What’s the magic number to retire? Is it 1 million, 1.8 million, or something else? A path to FIRE (financial independence retire early)…
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| Oahu, Hawaii |
Benjamin Franklin: “An investment in knowledge pays the best interest.”
In our early thirties, my wife and I decided to get off the rat race, away from the hustle and bustle of New York City, for land of paradise that is Hawaii. We envisioned living a slower pace of life, content with living close to nature and that beautiful Pacific Ocean surrounding the island.
We thought about drinking Pina Coladas or Mai Tais, while watching jaw dropping sunsets in the land where palm trees sway. We honestly thought that would be enough. We were tired physically and mentally, from working and living in a “city that never sleeps”, that is New York City.
For the first year of our life in Hawaii, we actually thought we could live simply, without much care in the world, and live with less, much less. We were making minimum wage working in retail/transportation industries but our expenses were low, as we forgo a car and we paid most things with cash.
We walked over to the world famous Waikiki Beach for just about every day while we first lived in Waikiki, meandering along the shop-filled Kalakaua Avenue, watching tourists gawking at the emerald/turquoise colors of the ocean.
Life was just about perfect! We couldn’t get enough of the ocean, the island, the cuisine, and the people. It was one of the happiest times for us, that first year.
However, like all good things, our honeymoon period would be over after a year. Once we started to work again, where we couldn’t walk over to see that beautiful ocean everyday due to work schedule, excuse, etc., we asked ourselves if our condominium we had purchased was enough to fund our retirement.
After careful analysis, we deemed it insufficient, especially if we were to live in one of the most expensive places in the world. With that realization, we would make a decision to move back to the mainland (Continental United States), to try to figure out how we can plan for a retirement that was fast approaching.
Looking back, we’re glad we made this decision to leave Hawaii (some of you may think we’re nuts for leaving Hawaii). Had we stayed in Hawaii, we couldn’t possibly have retired early at ages 48 (me) and 51 (my wife), making minimum wage…
So, how did we get to our early retirement you ask? Well, there are many things that contributed, but one thing that got me thinking, I mean really think that it could be possible to retire early, was encountering the FIRE (financial independence retire early) movement in my late-thirties.
After realizing we could retire early if we saved up at least 25 times our yearly expenses, we decided to go for it! At first, trying to figure out our magic number for our retirement was next to impossible:
- How do we know how much is enough to fund our retirement and our early retirement?
- How much do we need to spend per year to make this work?
- What about health insurance, car insurance?
- Where are we going to live?
- And list goes on and on…
Out of all these questions, the two most important questions were the first two:
- What’s our magic number to retire?
But before we can figure this out, we needed to first figure out how much we would need to live on a yearly basis. Why? The FIRE movement is simple in that as long as you withdraw 4% of your next egg each year, you would probably be able to retire early.
Why 4%?
In an average year, the stock market has returned roughly 10% rate of return. Even if you withdraw 4% yearly, the natural rise in the US stock market would provide enough buffer against inflation (which is typically 3%) and provide enough so that your initial nest egg wouldn’t decrease.
2. What’s our yearly expense?
This was tougher to figure out while we were both working, but eventually, we took our best educated guesses at what that might be after we retired. These were some of our best guesses and assumptions:
- We would be staying long term at AirBNB or Vrbo for 8 months out of the year and spend 4 months with our family
Budgeted $1000 on housing when using AirBnB or Vrbo; nothing when staying with family
- We would continue our car’s lease
Budgeted $500 for car payment, insurance, maintenance, tolls
- We would cook our own meals for the most part
Budgeted $400 for groceries
- We would do some dining out, but mostly takeout
Budgeted $200
- We would need to put aside a buffer for miscellaneous items like cell phone bill, entertainment, etc.
Budgeted $300
Total estimated yearly expenses: $24,800 times 25 equals $620,000. ***According to calculations used by FIRE movement, $620,000 is the absolute minimum amount we would need to retire early. In our magic number calculation, we assumed we would not be paying taxes as we planned on buying tax-exempt municipal bonds which we would withdraw from for about 8-10 years. Afterwards, we would withdraw from IRA, 401k, then hopefully, Social Security.
How close did we get to that amount in our first year of early retirement? We were right on! We actually spent bit less than that and we managed to save little bit of money for a rainy day fund.
Our guess was really good, but in hindsight, it only worked with careful planning, implementation, and our newfound lifestyle choice of being minimalists. Had we spent like normal (buying clothes, gadgets, knickknacks, useless things) like when we both worked, or had we not adhered strictly to our budget, then none of this would’ve worked.
The reason why I’ve been thinking so much about the so called “magic number” for retirement is because recently, I’ve come across an article online that mentioned a Charles Schwab survey that asked 1000 people what they thought their magic number was.
Unsurprisingly, it was $1.8 million. Why was it unsurprising? Well, that’s because I had seen a similar number ($1.7 million) few months ago, and before that something similar to that.
What’s the point of all these numbers? The point is that what people think they need to retire is completely different than what they actually have saved for retirement!
