The Retirement Equation states that Annual Expenses x Withdrawal Rate Inverse = Balance.
For example: let’s say that you need $2,500 a month; therefore $30k x 1/(4%) = $750k.
As straightforward as this sounds, unfortunately this is unrealistic for a number of reasons:
- This equation doesn’t factor in inflation: $2500 today will not be worth the same in 10 years.
- This equation doesn’t factor in your contributions, which may also increase over time.
- The equation has to calculate how much you would need in a few years based on inflation.
- Once your portfolio matches your inflation adjusted expenses is when you can retire early.
In this article, we go through the new online tool: The MYB Realistic Retirement Calculator.
We will go through some real world scenarios; one for a single person and one for a couple.
Once you understand how it works, give the tool a go and see when you could retire early.
Let’s talk about Inflation
As much as we would love for our expenses to remain the same, chances are that they won’t.
This is due to something called inflation, where the cost of goods/services increase over time.
You’ll find that your rent will increase every year, bills, travelling, and even leisurely activities.
Therefore we need to use a retirement calculator that factors this in to keep up with inflation.
On average, inflation is about 3% a year, even though in recent years it has been much higher.
Single person: earns $3,000 a month: their expenses are $2,500 and they invest $500/month.
Using 3% inflation, we can see that their monthly expenses in 10 years would equal to $3,360.
Couple: let’s say they earn $6,000 monthly: their expenses are $5,000 and they invest $1,000.
Using 3% inflation, we can see that in 10 years their expenses would equate to $6,720/month.
As you can see, it’s so important that we use a Retirement Calculator that factors in inflation.
What about Investment Contributions?
As well as your expenses increasing, your income is likely going to increase every year also.
Therefore you might be able to afford to increase your investment contributions every year.
In fact, I would say that it’s crucial you try increase your investment contributions every year.
It’s up to you how much to increase it, it will depend on how much your salary has increased.
I would say aiming for 3% a year would be great, at least to match with the rate of inflation.
Single person: earns $3,000 a month: their expense are $2,500 and they invest $500/month.
In 10 years, using an annual 3% increase in contributions, they would contribute $672/month.
Couple: they earn $6,000 a month collectively; expenses are $5,000 and they invest $1,000.
In 10 years’ time, using an annual 3% increase, they would be contributing $1,344 per month.
3% may not seem like much but over time, it’ll dramatically help you get to early retirement.
Let’s not forget Annual Withdrawal Rate
The standard equation assumes you’ll be using the 4% rule for your retirement calculations.
For example: if you wanted $40k annually, you’d need $1 million i.e. 4% of $1 million is $40k.
A 4% withdrawal rate would give you 96% chance of your money lasting all of your retirement.
However this assumes you’re invested 50/50 in stocks/bonds and you want it to last 30 years.
If neither of those are valid, then you need to choose a more suitable withdrawal rate (WR).
With the MYB Realistic Retirement Calculator you can choose whatever WR that you prefer.
Having a higher withdrawal rate is great; you can withdraw more and reach your target faster.
However, a higher WR reduces your success rate as to how long your money would last you.
Therefore you need to choose your WR based on your asset allocation and retirement length.
Check out this article on portfolio withdrawal rates to find your ideal withdrawal percentage.
Let’s discuss Annual Investment Growth
It’s important to use a retirement calculator that allows you to choose a starting lump sum.
A lot of online tools assume that you are starting from scratch, but that may not be the case.
You may already have around $10k invested – this dramatically changes when you can retire.
If you don’t have a sum of money to invest right away that’s totally fine – it’s a nice to have.
You’ll find that it’s really how much you contribute regularly that makes the most difference.
The other thing to discuss is your average annual growth – how much your money will grow.
Because your money is invested mainly in stocks, your shares will increase in value over time.
What annual investment return should you use in your calculations? I’d use 10% as average.
A lot of people would say that 10% is unrealistic, that around 7% is a more conservative rate.
However let’s note in the past 15 years, the S&P500 has returned on average 12.63% ayear.
Time to put it all together
Single person: they earn $3,000 a month. Their expenses are $2,500 and invest $500 a month.
Their expenses increase by 3% a year (inflation) and their contributions increase by 3% a year.
They start with a sum of $5,000 and choose an average annual investment return of 10%.
They use an annual withdrawal rate of 5% based on their asset allocation and other factors.
Using the calculator we can see that it would take them around 29 years to be able to retire.
This means it would take 29 years for their investment withdrawals to match their expenses.
Couple: they earn $6000 a month. Their expenses are $5000 a month and they invest $1000.
Using the same variables as above, we can see that it would also take them 29 years to retire.
This is probably not what you want to hear, you want to hear that it would take only 10 years.
That’s why it’s important to use a tool that paints an accurate picture on when you can retire.
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To find out more about early retirement, check out our articles on retirement and investing.
Do you know what your FIRE Score is? Take our FIRE Quiz to see how close you are to FIRE.
Are you on the path to early retirement? How is it going? Feel free share in the comments.
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