Track These 4 Numbers To Retire Decades Early

If you want to retire 10, 15, or even 20 years earlier than everybody else, it doesn't come down to picking the right stocks or timing the market or even how much money you make. It comes down to tracking four numbers. That's it. I can tell you that the people who actually retire early, they aren't doing anything complicated. They just know their numbers and they check them regularly. So in today's video, we'll walk through the only four numbers you need for early retirement and how to calculate each one. And the best part is, is that once you have this system down, it'll take you less than one hour per month to keep track of everything. The first number you need to track is your savings rate. This is the number that actually drives everything else. In terms of a savings rate, you want to take the percentage of your take-home pay that you're actually investing for the future, not just saving in a bank account, but actually putting that money to work. The formula for this is quite simple. It's your total amount invested divided by your take-home pay for the month, and that is your savings rate. So for example, if I invested $500 this month and I make $5,000 in take-home pay, my savings rate is there for 500 divided by 5,000 or about 10%. The reason we want to use take-home pay instead of gross pay is that take-home pay accurately shows you how much money you're saving. If you were to use gross pay, there's federal taxes, state taxes, FICA, and everything else that's involved with that. Technically, that's not your money at the end of the day. And using a gross pay number as the denominator is not great because it'll make you feel like you're underperforming even when you're doing well. Now, before we get into some example numbers and situations, some of you might be wondering, well, Humphrey, what about 401k contributions? If somebody is maxing out their pre-tax 401k contributions, those actually come out before the take-home pay. So how do you calculate that? The best solution here is to simply add your 401k contributions to your investments. I know technically it's not take-home, but it is money coming out and it's going toward your future. So it's okay to count it as part of your savings rate. As an example, if you make $75,000 a year in income, that's about 57K after taxes. If you contribute 5K to a Roth IRA and 10K to 401k contributions, that's $15,000 total that you have invested divided by your 57,000 in take-home pay, giving you a total savings rate of 26.3%. Okay, so now that you know how to calculate it, what should your savings rate be? Well, if you want to retire decades early, let me show you the relationship between savings rate and early retirement to using a NetWorthify online calculator. This is one of those great websites where you can plug in different variables and see how quickly or how soon you might be able to retire. So assuming you make 75K gross per year, which is 57K take-home, if you have a savings rate of 50% and starting with zero portfolio balance, you're looking at around 14.3 years to retire. Now, 50% is a lot and a lot of people won't be able to do this. So if you are able to turn down your savings rate to 20%, it'll take you much longer to get there, 28.5 years. But again, that assumes you start with a zero portfolio balance and if you're the age of 25 right now, that means you'll still be able to retire at the age of 53 and a half, which is one decade earlier compared to normal retirement age. Okay, so what happens if you turn your savings rate down to 5%, which is around the average personal savings rate in America? At that point, it will take you 47.6 years to retire. That means if you're the age of 25 right now and just starting your portfolio, you aren't retiring until at least the age of 72. I will leave a link to this calculator below, but I think it's fun to play around with the numbers and you can clearly see that we need to have a savings rate higher than the average American in order to retire any chance earlier. On this channel, I always like to say that our community here should have a savings rate as a percentage of our take-home pay be around 10 to 20%, but the more that you can increase it past that, I think the better. Mr. Money Mustache is a personal finance blog online and he has a really famous article on early retirement. And here's one of my favorite quotes. If you are spending 100% or more of your income, you will never be prepared to retire unless someone else is doing the saving for you. So yes, basically the more you spend, the less you have for later to invest and work for you. But then he says the following, if you are spending 0% of your income, so let's say you live for free somehow, and you can maintain this after retirement, you could technically retire right now. So your working career can be equivalently zero. Therefore, there's a relationship between saving money and when you can retire. So if you're able to save more, it actually makes it a lot easier to retire because you're spending technically less. But all of these calculations around savings rates are just one piece of the puzzle because all of the calculators online, they all assume that your annual expenses stay the same throughout your entire life. We know that that's not statistically very likely to happen. So that means the second number to track today is your annual spending number, which is how much your life actually costs per year. As I mentioned earlier, this number will influence your savings rate as well as it will also help us figure out what your fire number needs to be. In order to calculate your annual