You want to retire early but don’t know how. You want to be financially independent but don’t know how. Here’s the deal: the rules of FIRE (financial independence / retire early) are easy to follow, but the execution of your early retirement game plan requires complete focus and discipline.
The 4% Rule
The 4% rule is the glue that holds the financial independence / retire early blueprint together. If you break it, you could find yourself back at work after a short-lived retirement.
The rule states that you can withdraw 4% of your retirement funds each year (adjusting for inflation accordingly) to pay for your expenses. This 4% is known as the “safe withdrawal rate”, meaning your money will last through a typical 30 year retirement.
Let’s assume you retire early with $1,000,000 in retirement funds. In your first year, you can withdraw 4% of $1,000,000:
$1,000,000 * 0.04 = $40,000
In your second year, you can account for inflation by the long-term historic rate of 3% (assumed for illustrative purposes), so you can withdraw: $40,000 * 1.03 = $41,200.
Adjusting for inflation, $41,200 is equal to the $40,000 that you withdrew in year one and the process continues on. Ideally, your $1,000,000 of retirement funds will still be generating returns to offset the inflation effect.
The 4% rule operates under the following assumptions:
- The historical inflation-adjusted 7% return on the stock market will continue
- Your portfolio is 60% stocks and 40% bonds to properly diversify and balance risk
- You will only live long enough to need 30 years of retirement funds
- You will avoid large financial downfalls like unforeseen medical bills or costly lawsuits
The common rebuttals against the 4% rule are:
- In today’s low interest rate environment, you may not get the return necessary to sustain a 4% withdrawal rate
- People are living longer, which means they may need the money for more than the assumed 30 years
Some experts say weighing your portfolio more heavily towards stocks will allow for a longer retirement horizon. Another way to stretch your money out over time is to reduce the 4% withdrawal rate to 3.5% or 3%. Another thing to keep in mind is that any additional revenue streams (investment properties, businesses, etc.) can allow you to withdraw more than the recommended 4%. More money sounds like the best early retirement game plan to me.
Calculating your retirement number
Now that you know how to safely spend your retirement nest egg, you need to know how big to build it. This is where planning for retirement really comes in handy. If you’re thinking what I’m thinking, you’re absolutely right: your retirement number is directly related to the 4% rule.
If you already know how much you’ll need to spend each year of retirement, you can multiply that number by 25 (or divide by 4%, which is .04). That becomes the amount of money you need for FIRE. See how important the 4% rule is?
Let’s look at an example:
Let’s say you want to live on a steady diet of moonshine and pork roasts in South Carolina on $60k per year, or $5k per month. To retire, you’ll need $60,000 * 25 = $1,500,000. To retire for 30 years, all you need to do is save up $1.5 million! But how will you ever save $1.5 million!?
For a young professional pursuing financial independence and early retirement, the challenge is alluring. What is financial independence in the future going to cost you now? That depends on when you want to retire.
To retire as quickly as possible, your game plan should be:
- Saving as much of your after-tax income as you can (at least 40% is ideal)
- Investing your savings in a stock index fund (low fees and they mirror the returns of the broader market)
- Maximizing any 401k match your employer provides
The more money you invest (especially early on), the faster you can retire. Make your money work for you and take advantage of compound interest! Wouldn’t you have liked to learn about an early retirement game plan in school?
Be sure to use an official budget tool and keep track of your net worth if you’re not already doing so. You can build wealth, and you don’t need to wait any longer. What does your early retirement game plan look like? What’s your next step? Share it in the comments below!
All opinions expressed on this blog are solely those of Home at 30 and are in no way affiliated with any other organization or institution. The purpose of this blog is to give general education and information about investing, wealth, careers, and college; It is not intended to be professional advice.
Author: Josh Ramos
Josh has paid off $130k in student loan debt in 4 years. By founding Home at 30, he wants to help end the student debt crisis by helping students and young professionals make decisions that will reward them for a lifetime.