Determining your Financial Independence number

I mean really, what 30- or 40-something is never going to work for any money ever again??

(Answer = you know it.)

Surely some of them will hustle a blog, a course, a book, a podcast or other at some point. The list goes on.

Such FIRE-seekers and very early retirees are not likely misleading people on purpose: some are just simply entrepreneurs …

Forget “RE”, “FI” is the worthy goal

While I couldn’t care less about the retire early part of FIRE, I am working towards the FI part and have been doing so for at least a decade now.

I think most people should absolutely strive for FI instead of early retirement. (See this 2019 blog, Strive for Financial Independence, not Early Retirement).

How much do you need to save for any comfortable retirement?

“It depends.”

According to Fidelity, to be on track for a healthy retirement:

• You should have x1 your annual salary saved up for retirement by age 30.
• You should have x3 your annual salary saved up for retirement by age 40.
• You should have x6 your annual salary saved up for retirement by age 50.
• You should have x8 your annual salary saved up for retirement by age 60.
• You should have x10 your annual salary saved up for retirement by age 67.

As a 40-something, according to the pros we should have at least x3-x6 of our annual savings in the bank.

I’m glad I don’t listen to Fidelity. We’re beyond that milestone and we’ll be better off financially (sooner) because of it.

Here in Canada, MoneySense did some similar work on this a while back:

Do you really need this much? $1 million or $1.5 million? More?

“It depends.”

I can’t tell you unfortunately: since that answer comes with a complex set of income needs and wants and everyone’s spending goals are very, very different.

I can say with a rather firm set of certainty that if any Canadian or U.S. citizen that amasses this much portfolio value by age 65 and has modest spending needs they will be far better off financially than most.

Our FI number

For years, I’ve pegged our FI number to be around the $1 million portfolio value mark not including any home equity (and our soon-to-be debt-free home: we have to live somewhere!), excluding our workplace pensions, and excluding any future government pensions such as Canada Pension Plan or Old Age Security.

I largely arrived at this number by using a rather standard FI formula.

Financial Independence means:

1. earning enough passive income from my assets such that my asset-producing passive income is > general expenses, and/or
2. amassing a portfolio value such that reasonable withdrawals will be > general expenses for many decades on end.

What are reasonable withdrawals???

You could argue the birth of any reasonable and therefore any safe portfolio withdrawal formula was originated by U.S. financial advisor William Bengen.

You can read about his genesis for the 4% rule and why it still makes sense by reading this blog from earlier this year: Why the 4% Rule is (still) a decent rule of thumb.

Following Bengen and largely reinforcing his work, three professors at Trinity University published a paper about safe retirement withdrawal rates.

Those professors looked at stock and bond data from the mid-1920s through to the mid-1970s and their conclusion was that essentially over any 30-year investment period in that range, a retiree could safely withdraw 4% of their total assets per year without much fear (meaning barely any fear) of running out of money. Only in a handful of cases, the very worst cases in any 30-year period, would the portfolio go to absolute zero.

So, let’s look at that context when it comes to our goals:

If we managed to enter retirement with our desired $1 million goal of invested assets (along with no debt of course), then we could reasonably expect to assume we could withdraw $40,000 per year for our living expenses from that portfolio with very little fear of running out of money.

Henceforth, the study by those three professors from Trinity University, The Trinity Study, have set the framework for a gazillion FI number crunching exercises to this day and likely the same number into the future …

Determining your FI number 

Here are some options to crunch your math.

1. Determine your annual expenses and multiply by 25.

Essentially, this is leveraging the 4% rule albeit in a different way.

Should your general expenses be in the range of $40,000 to $50,000 per year (after tax) like ours intends to be, then spending $40K to $50K per year would translate into a FI number of $1 M to $1.25 M.

2. Use the “When can I retire?” calculator.

While any 4% rule is a nice starting point, what is even better is using a calculator!

I found this handy-dandy tool below and used some fictitious numbers for an example:

You can find this FREE tool on my Helpful Sites page.

3. Take a deep dive into your planned expenses and then consider using the VPM method.

I like the Variable Percentage Withdrawal (VPW) method for a few reasons:

• It combines the best ideas associated with constant-dollar withdrawal and constant-percentage withdrawal strategies.
• It adapts your withdrawals to market/portfolio returns so effectively you don’t drawdown your portfolio too quickly.
• It uses a variable, and an increasing percentage to determine withdrawals so effectively you don’t hoard your money “until the end”.
• This is one of the best approaches to increase spending in “good years” and decrease spending in “bad years” therefore giving investors psychological ease.

Here is how you can use the VPW method including a link to a FREE calculator to use. Click here.

Summary

Ultimately, I believe you’ll need to start with where you are to determine where you want to be.

This means getting a great handle on your current expenses as well as any planned expenses (in retirement), along with hedging the “what ifs” in life by keeping some cash for any plans that go awry is just smart planning.

Most definitely, you could use some very conservative 3%-3.5% safe withdrawal rates for longer retirement time horizons beyond 30-years but even then, you could end up with far more money than you can spend.

The future is always unknown.

Years ago my wife and I set some goals to hopefully retire or at least semi-retire around age 50. I would like to think we’re still on track. More posts this year will shed some light on that.

I would encourage you to figure out if you’re on track for your early retirement dreams by reviewing your own spending goals and/or using some of the FI tools and calculators above.

I look forward to hearing how you’re going about your business realizing your FI goals too.

Thanks for reading and sharing. I look forward to your comments!

Mark Seed is a passionate DIY investor who lives in Ottawa.  He invests in Canadian and U.S. dividend paying stocks and low-cost Exchange Traded Funds on his quest to own a $1 million portfolio for an early retirement. You can follow Mark’s insights and perspectives on investing, and much more, by visiting My Own Advisor. This blog originally appeared on his site on June 29, 2020 and is republished on the Hub with his permission.