How Much Money Do I Need to Retire?

If your ability to retire isn’t tied to an age, but instead a dollar value, what’s the number? How do you know when you have enough to retire and live off your investments without running out of money? Let’s nerd out for a bit.

If you’re new to Dollar Debrief and wondering how the heck we ended up here, read here and here to get up to speed!

Figuring out how much money you need to retire can seem like a nebulous decision with no clear answer. It’s hard to pull the trigger on retirement with confidence when you don’t know how much is enough. It’s especially difficult with people like Suze Orman out there saying you need $10 million before you can comfortably retire.

But this decision doesn’t have to be too complicated. Your target investment portfolio, or your FI (financial independence) number, should be influenced by two things:

1) How much money you plan on spending in retirement. The more you want to spend, the more money you’ll need to invest.

2) How long you plan to retire for. The longer your retirement, the smaller the percentage of your investment portfolio you’ll want to withdraw each year to make your money last (and as a result, the more money you’ll need).

Bottom Line: you need to have somewhere between 25 to 33.3 times your estimated annual retirement expenses (not your current expenses) invested to retire with a solid chance you won’t die broke.

Otherwise stated, if you can withdraw 4% of your investment portfolio or less each year, allowing for annual inflation adjustments, you can fully retire. This is commonly referred to as the 4% Rule, where 4% is generally considered a “safe” withdrawal rate for retirees of 30 years or fewer. This idea was first introduced by former financial planner William Bengen in 1994.

The history and research behind safe withdrawal rates is too long for this letter. Thankfully, Amazon has a concise, easy to read book that does a deep dive. The fact that the author and I share the exact same name, face, and birthday is just a wild coincidence…

As a formula, determining how much money you need invested to retire looks like this:

Using a 4% withdrawal rate: Annual living expenses in retirement x 25 = Investment portfolio value needed to retire (AKA FI Number)

Using a 3% withdrawal rate: Annual living expenses in retirement x 33.3 = Investment portfolio value needed to retire (AKA FI Number)

Someone with $48,000 a year ($4,000/month) in estimated retirement expenses would need an investment portfolio of $1,200,000 (at a 4% withdrawal rate) or $1,600,000 (3% withdrawal rate) to fully retire.

There are a few assumptions that this rule of thumb is based on that are worth noting. First, you need to know what you currently spend (this requires tracking your expenses over time). Second, you’ll need to gauge how your current spending compares to what you want to/think you will spend in retirement. Third, this assumes you won’t have any additional retirement income. Social Security and other income streams will reduce the amount of money you’ll need to have invested. Lastly, you’ll need to define what “safe” looks like to you.

Luckily, there are some tools out there to help determine what safe withdrawal rate suits your fancy. My favorite of all is FI Calc. No, we don’t get paid for recommending this calculator. Yes, I would be filthy rich if I did get paid each time I’ve recommended this calculator.

FI Calc allows you to run retirement simulations using historical US stock and bond performance from 1926 to present day. The end result is a probability (based only on past performance, making no guarantees of the future) that your selected FI number and withdrawal rate will make your money last your entire retirement.

To save you some time, I compiled the resulting success rates using multiple combinations of withdrawal rates, asset allocations, and retirement lengths into the table below. The success rates listed reflect the number of historical retirement horizons of identical length that had an end value greater than $0. The initial value of the portfolio doesn’t matter since I used a percentage withdrawal rather than a fixed dollar amount.

What are some key takeaways from this table?

• The longer your retirement, the lower your portfolio's success rate (as expected).

• The lower your withdrawal rate (as in, the less money you withdraw from your accounts each year), the higher your portfolio’s success rate (again, as expected). Notice the steep drop-off in success rates for everything over a 4% withdrawal rate.

• The lower your withdrawal rate, the higher percentage of your portfolio you can safely hold in bonds without completely depleting your portfolio.

• The higher your withdrawal rate, the higher the allocation of stocks you'll need to hold in your portfolio to make your money last.

So, what's a "safe" withdrawal rate after all?

• A 3% withdrawal rate is as sure of a bet as anything. Historically, a 3% withdrawal rate for a 50% stock allocation or greater has never failed over any retirement horizon up to 50 years. This isn't to say that it can't ever fail, just that it hasn't yet.

• A 4% withdrawal rate isn't too shabby either. A 4% withdrawal rate has yielded up to a 100% success rate for 20-year retirees and a 90% success rate for 50-year retirees.

• You begin to enter dangerous waters with withdrawal rates over 4%, especially over longer retirements.

Selecting your withdrawal rate is an entirely personal decision, with more nuances than I can possibly cover in a single newsletter. Future newsletters will elaborate more on asset allocation, taxes, and other factors worth considering before retiring.

Lastly, don’t let your FI number intimidate you. Sure, it may be big. But 1) compound interest can do the majority of the heavy lifting and growing for you, and 2) having a target number to work toward can be more motivating than investing aimlessly with no end in sight.

Call to Action

First, estimate what your retirement expenses will be, based on your current expenses. If you don’t know your current expenses, start there. Next, use the formula listed above to calculate your FI number. If you can’t decide on a withdrawal rate, use 4% as a baseline to run the numbers.

What We’re Reading/Listening To:

Military Money Show, Episode 153: The Steps to Financial Independence Retire Early (FIRE)

Debrief on Deck

Next week, Wilson will enter the Matrix as we talk about cryptocurrency and non-fungible tokens (NFTs). Maybe you, too, can be the proud owner of a Bored Ape Yacht Club NFT for the small fee of $693k.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (Twitter and Instagram).

Until then, stay the course.

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