One of the more fascinating trends in today’s society is known as financial independence and retiring early. People are discovering every day the joys that being financially independent can bring. Not having to deal with toxic work environments, dealing with office politics, and socializing with people you would rather avoid make the FIRE movement laudable. By avoiding the bad, people can attempt to use their money to be their best selves. They can volunteer at their favorite charities. People can attempt to start their own businesses. Retirees can travel to locations they only dreamed about. When you look at the benefits, the FIRE movement can bring fantastic benefits, but in today’s online world debate crops up about what it takes.
The Debate on How Much Money it Takes to Retire
When you look around the web, what do you see on this debate? A fair amount of people talk about how they only need $30,000 in income per year to retire. They talk about how they don’t need to sit first class or eat at 5 star restaurants. On the other hand, you have Suze Orman talking about how people will need $5,000,000 to retire early. Since this was in the headlines months ago, I’m pretty sure everyone remembers the online cacophony that erupted. Why the divergence and shouting? Well, $30,000 in income can be generated by a $400,000 portfolio of real estate. Not a lot of people want to hear that they still need to build another $4.6 million in assets. Even though that level of wealth would virtually provide a guarantee that you would never be poor again, that is an extremely difficult amount to get to. Then going in the other direction, a lot of people try to project their life desires on others. They can’t imagine somebody being happy on only $30,000 a year even though there are plenty of people who would be happy in such a scenario.
How I Think about this as a Math Problem
Taking the advice of Charlie Munger, and the mathematician Jacobi to, “invert, always invert!” Let’s take a look at what this would look like. Sit down and take a few minutes to imagine the life that would make you happy. Is it a nice house in a middle class neighborhood with a yearly trip to Disneyland? Is it ownership of five penthouses in San Francisco and New York with a private gulfstream jet? Picture it in your mind, and calculate how much income you would require to achieve your desired lifestyle. For the sake of simplicity let’s imagine the income you need is $45,000 a year. That amount of money would provide for housing, food, and entertainment in small town America! But what happens if a recession occurs? What if the companies you invested in cut their dividends? How about if the rental properties you own can’t find good tenants? I would say you need a margin of safety!
When you calculate the amount of money you need, in our example $45,000, I would divide that number by .75. The resulting number is $60,000. Why do I want you to do this though? Well, the answer is to provide you with a margin of safety! The extra $15,000 is what I would be reinvesting each year for additional income. By having a stream of money going into additional investments, you have built in a shield against higher than expected inflation. Rather than cutting your expenses if a dividend cut occurs, you can pull money out of that $15,000 to ensure that your standard of living isn’t harmed if you are paying for your child’s education or parent’s health care.
With America going through a period of political polarization there is one final step I would do. I would divide the $60,000 in income that we calculated above, and divide that $60,000 by .7. You may be asking why .7. Well, I would assume a 30% tax rate in the future. That amount would equal $85,714.29. Why would I want you to do that though? Taxes and political polarization. With the federal debt and deficit rising, and people calling for reduced spending or higher taxes to pay for it all, my bet is on higher taxes. By factoring in a higher tax rate, I want people to build in an additional margin of safety.
So, here we are. In order to get your ideal life by spending $45,000 a year, you will need a total income of almost $86,000 a year. For this, you will need a real estate empire of $860,000 paying you 10% a year in rents. If you want an all stock portfolio paying you a dividend yield of 3% annually, you will need a $$2,857,142.86 portfolio. In short, you will need a net worth of between $860,000 and $2.9 million.
Feel Free to Criticize How I Think about the FIRE Movement!
Is this a conservative way to think about retiring early? You bet it is! Part of the way I think about life though is trying to minimize risks. I don’t want people to retire, and then an emergency happens to them. I don’t like the idea that they are then forced to take a minimum wage job at a place they hate because they have been out of the workforce for too long. Plenty of people will disagree with me though. That’s fine. Just make sure that you are aware of the risks and consequences of what you want to attempt so you can go through life with your eyes open!
*Please Note that I am not a financial advisor or lawyer, and I do not have a fiduciary duty to you. I am not responsible for your finances, and any actions you take are ones that I am not responsible for. The pathway that I laid out may not be conservative enough, and you may not achieve financial independence if you follow it. Those are the risks of investing, and trying to retire early.