In this second part of my mini series on planning for early retirement (see part 1 here) I will look at how big a pot of money I need to service my estimated retirement spending for the rest of my life. In that first post I calculated that I will spend an estimated £29k per year once I’m retired.
To figure out how big my pot of money needs to be to allow me to safely withdraw £29k per year, I’m using the 4% rule. This is based on the concept of the 4% safe withdrawal rate – this is the amount you can withdraw from your portfolio each year without reducing the overall value of your portfolio.
There are many assumptions attached to this rule, not least that the research it is based on (The Trinity Study) was looking at a 30 year retirement period and those looking for early retirement are usually facing a much longer period. It assumes that stocks and shares generate average annual returns over long periods of time of 7% and that inflation will erode that growth by an average of 3% leaving 4% of realised returns.
However, the research does illustrate that historically there has been no time period where a 4% annual withdrawal rate reduced a retirement pot to zero in less than 33 years. Assuming I want to retire at 45, then this should get me to 78 without any problems and given how often I check my accounts, I’m pretty sure I would notice funds getting low well before they completely run out. And if it did look like it might not last, maybe because I retire in the middle of a market downturn, then there are always alternatives – I can find employment, tighten my belt and make savings in my expenses or use a cash cushion to ride out difficult periods.
So the 4% rule calculates how much to withdraw from my pot in a year:
Total retirement pot x 0.04 = Annual withdrawal
As I know what I want my annual withdrawal to be – £29k – then I can manipulate this equation to calculate the value of my total retirement pot:
Total retirement pot = Annual withdrawal / 0.04
Note that this calculation is the same as multiplying by 25 because 1 / 25 = 0.04 and this is often the method talked about on FIRE blogs so it looks like:
Total retirement pot = Annual withdrawal x 25
I love maths! Either way my scenario works out as:
Total retirement pot = £29k / 0.04 = £725k
So once my retirement fund is at £725k I can pull the trigger and retire! At the end of March, my net worth was £140k so I already have 19% of my retirement pot. I’d like to get to 25% by the end of this year! It makes it much more real when you can see your own numbers. In the third and final post of this mini series, I’ll look more closely at how long it will take me to reach this magic number and how it will be divided into pots.