When Amanda and I talked about retiring in our 40’s, we didn’t know exactly how much we needed. A good starting point that we used was to look at how much we spent right now and assume that we’ll need this same amount (with inflation) for the rest of our life when we retire in our 40’s.
We currently spend about $50,000 a year on housing (mortgage, property taxes, utilities), groceries, car insurance, vacation, etc.
Since we intend on traveling more when we retire, I estimate we’ll need about another $10,000 per year to ensure we can travel with comfort.
So in total, we’ll need $60,000 per year in today’s dollars when we retire by 40 (we’re currently 27 so 13 years from now). To maintain the same purchasing power 13 years from now, we’ll need almost $80,000 per year (assuming 2% inflation per year for 13 years on $60,000).
Knowing we need $80,000 per year by retirement would mean that we need our investments to grow and generate $80,000 per year so that we can we can draw from this growth/income forever starting at 40 without affecting the principal.
A good rule of thumb that industry experts use is the 4% withdrawal rule which provides a rough guideline in terms of how much can be withdrawn each year from your retirement nest egg to ensure that you don’t outlive your investments. The reasoning behind this 4% number is that it assumes your investments will continue to grow and generate enough income to pay out the 4% indefinitely without affecting the principal value of your investments.
$80,000 per year on a 4% withdrawal rate translates to a $2 million investment portfolio ($80,000 / 4%). Being able to quantify how much we need by the time of retirement helps us set savings and investment goals early and gives us lots of time to make adjustments along the way as required.
Whether we’ll be able to reach a $2 million investment portfolio by retirement will depend on a lot of factors (our savings rate, our investment returns, etc) so stay tuned for our next blog posts on how we plan to have $2 million by 40.