ideal number for FIRE.

Income Assumptions

First it’s important to establish a desired lifestyle package. In the case of my household, we’re perfectly content living off $50,000 net per year. That’s the equivalent of a Gold package lifestyle.

Ideally, we would aspire to the Platinum package which would put us at $75,000 net per year. That creates plenty of buffer, and an extra squeeze of extravagance.

This means my desired net income to satisfy my lifestyle ranges from $50K-$75K per year.

Tax Assumptions

Since my income assumptions are based on net values, I would need to calculate the equivalent gross income needed to cover my expenses.

I’ll keep things simple and use the new tax brackets recently announced. Based on a joint household, my maximum exposure would be 12%. This of course assumes no changes by the time I pull the trigger.

Using that percentage at face value, my required gross income would be $57K-$85K per year.

Capital Preservation Assumptions

Another important factor to consider is the extent to which I want to preserve my initial capital during my FIRE period.

I can model my FIRE calculation to keep my initial capital flat, to increase it despite collecting income, or to draw it down.

I’m against drawing it down, so that option is not acceptable in my calculation. I find this strategy too risky, especially when one has a family. My intent is to leave a legacy of financial security.

My only other options are flat or increasing. For the sake of this exercise, I’ll choose to keep it flat in relative terms, adjusting for inflation as detailed below.

I don’t see the point in increasing it during this period, since doing so would require taking on more risk, consequently jeopardizing my freedom.

Rate of Return Assumptions

This is the most difficult assumption to make. Of all the factors in a FIRE calculation, the assumed expected return is the riskiest.

If I estimate my return too high, I run the risk of running out of money if things don’t work out. Alternatively, if I estimate my return too low, it may take me too long to save enough to reach FIRE. It’s a tricky balance.

I also need to consider the impact of inflation, which as I pointed out earlier would account for keeping my initial capital flat. This is another risky assumption, since no one can predict what inflation will do in the future.

To keep things as realistic as possible, and acknowledging that past returns aren’t necessarily reflective of future returns, I’ll stick to historical facts.

If I look at historical stock market returns, the true annualized return has been 9.15% including dividends.

Adjusting for inflation, the actual return drops to 6.96%.

Withdrawal Rate Assumptions

The final major assumption to take into consideration is my targeted withdrawal rate. This assumption can mean the difference between a relaxed period of freedom, or a stressful one.

There are endless articles about Safe Withdrawal Rates (SWR), with the leading consensus being 4%.

For early retirement however, I prefer a much more conservative approach, and one with the highest probability of success. If you want to learn everything you ever wanted to know about SWRs, and even things you never knew you should know, head over to ERN’s blog and check out this little primer on the subject.

Based on that fantastic body of work, I’m comfortable using a 3.5% SWR assuming the rate of returns mentioned in the prior section. Since I’m looking to preserve my capital during this period, I’ll need to ensure my exposure to stocks is at least 75% to maximize the probability of success.

Revealing the Number

With all these factors and assumptions taken into consideration, I can now calculate the amount of money I’ll need to save for my FIRE fund.

On the low end of the range, I would need $1,628,571 to trigger my ability to FIRE confidently. This takes into consideration my gross income target of $57,000 and the 3.5% SWR.

At the higher lifestyle range, I would need $2,428,571 to upgrade my standard of living. This is using the $85,000 aspirational gross income, and the same 3.5% SWR.

With my FIRE fund currently sitting at $660,000 I clearly have a significant journey ahead of me. With a target age of 45 to achieve FIRE, I’ve given myself about 5 years to accomplish this goal. Regardless of which number is reached first, the trigger will have to be the value of the FIRE fund.

There’s no doubt that my approach is very conservative. I could change many of the assumptions to make the target more achievable. I prefer to take this approach because there are many unknowns which could have an adverse impact on my plan.

Planning for the worst and hoping for the best helps me sleep better at night.

Readers, do you have a target number you’re chasing? What is it based on? Do you take a more conservative or aggressive approach? Do you think I’m being too cautious or not enough? Share your thoughts and comments below! – Max

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4 thoughts on “The Only Number that Really Matters

  1. I do include my retirement accounts in my projections as I know I will be able to get to it earlier. In fact my date is set to find time to draw down those accounts at low tax rates, avoiding RMD ramifications.

  2. The main number that mattered to me was my happiness index. I worked through my fifties because it was such an entertaining hobby. When it stopped being fun I spent a year planning life after work and then retired. I don’t think that a full time job is necessarily inferior to early retirement. I chose to work past FI because it appeared to offer me maximum happiness at the time. I admit retirement is much better but I don’t regret working as long as I did and only retiring slightly early.

  3. EXCELLENT overview of how to determine “When Can I Retire”. A little trick I use which may be of interest: every Dec 31 when I update my Net Worth, I include a line at the bottom of my spreadsheet which totals up ONLY my retirement assets. I do a subtotal for assets that I can draw before 59 1/2, as well as retirement accounts. I then calculate income potential using 3, 3.5 and 4% withdrawal rates. It’s fun to watch my “retirement income” grow each year with my net worth. Great post!!

  4. It’s important you mentioned this : “There’s nothing more inefficient than working 50+ restricted (high quality) years, to generate 10-20 unrestricted (low quality) years.” I think that’s something many people overlook in the retirement equation. Its good to work, but you have to at least give some consideration to how many “good” years you have left. I believe life and health is certainly better at 45 – 50 than 60 – 65. To a point, I don’t even mind working and making some money, but many jobs (especially higher level jobs) require long stressful hours and don’t leave much time or energy for your own interests. My outlook is to plan more conservatively with a 5 – 7% return and a 3% SWR plus some side hustle income as a buffer (as long as it makes sense), even if I dont totally need it. If the markets do well then thats just gravy and I’ll fine-tune things as I go.

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