spending, this is what you need to do. I want you to pull up your bank and credit card statements from the last three months and then add up everything. So every single transaction, rent, groceries, dining out, subscriptions, everything that you can think of, add it up and write it down. You then want to figure out what your day-to-day life costs you. So those are going to be things like your bills, your rent, your transportation, groceries, and even discretionary purchases. Once you have that number, let's pretend it's $3,000 a month. You want to figure out what you spend on average on the bigger one-off purchases. Everyone has these random one-off big purchases like a laptop, a trip to Mexico, or maybe you bought a rare Pokemon card. These are one-time purchases that are hard to account for on a regular basis. You want to add up all of your one-off purchases for the period that you are tracking. So let's say it's three months. You add it all up and get an average spend per month for those one-off purchases. If your one-off purchases are increasing your spend by 50 to 100%, that is a problem that we may want to address, but that's for another video. Ideally, you figure out on average, how much you're spending on these bigger purchases. Let's pretend it's $200 per month. Then you want to just add it to your earlier number. So in our case, that was $3,000 for our day-to-day life. That's a total of $3,200 per month that we were spending. Want to multiply that by 12. And that's an approximation of how much you spend on an annual basis. Hopefully that made sense. You basically want to add up your recurring transactions plus what you spend on one-off big purchases and that's your annual spend. Now here's what's interesting. Research from the American College of Financial Services found that people who check their financial numbers regularly, they save significantly more for retirement. More than half of the people who check their retirement balance daily save over 10% of their income. People who check weekly or monthly were about 30% more likely to hit that 10% savings mark than people who only checked quarterly or annually. And guess what? The people that never checked their finances, only 10% of them saved more than 10%. So you can see that that's a pretty straightforward correlation of how often someone checks their retirement balance with how much they actually save. So a simple and effective habit is just to check your retirement savings more often. This is like if you weigh yourself at the gym every day. If you see that scale, you are going to generally make better decisions about your food throughout the day and the week. And I really do think it's the same for financial awareness. The awareness itself will change your behavior around your own finances. So I really don't think you need a complex budgeting system. So far we've talked about tracking your savings rate and annual expenses, but now let's get into the official third number to track today. And that is your investable assets number. Investable assets just refers to anything that you can actually generate a return on. So for example, a balance in a 401k, a balance in an IRA, perhaps a taxable brokerage account that all counts. The way that I would do this is once a month or once a quarter, you want to add up all of the balances of your retirement accounts, brokerage accounts, and any cash that you might have for investing in the near future. That is your total investable assets number. And it does not include some notable things such as your car, your house, any collectibles you might own or your furniture. The reason it doesn't include those things is that if you just added up all of your assets in addition to your investable assets, that would just be your net worth number. While net worth is a really great thing to track in general, I just don't think it's the best thing to track if you're trying to retire decades earlier. And the reason is that a lot of that money is not liquid. So let's say and then a retirement account of $450,000. You technically have a million dollars in net worth or total assets, and that sounds really great. So you might look at that and you might think, okay, I'm really close to being done here. I think I can retire pretty soon, but you can't spend your house. And it's not like you can fractionalize your house either. So it's not like you can say, Hey, I'm going to sell one of my bedrooms to cover my yearly expenses. You either have to sell your house or you don't. In general, I think the majority of people just aren't going to be selling their homes in order to fund their retirement because they still need somewhere to live. Unless you're planning on selling your home and downsizing completely, that equity that you have in your house is typically going to be locked up. Therefore, our actual investable assets in this scenario is around $450,000, which is just how much was in the retirement account. So while I think it's good to have a pulse on what your net worth is, if you're trying to retire decades earlier, I think that if you look at your total assets, it does inflate what your progress looks like because some of those assets you just can't touch. Somebody with a $1.2 million house and $80,000 in investments has a pretty high net worth. But then you could also argue that someone that's renting an apartment with $500,000 in investable assets, that person is way closer to financial independence. Tracking your investable assets is going to get you way closer to financial independence and our FIRE number, which we will talk about next. Now, the fourth number to track today is the number of years to FI or