More than half of working Americans feel they’re behind on their retirement savings, according to a 2023 Bankrate retirement survey. But do you know the amount of money you need to invest in order to retire?
There is a simple formula that can help you find your financial freedom number, and save money more strategically starting today.
The Financial Freedom Formula Is Simple To Calculate And Understand
According to the FIRE (financial independence, retire early) movement, you need to have 25 times your annual expenses in investments. To calculate this more specifically, I recommend first adding up your total monthly expenses in these five basic budgeting categories:
- Food, including what you eat beyond groceries;
- Transportation, including car payment, insurance, gas and parking;
- Housing consisting of either your rent or mortgage and associated costs such as taxes and insurance;
- Utilities such as your electricity, cell phone bill and internet; and
- Health, including household items you need to stay healthy like shampoo and cleaning supplies, as well as health expenses for your medical and wellness needs.
After you calculate your basic living expenses on a monthly basis, you can multiply by 12 to get your annual amount. Then you can multiply by 25 to get what personal finance experts refers to as your “FIRE number.”
This number assumes that if you only withdraw 4% of the total each year, the investments are also replenishing dollars through compound interest or growing in value or dividends. So you are unlikely to run out of money in your lifetime.
How You Choose To React Can Improve Your Odds
When teaching this formula to my financial education students, I typically get one of three responses. The first is people immediately decide that a FIRE number of 25 times their yearly expenses is impossible to reach. This is understandable because even when you have relatively low monthly expenses, it’s likely your FIRE number will be more than $1 million.
It’s a hard pill to swallow hearing that you need to be a millionaire to afford a basic standard of living in the United States.
The second response is people start dissecting the 4% rule and its flaws and then go into a spiral of how it doesn’t make sense in our day and age thanks to inflation, interest rates, the government, the economy or any other external factor of which individuals have no influence over. These learners typically spend more time overanalyzing rather than executing, and find themselves getting frustrated by their lack of momentum.
But my favorite response is the third one, where learners go into a short shock moment, process their feelings about the difficulty of achieving their FIRE number, but start asking questions on how they can inch their way closer to it.
The Easiest Way To Start Is To Pay Off Debt And Streamline Your Daily Expenses
To kickstart my own early retirement plan, I resolved to maintain a more essentialist lifestyle and find ways to streamline those five basic survival expenses by paying off debts like student loans, car loans and credit card debt.
I even went so far as to pay off my mortgage, once I realized that taking off that monthly bill of about $2,000 could lower my overall FIRE number by a whopping $600,000. Before you dismiss the idea of investing 25 times your expenses, consider what impact even investing 10% of your total FIRE number could have on your quality of life.
You may not be able to leave your career, but following this investing formula could buy you the travel you always wanted to do or allow you to spend more time on hobbies you enjoy outside of work.
Resolving to take small steps and at least attempt to move toward investing your FIRE number can move you years or even decades closer to a respectable retirement before your golden years.
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