In reality, a median retirement savings account at Vanguard had $27,000. Another survey by the Federal Reserve’s Survey of Consumer Finances showed a slightly lower number of $26,000 but this one includes total financial assets for a household like retirement accounts, savings accounts, life insurance, etc.
As you can see, this is not even close to what people think (and wish) they need to retire…Reality and what people perceive is yet again, totally at odds with each other!
As I laid it out above, the key to figuring out your magic number for retirement is first figuring out how much you’ll need to live on in your retirement. If you’re like most Americans, then that answer is probably around $47,000. This figure is the median income for households over 65 and above, according to the latest Current Population Survey Annual Social and Economic Supplement survey. ***This figure takes into consideration all the reported income including social security benefits, pension, retirement account income, salary for those who work, etc.
Using this median figure of $47,000, you can then assume couple of things:
- Social Security is designed to replace roughly 40% of your income after you retire, but not the total pre-retirement income (on average, a retiree gets about $1700 from it)
- You’ll need to have other sources of income to fill in the rest ($47000 divided by 12 month equals $3916 per month. If you’re getting $1700 from Social Security, you’re still short $2200.)
If you live with your spouse who also gets a Social Security check, then you’re only short by $500 per month. This scenario isn’t bad at all, IF you’re currently retired and getting Social Security right now.
What if you’re not? What if you’re like me who’s too young to get Social Security benefits but is already retired? Or, you’re thinking about early retirement in the year 2040, as you’re just starting out?
Many of you have probably heard that by year 2037, Social Security will only be able to pay out roughly 76% of what retirees get today (this info is listed on Social Security website as of 8/10/2023). If you’re planning on getting Social Security after 2037, what then? Can you even count on Social Security???
When my wife and I planned our early retirement, we assumed our Social Security benefits will decrease by the time we turn 62. By planning with this mindset, we are ok if we get less benefits than the current retirees do today. For us, Social Security benefits would be an icing on the cake, our fun money for us to enjoy ourselves with.
For those of you younger than me, you should all plan on saving up for retirement and rely even less on Social Security. Assume it’ll be less than 76% by the time you can cash in your Social Security check.
What should you do in this scenario to prepare for retirement or early retirement? These are the things you should do, just like us:
- Make a financial plan and write it down!
Without thinking through, planning, and putting it into practice, you can’t retire early. Figure out what liabilities you have (debt, loans, mortgage, etc.), and figure out what assets you have (paid off car, retirement accounts, savings account, etc.).
This would be the very first step in trying to gauge where you are financially. Once you do this step, then move on to writing things down on paper (or somewhere). Write down when you’d like to retire, write down how much you’ll need yearly to live on (make your best guesstimate), then figure out what your magic number is.
- Learn to budget right now and get some practice at it, as you’ll need it after you retire as well
Budgeting is not hard in theory, but it is hard in practice. Budgeting is all about reining in your spending. You must practice buying needs (groceries, electricity bills, housing) vs wants (latest fashion, latest gadgets, exotic vacations).
Write down, or keep track of every purchase you make. For us, using one credit card vs multiple ones, helps us to budget, as we can track our ongoing purchases anytime we want.
- Once you’re budgeting, you’ll then want to pay off debt and start saving up for an emergency fund
Budgeting will allow you to see how much you have left over each month when your bills are paid. With this newfound money, pay off your debt while simultaneously saving for retirement.
Having an emergency fund is also paramount for financial stability. Without one, a simple thing as a car repair will become an emergency, where you’ll probably end up borrowing from your credit card or worse.
Start with $500 in emergency fund, then build it up from there.
Financial experts will advise everyone to have 6 months of living expenses saved up, but in the beginning, this is next to impossible. Think small bites, and keep working at it. We did it exactly the same way…
- Once your debt is under control, consider increasing the money you put aside to your retirement accounts like 401k, Roth IRA, IRA
Ultimately, you’ll want to max out your accounts. The quicker you do this, the faster you’ll be financially independent. Remember the rule of 25 to retire early. Figure out your yearly expenses, multiply that by 25 to arrive at your magic number.
Look at some of these examples below:
Yearly expense: $25,000 times 25=$625,000
Yearly expense: $30,000 times 25=$750,000
Yearly expense: $35,000 times 25=$875,000
Yearly expense: $40,000 times 25=$1,000,000
Once you achieve that figure, then you can choose to continue to work or not. It gives you options. You can get off the rat race like we did, enjoying the freedom to not needing to work, and travel/spend more time with family. Or, you can pursue your passion and do something that motivates you.
In conclusion:
Figuring out your magic number is only possible with careful planning, budgeting, and sacrifice. You can’t just wish for some arbitrary magic number without putting in the work! In life, what you achieve is directly proportional to the amount of work, effort, perseverance, and sacrifice you put in.
There are no shortcuts to early retirement. Unless you hit the lottery, or have rich parents, for most of us mere mortals, wishing upon a star won’t get you anywhere.
Embrace all those important factors above like writing a detailed plan, budgeting, having an emergency fund, paying off debt, and maximizing your retirement accounts to realize your dreams of financial independence and financial freedom. We did it, and so can anyone, with the right mindset and hard work!
Thank you for reading and good luck on your journey of FIRE!
Jake
Wandering Money Pig
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