One of the common phrases I use in my posts is: retirement number. I define the retirement number as the number you need to reach to be able to retire. I realize that is pretty braindead simple though. The more interesting part is the construct of the retirement number.
When you’re reading my posts, it’s important to put this number in context. The bulk of my money is in real estate, index funds (equities and bonds), and CDs ….that’s about it. As I explain further in this post there are other ways to go about it though, if not better ways. More on that later.
The simple concept of having a retirement number has done a number of things for me.
- Expenses – I base my retirement number on my expenses. As I wrote here, I think this is a smarter way to think about this topic. The ability to generate a good and accurate retirement number is commensurate with the ability to accurately track expenses. The FI community commonly uses 25x annual expenses. In my opinion this is too lean by itself for an early retirement; however it’s still useful because it gives you a target which leads to my next point
- Clarity – I clearly remember in my 20’s and 30’s this concept of saving for retirement. In those years, if you would have asked me “how much do you need to retire”, or at least “what is the minimum amount needed”? I would have responded “I don’t know what that number is, but I do know it’s a lot more than what I have now.” The problem I ran into with that way of thinking is that it lead to a mindset where I thought I had to take on big risks to get the big returns to get this unknown large sum of money. I wrote about it in my post “swing for the fences investing”.
- Risk – Side-by-side with clarity is risk. Having a clear target to aim for allows you to take on as much risk as necessary as opposed to swinging for the fences.
Early Attempts at a Retirement Number
Not having a clear plan or vision on how much I needed and how I would get that amount led me to take on unnecessary risk. I was certain that I could invest in individual stocks, and thought it was critical to be able to build the wealth I needed to retire by say 65. In hindsight I was probably gambling more than investing.
I spent lots of time researching individual stocks and mutual funds. I bought online subscription services, and worst of all, I didn’t properly track my investments and convinced myself the losses weren’t that bad, and the few wins were better than they actually were. I was lying to myself. In the end, when I honestly tallied up my performance, I would have been better off with a simple total market or S&P 500 index fund. Not to mention the time I would have had for doing other things.
It didn’t take too long until I realized that my 401k balance was always up and to the right and my little brokerage account was just up and down, and overall trending down.
One Saturday morning I finally had the wherewithal to sit down and go through every single stock trade. I started up tallying up the wins and losses. I then added brokerage fees to the tally. Then subscription services. I was going to add in a cost for my time, but I didn’t need to. I was well below the amount of money I would have had, had I just invested in a S&P 500 index fund. Thankfully I was still in my 20’s at the time when I came to my senses. After this Saturday morning exercise, I didn’t hesitate, I sold out of my individual stocks and put my money in an index fund.
2000 Recession following the tech bubble
My first real big wakeup call was circa October 2000 when tech stocks started to plummet, and seemingly overnight (it really wasn’t overnight…) the tech bubble was over. All of these pumped up stocks, companies people were buying up and had no idea what they even did or how they made money, were going down.
I had one of these stocks and saw my first real big loser, I wrote about it here.
2008 to 2009 Recession
The 2008 to 2009 recession exposed some vulnerabilities in my personal finances and taught some valuable lessons. I was still pretty heavily career focused, and even more so through the recession, that I still didn’t have a clear vision of retirement or a retirement number.
The 4 percent …general go by
I stumbled across the 4 percent rule somewhere after the 2008 to 2009 recession. I didn’t give it a whole lot of thought or time, but filed it away. When I started getting into FI blogs, I realized that folks were essentially using an aspect of the 4 percent rule as the basis for developing their retirement number.
If you use the 4 percent rule in your everyday finances, you’ll benefit from reading the source of this rule, the 1994 article by William Bengen. One thing that jumps off the page by reading this is that it’s not a rule. There are several caveats that should be known before jump in head first and base your life around it.
All that said, the 25 times expenses calculation is a great way to ball park your retirement needs. It’s also helpful because you can always control spending, thereby manipulating that number downwards by eliminating or reducing your expenses. For me personally, I use the 25x calculation as a major component of my retirement number, but I also factor in cash, insurance, medical expenses, and myself (X-Factor) on top of it.
By tracking my spending over time, I began to see patterns emerge. I saw places where I could cut things out or do things more efficiently. I then started to really understand how much money do I need month to month or year to year. If you know that, then you can easily calculate your retirement nest egg by multiplying your annual expenses by 25. There are more considerations than that simple calculation, but that will get you pretty close.
Put another way, how do you know if you’ll hit your target if you can’t even see the target. Once you have a number, you can continue to tweak your spending to try and change that 25x number. You can also program into your goals what your retirement number is and then build up milestones to get there.
The overall theme here is to stop thinking that you have to save this really huge and unknown amount of money. It’s like playing basketball with no hoop, you need to see the hoop so you can make your shot. There’s also tremendous comfort in knowing your number.
Early 40’s
Growing up my parents would explain the concept of compound interest. In my 20’s and 30’s I read plenty of books and articles where compounded interest is mentioned. I know from grade school math the concept of exponential rise.
I didn’t really appreciate the exponential rise until I was in my 40’s. If I had a more sensible investment approach when I was younger, I would have probably noticed it in my 30’s but alas… years of saving following my swing for the fences days finally paid off.
By this time I was already well into my tracking and had a good handle on my annual expenses.
Retirement Number Construct
I wouldn’t recommend anyone limit themselves to just my version of a retirement number. Other things like income from real estate or one’s own business (or blog….) count as well. If anything these things are even better than just having money in index funds because they can diversify you into other areas. If stocks and real estate plunge, a business income could make a great hedge. If stocks slip into a correction, income from rental property can make up for the loss in stocks.
Personally I am working towards diversifying more into real estate and plan to do this slowly overtime.
Parting Thoughts
The main point that hit home for me was this:
- Don’t take stupid or unnecessary risks, don’t swing for the fences
- Start tracking and keep tracking, and don’t stop. Even if you don’t know what to do with all the data yet, that’s ok, you will eventually. The more data the better
- Don’t lose money
- Write about your lessons from past experiences
- Understand money psychology
- The goal is not a rush to the finish line, sacrificing everything life has to offer. Get your finances on track and get your life on track. Don’t lose out on years of living because you’re saving until it hurts.
- Most important – don’t give up. If my past lessons have anything in common it’s that I kept at it. I made mistakes and still attained a decent level of wealth considering.