So how do you understand what you actually need in retirement and reign in your goals? Let me walk through an example to get you started.
RULE OF 25 EXAMPLE
First, let me introduce the Rule of 25 if you’ve never heard of it.
The Rule of 25 is a simplified method of calculating the total amount that you will need in retirement. It assumes that 4% is the safe withdrawal rate at which you can spend your retirement savings, such that you don’t run out in your lifetime.
The math behind the rule is that a safe average return rate for investments is 7% per year before inflation. Inflation eats 3% on average, and you have 4% to live off in perpetuity. Saying this another way, taking 4% out of your investment account each year allows the overall balance to continue to grow, not shrink, forever.
Let me stress this is an idealized and simplified version for calculating your retirement needs. For example, you can certainly debate what the average inflation might be after our current run, but this rule is a great place to start as you get to know your numbers.
CALCULATING YOUR RETIREMENT NEEDS
Now that the concept of the 4% safe withdrawal rate is clear, how do we calculate our retirement using the Rule of 25?
For this example, I am going to use a monthly budget of $5,000. To convert that into your yearly budget, multiply the $5,000 by 12 months to get a $60K annual budget.
Then to get your total retirement estimate, multiply the $60k by 25, and that translates into $1.5M as the rough number that you’ll need for retirement.
To do the math the other way, the 4% yearly withdrawal rate of $1.5M is $60k per year, letting you start visualizing how the Rule of 25 works.
IMPACT OF SPENDING
Okay, now that we have an overall number to start working with, let’s look at the impact spending can have.
Lowering your monthly budget by $500/mo can change your overall retirement need from $1.5M to $1.35M. ($5,000 – $500 = $4,500. $4,500 x 12 = $54,000. $54,000 x 25 = $1.35M.), and you could retire with $150K less in your accounts.
When you start looking at how much you can save a year, this could literally shave years or even decades off your retirement date. Or it could provide you with the cushion or insulation for your savings to tackle things in the future like inflation.
CHANGING YOUR THOUGHTS
With this type of calculation, I want you to start thinking about how LITTLE you can retire with, not how much you need. This shift turns traditional thinking on its head and starts to put those far-off goals within reach. It’s the magic that will allow you to find your financial freedom!
Want more on this line of thought? Then read my article on “Why I Think You Should NEVER Retire” by clicking on THIS LINK, which will share with you a life-changing secret about retirement.