Financial independence, retiring early which is abbreviated as FIRE is another goal that has gained popularity, especially among individuals in their 20s. The core philosophy of the FIRE movement is to accumulate enough passive income during one’s youth to retire several decades before reaching the standard retirement age. But just how much money do you need to ensure that you have a wealthy retirement and hence attain the much-desired FIRE? Here’s a breakdown.
The 25x Rule
One of the best FIRE recommendations to follow is to aim at having at least 25 times your planned annual expenses in retirement. If, for instance, you expect to spend $40,000 annually when you are retired, then you will plan to save for 25 years, to have a total savings of $1,000,000 which will cater for your retirement expenses.
In essence, this 25x rule is supposed to mean that your savings can last the years in retirement, pay for the lifestyle you desire, and make up for inflation for over three decades of retirement. It is invested in diversified stocks, bonds, and other securities that are expected to pay average annual returns to cater for one’s retirement.
Well, the desired spending simply means different people have different spending targets and therefore the numbers will not be similar. If a person wants to retire early, it is very important to manage savings/spending rates for several years before one can get to a number that will take him to 30-40+ years of retirement.
Safe Withdrawal Rate – Is 4% Safe?
In connection with the 25 x rule, there is also something called the 4% safe withdrawal rate. This says you can retire, and take out of your retirement funds $4000 annually, and this is safe for decades.
As such, if you have saved $1,250,000 by the time you are 45 years old, then you can live on $50,000 in the first year of early retirement as this is equivalent to 4% of your total saving. You then increase $50,000 by a bit each of the following years to cater for some form of inflation. Once more, the 4% rule is based on the principle that one should have enough money invested to yield a return that is greater than the amount that is being withdrawn from the portfolio.
Geographic Arbitrage
The last factor we consider when calculating your FIRE number is where you envision retiring. FIRE enthusiasts planning to retire at 40 or 45 also use geographic arbitrage to relocate to cities that have much lower costs compared to the cities with high costs where they save most of their money.
Domestic destinations include small towns and small cities mainly in the Midwest and the South, which are far cheaper than major cities by the ocean averaging half the price. Other retirement destinations that can be considered are those in the international category, such as Costa Rica, Panama, Thailand, or Portugal where you can save even more. If the city of your desired FIRE location is cheap, it will not cost you the exorbitant 25x to sustain your preferred lifestyle. Even pennies saved each month are significant when one wants to amortize portfolios to fund early retirements lasting 40+ years.
Thus, although 25 times your planned annual expenditure and 4% SWR are helpfully defined FIRE savings targets for many people, your target amount depends on the retirement lifestyle, your planned location, and your particular circumstances. To this end, remember to place a high value on tracking expenses, optimizing for savings rates, and containing expenses several years before the set FIRE retirement age.
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