Last updated in November 2020
Learn how to calculate your FIRE number, manually or using a financial independence calculator. The financial independence, retire early (FIRE) movement is a lifestyle growing in popularity. And this is unsurprising: Who would not want to live a life free of mandatory work?
However, despite the FIRE movement, many people still overestimate how much money they need to say ‘goodbye’ to the nine-to-five work life. Monethalia’s aim is to make FIRE accessible to everyone and this includes dispelling the myths about the need for millions of pounds (or dollars).
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What is financial independence, retire early (FIRE)?
Being financially independent means that you possess a sufficient amount of money to never work again in your life. Thus, you are not dependent on making money. Instead, you can quit your job and retire early. This is commonly achieved by following key steps, adopting the right mindset, and investing.
If you are interested in becoming financially independent, the first step is to find out how much money you need. This article will help you with this and highlight different methods used to calculate the amount of money you need to be free, also known as your FIRE number.
How to calculate your FIRE number
The 4% rule
The most popular way to calculate your FIRE number is the 4% rule. This means you can withdraw 4% from your portfolio every year and your money should last forever. So imagining you have £1 million invested, you could withdraw £40,000 per year. This would give you £3,333 per month to live on which is more than enough to live comfortably in most places.
The Trinity Study
The 4% rule has its origins in the Trinity Study. In this study, the authors backtested a number of stock/bond mixes and withdrawal rates against market data compiled covering the period from 1925 to 1995.
The main result of this study was that 95% of portfolios of 50% large-cap stocks and 50% long-term high-grade corporate bonds survived the 30-year study period unscathed when 4% (inflation adjusted) of the total portfolio value was withdrawn every year.
Based on these findings, many FIRE aspirants now calculate their FIRE number with a 4% withdrawal rate in mind. However, as you may have noticed, there are a number of limitations to this:
- The withdrawal rate is based on historical data
- The study only observed a limited time frame of 30 years
- Even the study authors conclude that a more cautious approach is warranted
- Your life, your circumstances and your future are unique
- Nowadays many people prefer to invest more in stocks and less in bonds
Limitations do not mean the 4% rule is useless. It does mean that you have to be attentive and should not blindly follow guides.
More flexible withdrawal rules
Having realised the glaring limitations of the Trinity study, many people concluded that we need a more tailored approach to retirement. Monevator recently published a brilliant article on choosing safe withdrawal rates. In summary, the article advocates that your withdrawal rate should depend on a number of variables:
- How long your portfolio needs to last
- What you are invested in
- Success rate or risk tolerance
Thus, based on this, most of us should end up with a long-term withdrawal rate of somewhere between 3% and 4%. You can use 3% for a more cautious approach or 4% if you want to retire earlier and do not mind a slight increase in risk. The intermediate way would probably be using a safe withdrawal rate of 3.5%
Calculate your fire number without a financial independence calculator
Once you know your safe withdrawal rate, you can calculate how much money you need. The easiest approach is to base this on your annual expenses. Annual expenses are defined as your total annual spending.
Steps to calculate your FIRE number:
- Multiply monthly expenses by 12 to obtain annual expenses
- Divide annual expenses by your safe withdrawal rate (0.03 for 3% or 0.04 for 4%)
- The result is your FIRE number
If your monthly expenses differ every month, a good approach is to start tracking how much you spend and calculate an average. Alternatively, you can base your expenses on how much you expect to spend once you are retired
The second method (using post-retirement expenses) is more accurate although it may be difficult to make a correct estimate. You will have to take into consideration whether you may want to travel more, move to a cheaper area, etc.
Furthermore, this calculation assumes that your portfolio stays invested the entire time and returns a minimum of 6% per year. You can achieve this by investing in index funds and minimising investment risks.
If you are not interested in reaching FIRE, you can work out the amount of savings you should have at your age and use this as your target.
Calculate your FIRE number with a Financial independence calculator
Financial independence calculators are there to help calculate your FIRE number. Because they can take into account various factors, they will give you a more individualised number. But you also need to use them with caution as their validity is based solely on the underlying models.
There are several different financial independence calculators available:
As you can see, Networthify is a very simple financial independence calculator. It is ideal for beginners and those who quickly want to check their progress. You can adjust your safe withdrawal rate under Show more options.
However, its biggest drawback is that you cannot distinguish between current and future expenses. Thus, this effectively renders the calculator useless for those who aim to drastically change their lifestyle after reaching financial independence.
Playing with FIRE
The Playing with FIRE calculator is a financial independence calculator similar to Networthify. The key difference is that it accounts for asset allocation. Whereas you have to manually calculate your average interest for the Networthify calculator, Playing with FIRE does the job for you.
If you are young, you will probably have most of your money in stocks and shares so this feature is less relevant. However, those who are more cautious or closer to retirement may appreciate being able to enter their portfolio allocation.
On the downside, it is less useful if you want to use a safe withdrawal rate other than 4%. And as we discussed above, this is pretty important if you are aiming for a more than 95% success rate.
The Millennial Money FIRE calculator uses dollars as currency. But, you can easily just ignore the currency symbol as the underlying calculation remains the same regardless of your country.
This calculator has the advantage that it takes into account any side income you may make post-FIRE. This is important if you have passive income sources like a blog or rental property. Additionally, you can enter set future expenses, for example, if you want to pay for your children’s university education.
This is a pretty important feature as having a side income providing you with an income after retirement can significantly reduce your FIRE number. For example, for me, having a side income with a £300 return per month can take £90,000 off the amount I need to retire.
As a limitation, the Millennial Money calculator does not tell you how long it will take to reach your FIRE number.
The FIRE Age calculator is probably the most versatile FIRE calculator because it does not care about your current expenses (again, simply ignore the $ symbol). Rather, it is based on future expenses and current savings. Therefore, it avoids problems with differences between current and future expenses.
Other than that, the calculator is very simple. It does not account for extra income after retirement, or other factors.
The When Can I Retire? calculator from Engaging Data looks daunting at first. However, if you progress through the rows from left to right, it is actually much simpler than it appears.
This calculator accounts for asset allocation and you can distinguish between stocks and bonds. Plus, it also allows you to distinguish between current and future annual expenses. There is a lot you can do with this calculator to calculate your FIRE number but beginners may find the number of options confusing.
How to calculate your FIRE number summary
There are multiple ways to calculate your FIRE number. The traditional 4% rule, long seen as the gold standard, becomes increasingly replaced with other, more flexible methods.
To ensure you are on the right path, you can use one (or more) of multiple FIRE calculators. While financial independence calculators have their limitations, they are useful tools to gauge your progress and estimate your FIRE number.
You should also keep in mind that your FIRE number needs to be continuously re-assessed and check as you progress on your journey to financial independence. The closer you get to that stage, the more accurately you can gauge the amount of money you will need.
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