Use the 4% Rule to Calculate How Much You Need to Retire

If “new age retirement” is more about living your best life than about being old and doing nothing, it really hinges on only one rule: You must be able to live off your investments. If you have money that generates more money, and your annual return covers your annual expenses, you are retired.

This kind of retirement is fluent. You may achieve it in one year but not the next, but after a transition period of a few years, you should be able to consistently generate the sum you need to pay your bills every year.

Once you’ve arrived in that position, you are retired and can spend your time as you please.

But how do you get there? A famous study from Trinity University suggests you start by looking at your current annual expenses. How much do you need to live? Add up all basic expenses, like rent, utilities, car payments, gas, health and other insurance, groceries, clothes, etc. Do it for the past year. Maybe you already have some data. If not, begin by adding up the biggest recurring items you can think of.

Let’s say you arrive at the number $20,000. This is how much you’ll need every year to maintain your current standard of living. According to the study, you now multiply this number by 25. In our example, that’s $500,000. If you have half a million dollars in investments, you should be able to sustain your $20,000/year-lifestyle indefinitely. How so? At $500,000, you only need to generate a 4% return on your money each year.

That’s a very conservative amount. It is considered “safe” even after factoring in market downturns and recessions.

Better yet, if you do make those returns, you’ll never even touch your initial portfolio! The study assumed people would retire at 65 (of course) and live another 30 years, but it also suggested people would withdraw 4% each year, thus shrinking their pile. If you continue to grow your investments, you’ll likely be able to afford more over time and keep sustaining yourself for longer.

How well the 4% rule holds up depends on inflation (the rising cost of goods and services), changes in your lifestyle, and how you allocate the money in your portfolio to assets with different levels of risk, but when your journey is just beginning, it is a good tool to pull your goal in sight.

Action Item: Calculate your retirement number

Based on your current living expenses, how much do you need to retire?

Use the 4% rule to get a rough idea of your retirement goal.

If you can live on $20,000/year, you’ll need $500,000 to retire. If you want to live on $40,000, you’ll need $1 million.

What’s the minimum you need? How much would you like to spend? What’s the maximum, a budget you can barely imagine how to spend each year?

Calculate your retirement number for various scenarios. Try it on, and see how it fits. The clarity will help you because now, you’ll finally have a goal you can see.

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