So far, I’ve given you a rundown on my limited knowledge of investing, and we learned some terms to know. Now, it’s time to narrow down our concentration. There’s a lot of different facets of investing, so I want to make sure that, instead of glossing over everything, we can take a semi-deep dive into the most important buckets. In this part of the guide, I’m focusing on retirement investing. I think this is where everyone should start with investing because it’s a bit more straightforward, and it’s like an emergency fund for your life. You wouldn’t go planning multiple trips without having some money saved up in case something happens (well, you’re not supposed to. Guilty!). Similarly, beginning to invest in taxable stocks, bonds, and funds before taking advantage of the tax-deferred options that will help you later in life just seems silly. So, we’ll start with what every 24-year-old spends hours thinking about: retirement. *cue the sobbing*
Retirement is years and years away for me, so it often pains me to think about. I’m just starting to get a grasp on renting and paying bills, so thinking about getting older and having even more responsibilities makes me want to stop typing and take a stress nap. For you, dear reader, I’ll carry on. The fact that retirement is so far away is exactly why it’s important to be thinking about it now. I know the earlier I start investing the bigger payoff I’ll have in the future. The same way interest works against you and causes debts to grow, it can also work for you and cause your investments to grow. That’s the magic of compound interest*.
To make retirement a little less nebulous, it’s important to consider your goals. Do you want to travel across the world post-retirement? Sit on a beach and sip mojitos? Play golf? Pursue your recent pipe dream of a self-named bar and brewery with cutesy puns based off your own name (Briana’s Bar and Brewery, home of the famous Bri Beer and Bri-llinis)? Maybe it’s a combination of all of these things. Even if you love your job and want to do it for as long as possible, you can keep working with the solace of knowing your job needs you; you don’t need the job. There are so many options that one can pursue, but all these options have their own costs associated with them. After learning about the FIRE movement (Financial Independence, Retire Early), I’ve decided that I too want to retire early. Retiring (early or not) means that you’ll need to have enough money to last you throughout retirement; that’s where the 4% rule comes in.
The 4% Rule
When you retire, you want to be able to live off the investments you’ve been putting away for retirement without worrying about them running out. The 4% rule can help you ensure that happens. This rule came about from a study done by three finance professors at Trinity University. After conducting their research, they learned that in most cases, if you withdrew 4% of your investment portfolio (composed of 50% stocks and 50% bonds) each year, it would last you at least 30 years. This worked 96% of the time. There are some variables that aren’t totally accounted for (early retirees who are likely to have a retirement longer than 30 years, for example), but for the most part this is what many people use to determine how much they need to retire successfully.
So, how do you calculate the amount of money you need to have in your investments? The first step is knowing how much you spend in a year (your average annual expenses). I thought this was going to be pretty difficult for me, but I’ve been using Mint for years, and it keeps track of expenses (you’re welcome for the product placeMINT). I took a look at my expenses last year and then for the last 12 months and learned that my average annual expenses were about $33,680 which was actually less than I was expecting because sometimes I feel like a big over spender. Still, even if this is a little off, it’s not the number I plan on using anyway.
Right now, my life looks a lot different than what I think it’s going to look like in ten years or even next year. I live in a really low cost of living area (please ask me what I pay for rent; I love telling people). I don’t really spend a lot of my money on restaurants or bars because there aren’t many around me. I make a lot less now than what I think I’ll make in the future, and I know I’ll probably fall prey to lifestyle inflation. In the future, I’ll hopefully travel more and potentially live in another country. I may have a spouse and/or kids, and I’ve heard those are expensive. For all these reasons, I think my annual expenses in the future will be higher, probably around $50,000. This is still relatively low, and I want to be on the safe side, so for the purposes of calculating my retirement number, I’ll use $55,000. In ten years, when I’m more aware of my actual expenditures, I’ll revisit this number.
I know how much I’ll need each year in retirement, so it’s time to figure out how much I’d need in a retirement portfolio. With the 4% rule, it’s easy. You can take your average annual expenses and divide by .04.
$55,000 / .04
Though that might make math-y sense, for my mind, it’s easier for me to calculate by multiplying. You can also multiply your average expenditures by 25. By thinking of it that way, I know I need 25 times my expenses to retire comfortably.
55,000*25=$1,375,000
While 96% success is nothing to sneeze at (and with flexibility, can actually be even higher), it may still not feel super comfortable to think you might be in the 4%. I would consider myself moderately risk averse (and before I dove into all of this, I would have said EXTREMELY risk averse). Because of this, I’d give myself even more of a buffer. Instead of taking out 4% of my portfolio each year, I want to do a little closer to 3.5%, The calculation is no different
55,000 / .035.
For a grand total of
Whew, that’s a lot of money. By the time I want to retire, I should be over a millionaire (and a half). Honestly, that doesn’t feel possible right now on my meager teacher salary. I know saving alone won’t be the best bet for me which is why it’s nice to know I’ll have compound interest on my side.
Your retirement number may feel a little discouraging; I think I put off doing the actual calculations for a while because I didn’t want to come to terms with the number. The bright side is: someone I love isn’t being ransomed and I don’t have to come up with that money overnight. $1,571,428 looks like someone my age investing about $555 a month (I threw some numbers into NerdWallet’s retirement calculator to get this number. It assumes you’re retiring at 67, and it adjusts for inflation. I have no idea how to calculate this on my own, and these are the basics so you shouldn’t have to know either). Thinking in chunks like this makes it a lot more digestible, and any extra savings that I can add to that $555 means retiring earlier.
Well, there you have it, a pretty simple way to arrive at your retirement number. If you want to get into the nitty-gritty, you can check out a couple of resources I found really useful (and one I just skimmed). Did you find your retirement number? Share them with me and maybe we can be #retireebesties
*Compound interest is basically what you earn on what you gain. Say you invest $1. Next, year that grows to $1.10, and you earn money on that $1.10 not just the $1. Making money!
Resources used (so far):
- The Research Article by the Trinity Professors
- JL Collins Stock Series XIII: The 4% Rule, withdrawal rates and how much can I spend anyway?
- JL Collins Stock Series XXVI: Pulling the 4%
- Go Curry Cracker What is Your Retirement Number - The 4% Rule
- A good article about why you don't have to be a worrier like me and 4% is pretty safe
