Some might ask, what is a FIRE number? FIRE stands for Financial Independence Retire Early. This number is important because it gives you a goal to set in order to retire, as eventually, we all want to retire someday.
If this number is new to you, I’m going to help you calculate it specifically for you and your situation. It’s not that hard and only takes a couple of punches on the calculator. So, grab some paper and a pen and let’s get to it.
Calculate Your Annual Expenses
The first thing you need to do is find out how much your expenses are during the year. To find this number, you take your monthly bills and multiply by 12. I would recommend giving yourself some grace, as you don’t want these numbers to be too tight. So, give yourself some wiggle room and be conservative with these numbers. An easy way to ensure you have enough money is to simply take your yearly salary or what you eventually want to make each year when you retire.
The 4% Rule
The 4% rule might be something you’ve heard of before. If not, I’m going to explain how this rule can benefit your life. The number, 4% is something that mathematicians or investment bankers came up with, and it’s supposed to allow you to withdraw 4% of your account safely without having to worry about running out of money while you are retired.
Some people use 4%, while others use 5%, but really it’s up to you to decide. This number is supposed to allow you to effectively have more money at the end of the year that you’ve taken out throughout the year, assuming a 7% return on your investments. So let’s choose a number and stick with it for the rest of this exercise.
Find Your Number
Now that we have our number of how much we want to withdraw in retirement, we need to find out how much money we need to retire. To do this, we need to divide your number by either 4% or whichever number you choose. This will give you the number that you need. A simpler way to do it is to multiply your expenses by 25 or 30.
Let’s do an example. Let’s say our annual expenses are $30,000. We’re going to take that $30,000 and either divide it by 4% or multiply it by 25. $30,000 * 25 = $750,000. So, $750,000 is what you need to retire with an annual expense of $30,000.
Adjust For Inflation…Or Don’t!!!
Something that people do is adjust their safe withdrawal percentage based on inflation for that year. However, if you weren’t living under a rock for the past year, you know that inflation has been historically high for 2022. If people adjusted their percentage based on inflation, their 4% withdrawal rate would turn into almost 13% for 2023. Withdrawal of 13% year over year is not sustainable and will eventually lead to running out of money.
Therefore, I propose sticking to your safe withdrawal percentage, and most of the time, the stock market will outperform inflation, allowing you to withdraw more money because the stock market is going up as inflation is going up. The downside is that if the stock market loses money, you will withdraw less money the following year. But this approach would allow you to stick to your safe withdrawal percentage and have money throughout your retirement while adjusting for inflation over time, because as your account grows, your withdrawal percentage will stay the same, but the money you’re taking out will grow.
Monitor and Adjust Your Plan
The last thing you need to do is focus on adjusting your plan as needed. I’ve given you something that you can stick to and that can be automated, but we will always have to check and eventually adjust the plan to meet your yearly needs. It’s important to trust your plan. It has worked for you this long and will not fail you.
Rob’s Opinion
Overall, it’s a powerful tool that can enable financial independence and even early retirement. My advice is not much different from what I’ve stated above – use your yearly salary or slightly higher as your expense number, and make sure that your withdrawal rate stays consistent over time, adjusting for whether you have a positive or negative return the year prior.