financial independence. This is how all the other three numbers work together and they all converge into this question, which is like, how long until we are free? This is kind of like if you're going on a road trip and you load up your GPS and you're driving somewhere, you have an ETA or an estimated time of arrival. Your years to FI number is exactly that. It's just an ETA of when you're going to retire. For us, we are looking to arrive as quickly as possible. So you want this number to be as low as possible. If your savings rate goes up, guess what? That lowers your years to FI number, which is great. But if your spending goes up, then perhaps your years to FI number goes up, which is not ideal. To calculate this number, you need to know what your FIRE number is. So let's calculate that first. And then we will use the other three numbers from today's video to figure this out. FIRE stands for financial independence, retire early. And at the core of this number is the rule of 25. That's where you take your annual spending, which was number two in today's video, and we multiply it by 25. The reason it's 25 is that it's because it's built on the 4% rule, which is the idea that you can withdraw 4% of your nest egg in your first year of retirement, adjust for inflation each year after, and not run out of money over a 30-year period. So if your annual spending is $40,000, multiply that by 25, your FIRE number is 1 million. If you spend 60,000, it's 1.5 million. And if you've gotten your spending down somehow to $30,000 per year, your FIRE number is only $750,000. Now here's where it gets interesting. The founder of the 4% rule, William Bengen, has actually changed his own 4% number to 4.7%. Bengen started to notice that retirees were dying before spending down their savings. And when he examined it closer, he said that, quote, he created this 4% rule based on an imaginary investor who retired in October of 1968 and ran into a terrible, perfect storm. That was a perfect storm of bad stock market returns and very bad inflation. So he says that you can actually revise it to 4.7% of a withdrawal rate, and that actually changes quite a lot. At 4.7%, you need about 21.3 times your annual spending amount. So on a $40,000 spend, that's the difference between needing a million dollars with the rule of 25 versus needing $851,000 to hit your FIRE number. And it gets even better if you factor in Social Security or a pension. The average Social Security benefit is around 20.71 per month per retiree, which is around $24,850 per year. If you're spending $40,000 a year in retirement, but you're receiving about $25,000 from Social Security, then you only need your portfolio to cover $15,000. At a 4.7% withdrawal rate, that's a nest egg of around $322,695. So once you have your FIRE number, either based on the 25X rule or the 21.3X rule, you can calculate your years to financial independence number, and that is quite straightforward. So let's pretend your FIRE number is $1.5 million. You want to simply take that and subtract your current investable assets. So let's pretend that's $500,000. That means your gap between FIRE and what you have right now is $1 million that you need. Now to estimate your years of financial independence, you want to take that gap and divide it by how much you're investing per year. If you're saving $50,000 a year, that's going to be roughly 20 years of saving with assuming zero growth to fill that gap. But of course that doesn't happen because your money is actually growing. Your existing 500K that you have is compounding and every new dollar you invest starts compounding as well. So the real years to financial independence is actually going to be a lot shorter than this, and you can use a compound interest calculator. I like this one from moneychimp.com. You can input your current investable assets into the current principal and the amount that you're saving per year into the annual addition column. $500,000 with a $50,000 annual addition per year means that in eight years, at 8%, it will grow to $1.5 million. So with this calculator, I like to play around with it, put in my current variables and see what it would take to get to my fire number. In our case, let's say we have $500,000 in investable assets, and then we add 50K to it every single year. That means in eight years, it'll grow to $1.5 million, assuming an interest rate of 8%. That's almost 11 to 12 years faster than the simple math that I suggested where we're getting zero growth. That's the compound interest doing the heavy lifting. So we're basically using all the three numbers that we found in today's video to get to our fourth number, which is the years to financial independence. And in our case, it was eight. Once you're tracking these four numbers, I want to keep them somewhere visible and somewhere accessible. I personally put mine in all of the spreadsheets somewhere along with my net worth tracker. And then once per month, I will just simply update the four numbers and ask myself how these numbers are trending. Are they all moving towards the right direction or do I need to course correct? Because I all of a sudden am spending too much money this month. If you know your savings rate, your annual spending, the investable assets that you have and what your years to financial independence are, these are the only four numbers that you need. If you enjoyed this video, make sure to check out my next video on if 250K, 500K, 750K or a million dollars is enough to retire. And I will link it right here. All right. I'll see you guys in that video or a future one on the channel. Thank you for being here again. I'll see you later.