Episode 22: How Much Money You Need to Retire (and Why it May be Less Than You Think)
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On this episode of the personal finance podcast, we're going to talk about how much money you need to retire. And why it may be less than you actually think. What's up everybody, and welcome to the personal finance podcast. I'm your host, Andrew, founder of dollar after dollar.com. And today on the podcast, we're going to be talking about how much money you actually need to retire. And why it may be a lot less than you actually think. And I'm going to show you how to run the numbers. So you can figure out how much you need to retire. And this will give you your exact goal of what you need so that you can start pursuing financial independence because this number is extremely important. And we just talked about why your savings rate can change your life. And it truly can. Because your savings rate is going to allow you to get to this number, whatever your retirement number is to be able to pursue financial freedom. And you can retire a lot earlier than you think you don't have to work your entire life. And what I'm going to show you is how much money that you can draw down each year once you hit your number and how to figure that out as well. And then we're going to go through the process of well, what if everything crashes and the market crashes, what do I do with my money, then can I still stay retired, and I'm going to show you exactly how to go through this process. And this is another life changing episode because understanding this simple math is going to allow you to truly retire. And a lot of people are doing this same process and retiring by the age of 30, by the age of 40, by the age of 45. And they're retiring much earlier than everyone else. And this is truly a life hack. This is truly a life secret. And I think this is one thing that people can open up and a lot of people just don't know that this is available to them. But if you understand this, I guarantee it's gonna change your future, it's gonna change your family's future and everybody around you because this is true wealth, true wealth is getting your time pack, and being able to obtain your time back and take control of your time. And you're not trading time for money anymore, you're using your time to pursue the activities that you want to do each and every single day. And this is the baseline for it. Because understanding this is the baseline to understand how you can go about doing that how you can retire in your 30s, how you can retire in your 40s. And the fire movement has done a great job of spreading this message. And we need to spread it even more, because this is a possibility for anyone if they understand how it works. And I'm going to show you exactly how it works today. So let's get into the steps to take to figure out how much money you need to retire. So the first thing you have to do is figure out how much money you want to have each year in retirement. And now this number is going to be vastly different for everyone. Because what you have to understand is personal finance is extremely personal. And it's different for every single person out there, your number is going to be different than your friends number and your friends number is going to be drastically different than someone who say lives in the middle of San Francisco where the cost of living is much higher. And the person who lives in the middle of San Francisco's number is going to be drastically different than the person who wants to retire in the middle of Idaho. Because cost of living matters. And so you have to take into consideration the cost of living of where you want to retire. And when I say retire. I'm not saying you're gonna sit on a beach all day and drink margaritas, what I'm saying is you're now free to pursue the work you want to do because you have enough money to take care of your living expenses and to take care of all of your needs. And you don't have to work anymore, so you can pursue the work you want to do. But a lot of times when you retire, most people can't just sit around all day, most people can't sit on their backs and watch Netflix all day. So they pursue things that bring them joy, they go after things that bring them value. And that's what this is all about. So setting this retirement number is setting the baseline for you to be able to stop working. It's the number that allows you to go to your boss and say, Hey, I only want to work three days a week, I'll get the same amount of work done. But I only want to work three days a week. And if they say no, you say, Okay, I can do whatever I want now, because I have enough money to go ahead and pursue my goals. It's a lifestyle design. And so you have to figure out what number is going to work for you for that lifestyle design. So for everyone, I could be vastly different. It could be $50,000 a year, it could be $30,000 a year, it could be $150,000 a year, it's very different for every single person. So think through this, think through how much you really need. Think through all your costs of living, how much you're gonna need for food, are you gonna have a mortgage or not? Are you going to have housing expenses or not? If you aren't, then you can take that expense out. If you are if you plan on having a mortgage, which there's no issue with that, then you just go ahead and factor that expense in but how much money do you need, and that's where you want to start? Because once you have that number, then what you're going to do is you're going to take that number and multiply it by 25. So let's say you want to live off $50,000 a year in retirement. You're going to have a house paid off. You're not going to have a mortgage, your expenses are going to be something What low, and you want to live on $50,000 a year? Well, the math is extremely simple to do this, all you're going to do is multiply 25 times your yearly expenses, or you're just going to multiply 25 times 50. And what happens there is you come out to $1.25 million. So for someone who wants to live off $50,000 a year, they need $1.25 million to retire. So when I say that it may sound like a lot for some people, and it may not sound like so much for others. And what's happening here is you're going to see how personal personal finance is. And you're saying, Well, where do I get this 25 number from? Why am I multiplying $50,000 by 25. And the reason is a major rule of thumb in personal finance, and it's called the 