I want the choice to retire by the time I hit 45. That isn’t to say that I will literally start my retirement at that age, but I want the freedom to not be worried about job precarity from then on.
For me, the best way to achieve an intention is to decide exactly what that intention entails. Of course, the freedom to retire will mean different things for different folks, depending on their desired lifestyle and current situation.
Freedom in (theoretical) retirement
“It’s amazing to think we ever had time to go to work!” – Reg & Shirley Slack
I often try to tell people about my grandparents and end up saying that if I have half of their energy, social life, travel experience and general awesomeness by the time I’m 70, then I will be more than content with life.
Retirement shouldn’t be seen as a simple state of ‘not going into work’, but rather ‘more time to pursue what I want to do’. For some folks, this might still be going into work on a daily basis…but without the stress of requiring the paycheck to keep a roof over their heads.
Caution, Math Ahead
This is where we need to get a bit technical.
How many times have you heard the phrase “if I won a million dollars, I’d retire and travel the world,” from someone in their thirties or forties?
-Raises both hands-
Unfortunately, this common dream has some flaws. Here’s why.
Assumptions: The person is 45 when they win the lottery, and will live until the ripe old age of 85. They’ll want to spend around €40,000 per year for them and their spouse doing all the things they want, without worrying about finances.
First of all, the money has to last for 40 years (85-45).
A simple (slightly hand-wavy) equation will let us know immediately if that cool €1M would last that long if they stuffed it under the mattress.
€1,000,000 / €40,000 = 25 Years
What do you really want?
At this stage, I know that 40k per year is a number I could live suuuper comfortably with. Especially if it was passive income, after tax. So let’s see if we can figure out how to get me to that point.
Using the same simple sum as above: €40,000 x 45 years, is €1,800,000.
Withdrawals, Returns and Inflation – oh my!
Before we can plug in all the numbers, there are a few more things to take into account.
There’s a financial rule of thumb for retirees that suggests withdrawing 4% of a retirement nest-egg each year. (There are issues of liquidity, but since this is a thought-experiment, you’ll have to forgive some hand-waving). Now this might be a great idea for a 65-year-old, who’d likely be happy with their retirement savings lasting for 25 years (4% x 25 = 100%), but not very useful for me and my 45-years-of-retirement.
However, because we know how much I’m aiming for per year, we can plug in this number instead.
Withdrawals = €40,000 p/a
Unfortunately, €1 today will not be worth €1 five years from now. (This is called ‘reduction of capital purchasing power’. Or, ‘how much bread can I buy with €1, next year?’) The average inflation rate over the last 100 years for the UK is 2.88, and in the US it’s slightly higher. It’s better to overestimate than underestimate so we don’t fall short and run out of money, so we can assume an average annual inflation rate of 3.2%
Withdrawals = €40,000 p/a
Inflation = 3.2%
Not many folks would want to have €1million gathering dust in a regular savings account, especially with interest rates below inflation (so you’re actually losing money by keeping it in a regular savings account!) There are plenty of investment opportunities out there that might result around a 7% return (gross) per year. (More hand-waving here regarding risk versus return). Since we’re looking at gross return, we can assume that it means before inflation. So if we do a super simple calculation:
Gross Return (7%) – Inflation (3.2%) = Net Return (3.8%)
This essentially means that we can withdraw 3.8% of our portfolio per year, without touching the principal (basically living off the interest).
Now, let’s find the number that we can remove 3.8% from in order to get €40,000 per year.
3.8% of €1,055,000 = €40,090
A difference of…a lot
It’s amazing what just a few percent of interest can do for financial longevity. Between the first and last calculations, there’s a whopping €745,000 difference!
Granted, this has been a thought-exercise rather than a close-analysis of exact amounts required for my retirement goals. Other considerations to be wary of when trying to figure these numbers out for real include:
- Liquidity of Capital
- Market Volatility
- Health expectations
- Desired inheritance to leave in your will
What does it all mean?
According to all the lovely workings-out above, this is what I need to work towards within the next 16(ish) years.
It’s not an exact number, because who knows what the stock market or inflation rates or investment vehicles are going to do or evolve into within the next ten years, let alone the next forty. But I truly believe that having a set goal that’s based on loose calculations is better than just ‘aiming for a million’ and hoping for the best.
T-Minus 16 years to generate €1,055,000.
The clock is ticking.
What’s your financial goal for the next decade?