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Tuesday, October 12, 2010

Financial Independence= X times 25

Once again, Jacob of Early Retirement Extreme gets me thinking. Assuming that the oft-touted 4% withdrawal rate from your savings/investments will likely last forever(?) and will accommodate inflation, Jacob points out that you can take an expense, multiply it by 25, and see what you need to amass in order to support your lifestyle.

Here is what he says on food, obviously a need.

What about food expenses? These can range from less than $50/month per person to more than $500/month per person.

Required savings for $50/month:

$50/month = $600/year food expenses. This needs $600/0.04 = $15000 in savings. Whereas $500/month = $6000/year needs $150000 in savings. That’s a lot!

Aiming for the lower figure of $15000 is doable in a foreseeable number of years. After saving $15000 one NEVER needs to worry about food again. One is financially independent of the food expenses.

I like this model, because it tells me that I can save for retirement bit by bit, accommodating first NEEDS (shelter, food, utilities, transportation, healthcare) and then wants (too many to mention here, mostly revolving around TRAVEL).

It also might make me think twice about the many small purchases to which I succumb. Recently, for instance, I have NOT bought a Greek wool hat (for Mr. FS), a Chico's linen shirt, a really nice comforter, and STOP...this is getting embarrassing.

Even though each of these things is ONLY around $3.00, if I forgo, say, 5 a month, I will have eliminated $4500.00 from my retirement needs. Not to mention, the clutter that comes from bringing in 36 new items per year.

Do you think it helps to "multiply expenses by 25" to see what a retirement plan amounts to, or do you think it a silly gimmick?

I love it, myself.


Anonymous said...

Well, it might be a gimmick, but it has me thinking. I also like how he has ranked priorities, so travel is somewhat down the list.

Duchesse said...

What is sobering is to see the stats; spending for travel peaks from age 65-early 70s, then trends down gradually to around 80, when it more or less stops. It's not that you won't be around, but you (or your partner) will travel a lot less then.

Shelley said...

The book Your Money or Your Life by Dominguez & Vicki Robin first brought home to me the idea that we exchange the (limited) hours of our life for money and then spend that money on stuff. I have likely traded years of my time on earth for things I don't actually value. This is an idea most of us avoid because we don't like thinking about what Privilege calls The Death Probelm. Jacob's approach avoids looking at that angle and looks at it a different way. Anything that helps me be more conscious about how I'm spending money has to be a good thing as far as I'm concerned. "Gimmick" is apparently marketing language and we swallow that bilge all the time without a second thought. What Duchesse says is just how Bill and I are thinking - how much more travel can we manage before we're too old to enjoy it?

FB @ said...

That's how I calculate what my retirement should be ---- expenses x years lived.

Don't forget inflation and cost of living in the area, seeing as you may not retire where you live

As for travel, I'm doing it now, so I don't regret it when I'm older when I don't go back to Japan, for example.

Duchesse said...

Yes, travel now. And you may also travel 'then', but perhaps your trips will be shorter or closer to home. I once worked with a group of professional tour guides, who told me, "Our job is hauling half-dead people around Europe". They said it with compassion, but meant it.

Funny about Money said...

It's a good rule of thumb. But it doesn't take Social Security into consideration. During at least some part of your retirement, you can reasonably expect to receive Social Security payments.

So your calculation is not monthly expenses x 12 x 25 = required nest egg.

It's monthly expenses - net monthly SS benefit x 12 x 25 = required nest egg.

If you plan to retire before you're eligible to collect social security, then you would have to adjust your figures to show the amount you would need between Retirement Year 1 and Social Security Benefit Year 1. As to what that formula might be, I dare not hazard a guess.

Anonymous said...

I used to adhere to the 4% / 25x rule too. But recently another p.f. commenter corrected me. The 4% figure is NOT for an indefinite withdrawal period. The original study was for a 30 year time period (with 95% chance of not running out of money.) Prompted by the commenter I went and read some of the studies for myself.

Unfortunately I don't know what the replacement number is. There's got to be some number that you can use. College endowment funds have a goal of spending without burning principal, so we should be able to do the same somehow.

Anonymous said...

This is not to devalue the overall point of your post, which is to say that the less you spend, the less nest egg you need. Regardless of whether you're using X times 25 or X times 100 or any other number, smaller X = smaller nest egg needed.

Over the Cubicle Wall said...


3% withdrawal has historically lasted forever, so one would need 33.33 X annual expenses or 400 times monthly expenses.

Frugal Scholar said...

@Terri--it has me thinking too...Note that he has traveled a lot already, so he would put it lower than many.

@Duchesse--Totally agree. I just meant that you wouldn't DIE if you didn't travel!

@Shelley--That book was an eye-opener for me. I recently gave it to my son. He said "I know this stuff already."

@FB--We have so many travel plans. We are building travel into our budget--not an add-on.

@Duchesse--Thanks for emphasizing the importance of travel when you have mobility.

@Funny--Yes--social security needs to be factored in. As others have said, inflation is taken into account.

@stannius--The book "Work Less, Live More" suggests a 4% drawdown MINUS 5% in years of economic declines. Thanks for commenting and sorry about my delayed response.

@Cubicle--Thanks for the tip. How I've missed your blog. Hoping you are making good progress toward your goals.