4% rule. And what the 4% rule is Put simply, is that you can draw down 4% of your nest egg every single year, and be able to preserve your principal. And what your principle is, is the amount of money you started with. And then a lot of cases, which I'll get into here shortly, you're going to preserve it and your money is going to grow significantly over the course of your retirement based on you guessed it, our best friend, our good old fashioned pal compound interest, the eighth wonder of the world compound interest compound interest, you're the real MVP. And if you want a real simple way of where the 4% rule came from, just think of average market returns being at 7%. Now, I always tell you index funds, which are following the market averages are usually seven to 8% average return historically. And so let's just get conservative here and say a 7% return for the long run and inflation over the long term history of time has been about 3%. Now in the last 20 years, we've seen inflation lower to about 2%. But just taking that 7% average return minus 3% allows you to safely withdraw 4% every single year, and this 4% rule, you're also going to hear people call it the safe withdrawal rate, this is the safe amount that you can draw down and preserve your wealth, a lot of times your wealth is going to significantly increase even as you're drawing it down. So every couple of years, you're gonna be giving yourself a raise in retirement. And that's the beautiful thing about this. Because if you have a longer time horizon, and say you retire in your 30s, you're going to be getting yourself a raise over and over and over again. And as time goes on, you're going to be spending more and more money. And I'm going to show you how to handle that and go through the ebbs and flows of life as they come about. But this is one of the most amazing phenomenons that a lot of people just don't not understand. And if you pursue financial independence early on in life, and you save the additional income and you work on increasing your income, you can hit this much sooner than you think you can. So I'm going to show you an example of the 4% rule, just so you can see how it works. And the really cool power of compound interest within the 4% rule. So let's say you have a Roth IRA, and we've talked about a Roth IRA and how you can get a million dollar Roth IRA. But let's say you've saved up $500,000 in your Roth IRA. Now I'm saving, I'm saying $500,000 only because it's easy math for us. But this is going to give you a clear example of exactly how this works. So if you're going to draw down 4% every year of $500,000, then that's $20,000 a year. And that's how I like to think about it every $500,000, or every half a million dollars is $20,000 a year that you can draw down in retirement to be a million dollars, you could draw down 40,000. If you have $2 million, you could draw down $80,000 a year. That's how this math works. So let's say you have half a million dollars in a Roth IRA, your first year retirement, you draw down your $20,000, which is 4% of that half a million dollars. So now you're at $480,000. And let's be conservative here, let's be extremely conservative in our assumptions, let's say that you have a average market return every single year of 6%. Now, like I just said, historically, that's lower than the 8% average that usually comes out. But let's just say you get 6% every single year from here to the future. Because as we know, market returns are not guaranteed. So your $480,000 that's left in your Roth IRA, after you drew down your $20,000 to live on has all year long to grow. It has from January to December to grow at an average rate of 6%. By December 31, you're going to have $508,000, see where this is going. So you started with $500,000, you drew down $20,000. And by the end of the year, all of a sudden you have $508,000, then let's look at the next year. So now you have $508,000. And you're going to give yourself a 2% raise every year. So let's say you give yourself a 2% raise just to maintain inflation, because inflation is going to eat away at your buying power, as we've talked about a couple of times, especially in the lifestyle creep episode, but inflation is gonna eat away at your buying power. So let's just give ourselves that 2% raise just to maintain inflation. And here's the beautiful thing about this. So you had that $508,000 your money grew from 480 to 508. And you draw down another 20%. So now you've drawn down to $488,000. And your money has from January to December to grow again. So that $488,000 is now going to grow to $517,000. So you started retirement You had $5,000. And in year two, at the end of year two, going into year three, you already have $517,000. And you've drawn down enough money to live on that, you can see how this is working with a half a million dollars. Imagine if you even had more money. Imagine if you had a million dollars, or $2 million, or $5 million, how much this compound interest is going to grow, and how much your money is going to grow. In some years, it may go negative, some years may go positive. But what's happening is as you average this out, as you average out this 6%, it's all gonna work out. And the math is showing you here how it's going to work out. So you may still be second guessing this. So let's get into how safe the safe withdrawal rate of 4% actually is. So you may be saying yourself, yeah, that's all great information, I see how it works, I see how it can compound and grow. But how do I know how safe the safe withdrawal rate actually is? And where the heck did the safe withdrawal rate come from? So the 4% rule came from a few things. And there was a bunch of studies done. And one of the most famous studies that was done was called the Trinity study. Now, I'm not going to go into detail into the Trinity study, because I'm not going to try to bore you to sleep, if you want to take a nap, then go ahead. And you can read all about the Trinity study. But there's a lot of studies that were done before and after the trainee study as well, that basically studies people's portfolios and how they performed in the best and worst of times. And they also have done studies on portfolios for the last century. And what would happen throughout all these historic catastrophes that we've had with the safe withdrawal rate and the 4% drawdown rule. And one of my favorite references for retirement info like this is a gentleman by the name of Michael kitsis. And what he does is he looks into a lot of this