I’m in the business of helping people successfully retire early, so I get a lot of questions about personal finance. People ask me how to get out of debt, how to invest their money, how to reduce their expenses, and how to earn more income.
But the one question I get more than any other is “How much money do I need to retire early?”
I see this question on Quora, where I’m a Most Viewed Writer in Retirement Planning. I see it on Wallethub, where I’m a Finance Expert. And I’m asked this question by friends, relatives, and colleagues who would love to be able to retire a little early.
The answer to this question depends almost entirely on one single factor: your expenses. Once you’ve figured out what your monthly and yearly expenses are (or what they will be in retirement), you can then calculate exactly how much money you need to retire.
So what’s the magic formula? I’ll tell you what the general rule of thumb is, and then I’ll tell you what I recommend. Here we go…
The Rules of Thumb
Allison (my wife) and I retired in our early 40s without knowing anything about the so-called “rules of thumb” for retiring early. We just crunched the numbers in our financial spreadsheets and determined that we had enough to retire.
But it turns out that there are two general rules to help you figure out how much you need to retire. These two rules are the 4% Rule and the Multiply by 25 Rule.
These two rules are really the same rule expressed two different ways. Basically, it states that your yearly expenses should be no more than 4% of your savings (or nest egg). The flipside of that statement is that your nest egg needs to be 25 times greater than your yearly expenses.
The 4% Rule
Let’s look at the 4% Rule a little closer.
The 4% Rule is used to help you determine the amount of money to withdraw from your retirement nest egg each year. The idea is for you to withdraw a small percentage of your nest egg to live on for the year while leaving the bulk of it untouched, so that it can continue to work for you.
In other words, according to the 4% Rule — if you stick to a withdrawal rate of 4% (or less) of your nest egg each year, you theoretically should never run out of money!
Where did this rule come from?
In 1994, financial advisor William Bengen conducted an exhaustive study of historical returns, focusing heavily on the severe market downturns of the 1930s and early 1970s. He concluded that even during very weak markets, no historical case existed in which a 4% annual withdrawal exhausted a retirement portfolio in less than 33 years.
The Multiply by 25 Rule
As I mentioned, the Multiply by 25 Rule is just the inverse of the 4% Rule. However, I like this rule better, because it clearly answers the question of how much money you need to retire.
Essentially this rule states that your required nest egg for retirement should be at least 25 times your yearly expenses. So for example, if your yearly expenses are $30k, then your nest egg needs to be at least $750k (25 x $30k).
If your yearly expenses are $100k, then your nest egg needs to be at least $2.5 million (25 x $100k). You get the idea!
As you can see, it all comes down to how much money you spend each year. If you can reduce your yearly expenses, then you can reduce the amount that need to save.
Nest Egg
We should also clarify what we mean by “nest egg.”
Your nest egg is very similar to your total assets, but with one big difference. For your nest egg, you only want to include liquid assets, which are cash or assets that can be easily converted to cash (like stocks, bonds, and mutual funds).
You can also include what I would call semi-liquid assets, which are your retirement accounts (like IRAs and 401ks). These aren’t fully liquid, because they have restrictions and/or penalties for converting them to cash before a certain age. (The one exception is for Roth IRAs, which allow you to withdraw your “contributions” at any time without penalty).
What don’t you include? You wouldn’t include non-liquid assets like your home, your car, your furniture, electronics, etc. Those are all assets, but you’re not going to buy groceries or pay your rent with those assets (unless you sell them and turn them into liquid assets).
Our Recommendations
We recommend you go further than the 4% and Multiply by 25 Rules. I wouldn’t feel totally comfortable retiring unless I had at least 30 times my yearly expenses saved up.
In fact, Allison and I currently have over 50 times our yearly expenses in our nest egg. And we even have a plan to get that 80 times by eventually selling our fully-paid condo (non-liquid asset) and either renting or buying something less expensive.
We were able to do this by not only building up our nest egg over time with aggressive and strategic investing, but also by reducing our expenses. We drive an older model car that’s fully paid and requires very little insurance. We buy our household goods in bulk. We purchase expensive items used. And we keep an eye out for great deals and free stuff.
You can learn more about our cost-cutting recommendations in our blog post How We Live Comfortably for Under $3k per Month in the Bay Area.
