How much do I need to retire?

Well, that is a million dollar question, or maybe a couple of million dollars or  maybe ten million. Depends on who you are talking to. Financial pundits will advice that you need 25 times your retiring salary, so for example a retiree earning 70K as his last salary, needs to stack away $1.75 million. I think this sort of advice is misleading at best and is demoralizing. One would lose the battle even before going to the war, so most folks will give up and simply not bother to give savings a decent piggy bank. Read this awesome Early retirement tips guide

But how much do I really need?

Unfortunately there is no easy answers, nor is there is a one size fits all approach. How much you need for retirement is based on your lifestyle and specific spending habits and hence  your magic number can be vastly different from someone else in a similar income band. In the world of Financial Independence practitioners there is a commonly used term called “SWR” or “Safe Withdrawl Rate” or “The 4% rule”. Stay with me – the concept is pretty simple and backed by historical data. Let us first understand “SWR”.Safe withdrawal rate is the maximum amount of money you can withdraw from your retirement portfolio per year, so that you don’t  run out of money in your lifetime. The trinity study did a detailed study based on historical data and came up with the recommended SWR.

What is Trinity Study

 In a  landmark study in 1988 called “ The Trinity Study”, 3 professors at Trinity university – Cooley, Hubbard and Walz studied historical data for the US to determine the chance of success for different withdrawal rates from ones retirement savings for different time horizons and asset allocations. The study considered increasing percentages of spend every year adjusted for inflation as derived from CPI(Consumer Price Index) data. For the annual data between 1926 and 1995, they found that a portfolio comprising of 50% large cap stocks and 50% bonds would provide 95% chance of success with an inflation adjusted annual withdrawal of 4% of the portfolio value at the time of retirement. Success here is defined as not going broke during the 30 year period. So a retiree with a million dollar stash can withdraw $40,000 in year 1, $41,200 in year 2 (assuming a 3% inflation) and so on for the next 30 years and not run out of his money. A guy called Wadu Pfau updated the study till 2009 and plotted the trinity study data and has this useful chart. (https://retirementresearcher.com/trinity-study-updates/) 

As you can see from the figure above, 4% is really the worst case scenario and in most years, retirees could have withdrawn more than 5% and still see a increase in their portfolios. Also the interesting math here is that even after 30 years, there will not be an impact on the success of this model. Thats good news for all the folks who are aiming to retire in their 40’s or even 30’s and hence may have a 40 to 50 year horizon for their money to last. Read our travel guide here

Let’s dissect that 95% chance of success number a bit more.  The Trinity Study had data from 1926 to 1995.  To consider retirements lasting 30 years, this means they could only consider retirement dates from 1926 to 1966.  which represents 41 beginning retirement dates.  Of those 41 dates, the 4% inflation-adjusted withdrawal rate failed 2 times, in 1965 and 1966.  Thus, it’s success rate was 39/41 = 95.12%, or 95% when rounded down.

Now complete annual data is available through the end of 2009, giving us now the chance to look at 55 retirement periods of 30 years, as we can now consider retirement dates between 1926 and 1980.  Of the 55 periods now available, there are still only 2 failures, 1965 and 1966.  There hasn’t been any failures since then.  Now we have a success rate of 53/55 = 96.36% or 96%.

But there are skeptics who would question the predictability of the model beyond 2009, Trinity study was based on the US prosperity boom, what about the future? what will be the impact of climate change on inflation? what if there is a global calamity or war ? Trinity study did fail for two years, etc. etc. Well for the Naysayers, The Trinity study actually does not factor in the following:

• Social security payment so $12000 or more during the retirement years.
• No additional income from part time jobs or inheritance
• No reduction in spending to manage years of economic downturn or aging.

Overall the Trinity study results look to be solid as gold and I believe is still a conservative plan. Which means 25 times your annual expenses is a fool proof plan which has stood the test of time.

For someone who is open to working just a few hours per week , I think 5% is also a bullet proof SWR.

For retirees who can live on $30,000 per year, this means having a retirement corpus of $ 600,000. If you spend $ 40,000 annually this would mean $800,000 and so on. You get the idea.

If you like to play around with the numbers from the Trinity study do check out the FIREcalc website. Tweak the variables and see the results for yourself.

It is highly recommended that reducing the annual expenses is the easier way to expedite your financial independence as opposed to increasing your income. More on that in another post.