information, and goes through studies and does studies of his own with his own team. And a few companies that he has now he's a financial advisor. So they do academic studies on this stuff to look through and see what's the fail rate, what could happen here, what could happen in the worst historical situations that could cause this to fail. And we're going to get into some of this as well. And I'm going to show you exactly how this works. But if you look at kitces writings, a lot of things that he goes through, is showing how fail proof this truly is in the 4% rule actually has a 96% probability of leaving more than 100% of your starting principle. So you have a 96% chance of having more money than when you started. If you asked me, hey, how many bets would you take that have a 96% chance of you winning, I would take all of those bets, every single one of them. In fact, even when a retiree starts with the 4% withdrawal rate, there's only four years in the last century, that you may not have the same amount of your starting principal, because you started so low. And that's 1929, which is the Great Depression ever heard of it. 1937, which were going into World War 219 65 in 1966, in the amazing thing is over two thirds of retirees throughout the entire century. So 66% of retirees that finished that 30 year time horizon of their retirement have more than doubled their starting principles. So if you retire with a million dollars, you have a 66% chance of finishing your retirement with $2 million, if you're drawing down 4% every single year. And the amazing thing is the 4% rule held up to the Great Depression, it held up through World War Two, it held up through the 2008 crisis, it held up through the tech bubble, it held up through every single financial crisis we've ever had. And it's held strong throughout that entire timeframe. In fact, if a retiree retired the first year of the Great Depression, which will be the worst time in history to retire, because you have an 89% portfolio decrease, if you retired the first year of the Great Depression, guess what you have to do, you have to wait through the entire Great Depression, and then you get hit by World War Two at the same time, which starts in the late 1930s. and ends in the 1940s, you have to get through World War Two, and you still don't run out of money. And a lot of times your money is still preserved throughout that entire time frame and you get to year 30 with enough money to still be drawing down 4%. That is unbelievable. That's how safe this withdrawal rate is, it would literally take a global famine for you not to be able to have this safe withdrawal rate within the 30 year timeframe. And what I'm about to talk about is if you retire early, say in your 30s or 40s, how you can go about using this same time frame and be able to double or triple that time frame to preserve your wealth and grow your wealth significantly. because believe it or not compound interest is working in your favor. So you have a longer time horizon, and you're actually going to have even more growth if you retire early. That's the beautiful thing about this. That is why you want to get started. So early building wealth because it's gonna change your life and you can literally be retired and your portfolio increases significantly over time and we're gonna get into that here shortly. So let's say you do want to retire early, you do want to retire in your 30s or your 40s. Well, how does this 4% rule hold up and all you have to do is you just have to reel it back a little bit and withdraw 3.5% if you're gonna to retire extremely early, and this is holding up for 50 6070 years of retirement, unless you're the bionic man, and you think you're going to live to 150, then just reel it back to 3.5%. And I'm gonna show you the probabilities of this and how certain this number actually is because 3.5% is the floor no matter who you are. So if you want to be safe, if you're going to retire, say, in your 50s, or 60s, and you want to be safe, you can relate back to 3.5%. And I'm going to show you the probabilities of someone who rolls back to 3.5% over the course of 50 years, so 95% of the time, you still end up doubling your money. So 95% of the time over the long horizon, if you retire with a million bucks, you're going to finish your retirement with 2 million bucks, that is unbelievable. But here is the crazy part for an early retiree, you have a 50% chance of increasing your nest egg by eight x. So let's say you retire in your 30s or 40s, and you retire with a million dollars, you have a 50% chance of finishing your retirement with $8 million. Now, that is absolutely unbelievable. And these numbers are life changing for most people, because what's happening is compound interest is still working for you. So you have a 95% chance of doubling your money. So compound interest is gonna work for you no matter what, but you have a 50% chance of increasing your money by eight x, let's just say you did have that you have $4 million in your retirement account $4 million dollars drawn down as $160,000 a year in retirement, that's a nice race, that's a nice retirement, I don't care where you live, you're in a good situation for retirement, a much better situation than 99.9% of retirees. And these numbers are not even taking into consideration Social Security benefits, or other cash flowing assets that you have in other assets that are coming in. And I'm going to get into exactly what they're not even including, and things that you can be doing. But here's the crazy part, because in the best case scenario, you can go from having $1 million, the best case scenario to $71 million dollars, you have the same probability of getting to $71 million as you do to running out of money. And let me just tell you, if you think you're going to run out of money in retirement by doing this drawdown rate, you have to be just walking towards a cliff and falling off, especially if you retire early. Because if you retire early, guess what all you have to do is just earn a little bit of part time income. And you you can retire much earlier and this rule, this 4% rule shows you exactly why because let's talk about this for a second. Let's say you think you need $1.5 million to retire. So that would get you $60,000 a year in retirement and you're at a million dollars, and you need that next $500,000. And you've been working towards it. And you've got that million dollars, guess what, think about this for a second. If you have a part time job, and