Super Easy Retirement Math
It’ll be painless, I promise
Disclaimer, this theory is almost entirely ripped out of this article to whom I give full credit. My main value-add here is the millennial spin.
Let’s back up a bit and define a few things.
What is retirement?
In the old days, it was the end period of your life where you were too old to work at your laborious job because physically we humans are defined by unfortunate mortality: we’re constantly in a state of decay.
Those too were the days where people got a job and worked at it for 30–50 years and at the end the company gave them a gold watch and a pension, a concept that doesn’t really exist anymore. Most of us will have dozens of different jobs, even multiple career paths across our lifetime.
In 1935 Roosevelt signed something called Social Security, which is an aid for seniors who are retired and not earning money but still need to pay rent and eat, as they often do. Young people pay for the old people and in turn they get some money from the next generation of new people when they’re old. This too is a dying concept because over time the numbers and variables shift and the huge systems start to not be as affordable. So, we can’t bank on that.
So what are we going to do?
We’re going to save money and live on it later when we need it.
Also, we’re going to structure our lives a little differently in the meantime.
Note: a lot of the following math comes from the FIRE (Financial Independence / Retire Early) type people. Even if you want to retire at the normal age 65 this paradigm of seeing retirement math is useful.
How to save money and live on it later.
The biggest thing you need to know is this:
How much money does it take to live?
And it’s sort of tricky because you have to guess for the future which is doubly tricky because we’re so young and a lot could change by then.
If you followed along the introduction article, you should be on your way to quantifying how much you current cost to live, and how much income you have coming in.
Your savings rate as a money number doesn’t matter as much as…
Your savings rate as a percentage of your income does.
So let’s break this down.
Earnings − spending = savings rate (money left over) as a number
This means as earnings goes up, savings goes up. As spending goes down, savings goes up. As spending goes up, savings go down (this is what basically everyone is afflicted by; too much spending and no savings).
Spending / earnings = savings rate as a percentage
So let’s say you earn $2000 a month after taxes and spend $1000 a month on expenses (rent, food, everything). That means you have $1000 left for savings, and so your savings rate is 50%.
If you can save 50%, you can retire in 16.6 years.
No matter what your income level is.
(and, if you think that number is impossible, I did it last year even with my average salary and living alone in an expensive apartment and a minor pizza ordering addiction. It’s definitely workable with a tiny bit of structure.)
You can play with Networthify with your own numbers and see the difference.
Basically, it works the exact same way as the compound interest curve we saw yesterday. As time goes on, the whole thing curves in your favor. This time we’re just displaying time curving down instead of money curving up.
Also, if you remember bonus tip #3 yesterday we can say savings rate counts double because you’re not only saving more, you’re also living on less. Since we’re using that ratio to figure out time, each dollar saved counts towards a proportionally big amount of time savings. This is why each percent in the calculator there is worth so much: moving money from one column to the other is very powerful for that curve.
So what does this all mean?
If your savings rate is 100% of your income you can retire right now! Congrats, you have zero expenses and therefore can live like that in perpetuity. Most of us haven’t had 100% income since our weekend jobs in highschool living at home with our parents.
If your savings rate is 0%, obviously you have no money to sustain even the slightest non-working period. So, you can’t retire ever. Yikes.
Somewhere in between those two extremes, then, is where we can equate savings percentages with time until retirement.
Image / numbers source
You can see then why it doesn’t matter what the income / spending amounts are as a specific money number, just that when you divide them against each other you can get a useful ratio that works out to time.
NERD ZONE
If you want the full explanation of how the above calculator is spitting out those year numbers, basically we can Monte Carlo the math for how the markets and spending and inflation and everything will play out and determine the 4% / Trinity Study rule of safe withdrawal.
Here’s a shot from FIREcalc:
All that to say, there’s statistics involved for how much money you need without going broke in even the worst economic downturns. Some of the statistical paths fail, but most of them succeed.
Your risk of how close you are to the zero line can be described as a percent of withdrawal rate — how much money you’re taking out of your account. The more you take out, the more of a hit those paths take downward.
The happy medium withdraw turns out to be about 4% (although some prefer more conservative or aggressive numbers) and so it’s a widely used number.
END NERD ZONE
So.
Your savings as a lump sum is actually earning you money because of that interest / market gains (minus inflation) and we can live on that interest if we spend in a smarter, lower way.
I think the most common misconception about retirement targets is that you’re going to be spending that full amount until it’s zero.
Like, the wrong math would be: “I spend $50k a year and I want to live for 20 years past retirement date, so I need $50k x 20 = $1 million to retire, and I’ll hope to die exactly when I spend the last cent”
But the correct math, based on this rule, is actually: “If I had a million dollars I could live forever on 4% of that, which would be $40k per year as long as I live, and I’ll be able to still pass that million to my kids when I die because I’m never drawing out of it directly.”
If you want to work out what your ‘million dollars’ is you can run the math backwards knowing your (estimated) yearly expenses number like so:
(yearly $$$ / withdrawal percentage) x 100 = retirement target
If you can live on $20k a year (which is what I’m currently spending myself) then you have: (20000 / 4) x 100 = $500k
Obviously you can / probably want to shoot for more than that. But in theory that’s the safest minimum you need for that yearly spending amount.
Then, we can run backwards again with a compound interest calculator
And see that $4000 a year for the next 40 years is $507k, and that works out to $333 per month in savings.
OPTIONAL: you can math check that backwards and see your $20k year spending is $1666 per month + $333 savings means you’re saving rate is 16.6% and that works out on the chart above to roughly 40 years, which is the same as we put into our calculator. Hooray!
By the way, I’m using 40 years because I’m calling a millennial 25 and retirement is normally 65. It’s also an easy round number.
So, if you’re happy retiring at 65 you need to save 17% or more.
If you want to retire sooner, save more. If you want to save more, spend less.
…which leads us nicely into tomorrow’s segment which is about exactly that.
