Mr. B here. After reading my last post, and now that you have the first month or two of your spending data, let’s have some fun! This formula will be covered in more detail in a future post, but let’s go back to that 5% theoretical investment that I previously discussed. (We are personally shooting for an investment return/withdrawal rate of 4% per year, but again, I’m trying to keep things simple for now.)
Take your monthly spending total and multiply it by 240. Random number? No, I didn’t just pull it out of my ass. It’s just an easy way to find out how much money you need to accumulate in order to generate your current monthly spending at a withdrawal rate of 5%. The number is 300 if you are only planning on generating 4% per year like us.
For those more mathematically inclined:
Assume you are spending $50,000 per year on your various expenses and lifestyle. At a withdrawal rate of 5%, you need $1,000,000 to generate that income. $1,000,000 divided by 20 (5%) = $50,000. $50,000 then divided by 12 = $4,166.67.
20 times 12 =240! Voila!
From there, go ahead and play around with your numbers. See how much less you will need to accumulate if you can cut $100, $200 or $500 from your monthly spending. So for example, if you can cut $500 from your monthly expenses, then that is $120,000 less you’ll need to save.
Once you have “your number,” we can try to get a very rough estimate of how long it will take to reach that number. Hint* it’s going to be a long-ass time, especially if you are just starting on this journey with minimal savings. Over time though, as your lifestyle becomes more efficient and streamlined, your date will continue to get closer and closer.
Your financial independence date will be a product of your current savings total, how much you are saving each year, and what your assumed rate of return on the savings will be. To calculate this information, I use a compound interest calculator. The simplest one that I’ve found is from the website moneychimp.com. Use the following link and let’s try a made up scenario:
Mr. And Mrs. Smith currently have $50,000 in retirement savings. They bring home $100,000 combined after taxes and are saving $25,000 per year (they’ll get that savings rate up over time after reading this blog). They believe they can average an annual return of 5% on their investments and also believe they can slash their spending to $50,000 per year going forward. Using our formula from above they will need to accumulate $1,000,000 ($50,000/12 months = $4,166.67 X 240 = $1,000,000). As you can see, the calculator tells them they will reach their number in about 20 years!
After seeing this, Mr. And Mrs. Smith decide to really ramp up their savings because 20 years is simply too long to wait. They used the “Prosper Daily” app (discussed in a prior post) to see where that additional $75,000 of after tax income was going, and realized that they could cut an another $25,000 of spending that really wasn’t making them any happier, and add that to savings. This change cut over 7 years off of their financial independence date immediately.
If you are unhappy with the results, it’s ok. Keep following this blog to see how we have managed to save more than 50% of our income for the past few years. Each dollar cut from spending and added to savings will slash your timeline to financial independence! In case you were curious, our financial independence date is January 9th 2020. Mrs. B and I will be 37 and 35 years old respectively.