you make $20,000 a year and that part time job instead of working full time in a cubicle that you hate, let's say for example, you love craft beer. Okay? Let's say you just love craft beer, you love the process of finding out how they make craft beer, you love tasting craft beer, you have everything about craft beer, you could go work at a craft brewery part time, a couple days a week, let's say two days a week and make an additional $20,000 a year. And now now that we know this 4% rule, what is that $20,000 a year equivalent to having an additional half a million dollars in your retirement account, you can retire right now. And you could go pursue brewing craft beer at your local craft brewery with your time it's your part time job two days a week and you have five days a week off. This is the flexibility that you have of early retirement that a lot of people don't realize that they have. This is the amazing thing about building wealth, because it gives you that type of flexibility. A lot of people say, Well, what if I run out of money and I retire too early on, we have a million dollars and it doesn't increase and it goes down, you're young enough that you can go do part time work and make up for a small portion when times are bad. And if times are bad, all you have to do is if you're truly that worried, is slightly adjust your spending a little bit because even slight adjustments, when you have this much money in your portfolio are going to make a significant impact over the long run. And I just told you the probabilities. So making that slight adjustment, just making a small adjustment of a couple hundred bucks every single month will take you from a probability of 96% being able to double your money to 100% being able to double your money, it changes that probability that much. And that is where this is such an unbelievable strategy and an unbelievable life hack that a lot of people don't understand. And this 4% rule is obviously based on a trinity site that I just talked about. The Trinity study assumes that you're not going to make additional income, that you're not gonna do any part time work or anything like that, which is something that you can do because you're going to be bored, what are you going to do with your time all day? Maybe you want to sell some items on Amazon, maybe you want to start a small online business that takes a couple hours a week. Maybe you want to be a writer you love writing and you want to do creative writing, and freelance writing. There's all sorts of things that you can do that will allow you to make a little bit of money and you can retire either Earlier, this is why you can retire earlier than you think. Because you have this flexibility. And as long as you're willing to be flexible, then you have this opportunity right in front of you. But the Trinity study also assumes you'll never collect a single dollar from Social Security. So by the time you get to 60, you're going to have social security coming in, because you don't want to depend on something like that. So they assume that you're not going to get social security. So if you do get social security, it's just all gravy baby, it assumes you're never going to adjust your spending. So the Trinity study literally assumes that if there's a massive recession, and the market drops 50%, that you're not going to adjust your spending whatsoever. So if you adjust your spending, you're increasing your chances all the way back up to 100%, it's not going to fail. So it's not the probability of failure, it's the probability of adjustment. That's all that the probability is there's no probability of failure, it's just what's the probability that you're going to have to adjust your spending slightly, or you're going to have to adjust your time to work a couple extra hours doing something you like, just to make a couple thousand dollars a year, the probability of failure is zero, as long as you're willing to adjust slightly, it also assumes you're never going to collect an inheritance, say from your parents or rich uncle or something like that. Even if you collect an inheritance a small inheritance from your parents, a $50,000 $30,000 $100,000. somewhere in that range, it's still going to make a significant impact on your finances. In the long run, the trendy study does not account for that. So you're already at a 96% success rate. And then making these adjustments when times get tough, or for the short term just for the first couple of years, allows you to change your entire trajectory, to it completely fail proof. And that's why the 4% rule is so powerful. That is why it's so amazing. So just think about it this way, every million dollars you save in retirement, you can draw down 35,000, depending on if you're going to retire early in life, or if you retire later in life $40,000 every single year. So if you retire early, and your nest egg grows from $1 million, say to $5 million, you're gonna be able to spend $200,000 a year in retirement. That's a massive retirement, think about the wealth building principles that you can show your kids show your family. This is generational wealth for you and your family. And that is why this is so important to understand. Because you can change your trajectory of your life allow you to have more time with your family, pursue the things you actually want that bring you value. And that's the power of your money. That's what your money is here to do. It's not to buy stuff, your money is not here to buy stuff. Your money's here to buy your freedom. It's for financial independence. And that's what this podcast is about. We're all about creating freedom for you and your family, creating financial independence for you and your family. But you can literally change your life forever. Thank you guys so much for listening. If this is your first time listening, consider subscribing so you never miss an episode. And hey, if you get value out of this show, consider sharing it with a friend because we believe that every person in this world can build true wealth and build financial freedom. We want to share that message with everyone else because it starts right here. It starts with financial education. And it's not taught in high schools. It's not taught in colleges. So we want everyone to understand exactly how they can build wealth and how they can go about building an amazing financial future. Again, thank you so much for listening and I hope you guys have a great day.
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