For any veterans of the financial independence / early retirement world, you’ve probably already ingrained this calculation into your brain, never to be forgotten. You might even have a poster on your wall that you bow down to each night that simply states four words, “Maximize Your Savings Rate”.
This article might not add a lot of value to you if you are one of these people, but there are many, many people who don’t really know the simplicity of financial independence, and this calculation is basically the gospel that the entire financial freedom world is based upon. So for those who aren’t familiar with this, let’s get to business.
When searching for an online retirement calculator, you will be inundated with bloody tons of them. This leads people to get all flustered and confused, only to turn to the dreaded financial advisor who will probably recommend some God awful GIC to you. Anyway, the truth is it’s not hard at all to calculate when you can retire, all you need is a bit of data on your earnings and expenses, and a couple of assumptions along the way, and you’re golden.
You might also be surprised your income doesn’t even make a difference. You could feasibly retire at the same time, or even earlier, than some geezer earning considerably more than you.
All you need to calculate is your annual savings rate. A chimp with a calculator could do this, so go and get one. Put this in:
Annual Savings Amount / Annual After Tax Pay
Let’s assume your household earns $100,000 after tax and manage to sock away $30,000. You have a savings rate of 30%
Now let’s assume your household makes $50,000 after tax and put away $15,000 per year. These too would have a savings rate of 30%.
Using this savings rate, we can put it into this handy dandy calculator to tell us how many years it will take before we can retire.
The key here is the savings rate. No matter how much you earn or spend, if your savings rate is 30%, you can likely retire in just under 26 years, so the $100,000 family and the $50,000 family can both retire at the same time.
What is this wizardry?!
The reason for this is because all that really matters when reaching retirement is your savings rate and annual expenses. The following assumptions have been used, I should note:
- Current annual expenses will remain unchanged in retirement
- Income is after-taxes
- Return on investment is after taxes and inflation
You can’t change these assumptions, however, there are optional assumptions that you can adjust:
- Return on investment
- Withdrawal rate in retirement
For the above calculation, I used an ROI of 6%, which is damned conservative, to say the least. I’d personally be gunning for returns closer to 9% or so, which would reduce this figure drastically to around 21 years, but hey, some people are wusses who like to invest in detrimental things because they don’t like volatility.
The next adjustable assumption is the withdrawal rate in retirement. This is assumed to be 4%, or $40,000 per year if you have a $1 million portfolio. I’ll write an in-depth article on this later for those that want to know more, but for now just leave it at 4%.
So how do you speed up your retirement?
Well, that’s easy. Increase your savings rate as much as possible. Let’s assume your house is earning the $50,000 per year but you manage to save $20,000 a year instead of $15,000. This increases your savings rate from 30% to 40%.
Looks like you shaved almost 6 years off your working life with a meager $5,000 per year increase in savings. And let’s not forget, this is using the wussy 6% ROI, which I don’t encourage for anybody seriously pursuing financial freedom. With a 9% ROI, you’re talking more like 17 years, which ain’t bad at all!
Some of the major financial independence bloggers have savings rate nearer 75%, which can allow a retirement time frame of around 6-7 years. This is how many people actually manage to reach financial freedom in their 30’s. Typically though, these guys have had enormous salaries and low costs of living. If you’re a major player like them though, aim high! For me (and most people), something like a 50% savings rate is a huge accomplishment, providing an amount enough to retire on in about 14-16 years depending on your ROI.
A Pinch of Salt
This is a great calculator for giving you a good estimate of when you can potentially retire, and it allows you to play with some assumptions to give you feedback on what would happen if you changed XY or Z. However, one of the major assumptions you cannot change is that you will spend the same amount in retirement as you do when working. This is a contentious assumption, as many people will spend less in retirement, whilst others will spend more. Any change in your spending after retirement will potentially affect the outcome of this calculator.
I’m of the opinion that our annual expenses will go down in retirement, largely because we would leave Vancouver (which is extremely expensive) and live in a much cheaper area. We could likely half our rent alone by doing this. This would allow us to shave a few years off the calculations for sure, or you can likely add a few years if you anticipate spending more in retirement
So what do you take from this? Well, your number one priority, if you are aiming for financial independence, is to maximize your savings rate as much as possible. This is obviously done by both increasing income and reducing costs, as well as investing your savings effectively. This is where Money Miser is hoping to help out as the Miser household has been jumping through these hoops for years now and have gotten many of the nuances down to an art.