What Is Your Number

Achieving financial independence and retiring early (FIRE) is a dream for many, but it all starts with knowing your “number” – the amount of money you need to have saved to live comfortably for the rest of your life without working. Calculating your FIRE number is a critical step in this journey. It gives you a clear financial target and helps you stay on track toward your goal of financial freedom. But how do you determine this number? Let’s break it down into simple steps.

The first step in calculating your FIRE number is to estimate your annual expenses. This includes everything from housing and utilities to groceries, transportation, insurance, healthcare, and even discretionary spending like entertainment and travel. The goal here is to be as realistic and detailed as possible. Look at your current spending patterns and think about how they might change in retirement. For instance, you might spend less on commuting but more on healthcare or hobbies. It’s crucial to consider any big-ticket items, such as home repairs or education costs, that might come up. Once you have a clear picture of your annual expenses, you can move on to the next step.

Next, you need to decide on a safe withdrawal rate, which is the percentage of your savings that you can withdraw each year without depleting your nest egg too quickly. The most commonly cited rule is the 4% rule, which suggests that if you withdraw 4% of your savings each year, your money should last for 30 years, assuming a reasonable rate of return on investments. However, some experts suggest adjusting this rate based on factors like market conditions, your investment strategy, and how long you plan to be retired. For example, a more conservative approach might involve a 3.5% or even 3% withdrawal rate, especially if you expect to live longer or want to leave a legacy.

With your estimated annual expenses and withdrawal rate in hand, you can now calculate your FIRE number. Simply multiply your annual expenses by the inverse of your chosen withdrawal rate. For example, if your annual expenses are £30,000 and you plan to use a 4% withdrawal rate, your FIRE number would be £750,000 (£30,000 / 0.04). This is the amount of money you would need to have invested to safely withdraw £30,000 per year without running out of money. The calculation might seem straightforward, but it’s a powerful tool that gives you a concrete target to work toward.

Calculating your FIRE number isn’t just about multiplying a few figures. There are other factors to consider that can significantly impact your final number. For instance, inflation can erode the purchasing power of your savings over time, so it’s wise to factor in a modest annual increase in your expenses. Additionally, consider any private pensions, state pensions, or other income streams you might have in retirement. These can reduce the amount you need to save. Finally, think about potential changes in your lifestyle – will you move to a more affordable area, or do you plan to travel extensively? Each of these factors can either increase or decrease your FIRE number.

Your FIRE number is not set in stone. As you progress on your journey to financial independence, it’s important to regularly review and adjust your calculations. Changes in your lifestyle, unexpected expenses, or shifts in the economy can all impact your number. Regularly revisiting your estimated expenses, withdrawal rate, and investment performance ensures that your plan remains on track. Consider doing a thorough review at least once a year or whenever you experience a significant life change. This practice keeps your goals realistic and achievable, and it helps you stay motivated as you inch closer to financial freedom.

Imagine Jane is 35 years old, living in the UK, and aiming to retire early at age 55. She has carefully tracked her spending and determined that she currently spends £40,000 per year. Jane wants to maintain a similar lifestyle in retirement, adjusting for potential future expenses like healthcare.

Jane estimates her annual expenses in retirement will remain around £40,000. She believes this figure accounts for all necessary costs, including housing, utilities, groceries, transportation, healthcare, and some leisure activities. Jane also considers the possibility of minor lifestyle inflation and decides to round this up to £42,000 to stay on the safe side.

Jane chooses to use the 4% rule as her withdrawal rate, a commonly accepted rule of thumb in the FIRE community. This rate suggests that withdrawing 4% of her retirement savings annually will allow her to live comfortably without depleting her funds too quickly, assuming her investments continue to grow over time.

With these figures in mind, Jane calculates her FIRE number. The formula is simple:

FIRE Number = Annual Expenses ÷ Withdrawal Rate

For Jane, this calculation looks like:

£42,000 ÷ 0.04 = £1,050,000

Jane would need to save and invest £1,050,000 by the time she plans to retire to safely withdraw £42,000 per year.

Jane realises she should also consider other factors. For example:

• Inflation: She considers that over 20 years, inflation could increase her annual expenses, so she adds a small cushion, targeting closer to £1,100,000.
• Other Income Sources: Jane expects to receive a small pension of £5,000 annually from age 67. To account for this, she could reduce her FIRE number slightly, but she decides to keep her target at £1,100,000 as a conservative approach.

Jane knows that her circumstances could change, so she plans to review her FIRE number annually. As she gets closer to retirement, she’ll reassess her expenses, market conditions, and any other factors that could affect her financial needs.

When calculating your FIRE number, there are a few additional considerations that can further refine your strategy and ensure you’re fully prepared for financial independence:

While calculating your FIRE number, it’s essential to consider an emergency fund or additional buffer. Unexpected expenses can arise, such as medical emergencies, major repairs, or economic downturns. Having an extra cushion beyond your FIRE number can provide peace of mind and financial stability in uncertain times. This buffer might be 6 to 12 months’ worth of expenses or even more, depending on your risk tolerance.

Healthcare costs can be unpredictable and may increase significantly as you age. In the UK, while the NHS covers many healthcare needs, there might be costs associated with private healthcare, dental care, or long-term care that aren’t fully covered. It’s wise to estimate these potential costs and incorporate them into your FIRE number.

Understanding the tax implications of your withdrawals is crucial. In the UK, pension withdrawals, dividends, and capital gains may be subject to tax. Knowing how much you’ll need to withdraw after taxes can affect your FIRE number. Planning your withdrawals strategically to minimise tax liabilities is important, especially if your income during retirement puts you in a higher tax bracket.

Your investment strategy plays a significant role in achieving and maintaining your FIRE number. Consider how your portfolio is allocated between stocks, bonds, and other assets. As you approach retirement, you may want to shift to a more conservative investment mix to reduce risk. Understanding how market volatility can affect your savings and withdrawals is key to ensuring your FIRE number is realistic.

Your lifestyle and personal goals may change over time, and it’s essential to remain flexible. For example, you might decide to downsize your home, move to a more affordable area, or spend more time travelling. Flexibility in your retirement plans can help you adjust to changes in your financial situation or personal preferences.

If you have a spouse or dependents, you’ll need to consider their needs and expenses when calculating your FIRE number. This includes whether you plan to retire at the same time, how you’ll handle joint expenses, and how your combined assets and savings impact your overall number. Additionally, if you plan to support aging parents or help children with education costs, these should be factored into your calculations.

If you have aspirations to leave a financial legacy for your children, grandchildren, or a charity, this will also impact your FIRE number. Planning for an inheritance or charitable donations means you’ll need to save more than just what you’ll need for your retirement.

Finally, it’s worth having a contingency plan in case things don’t go as expected. This could involve considering part-time work, side gigs, or alternative income streams in retirement. Having a backup plan can help you feel more secure as you approach financial independence.

Calculating your FIRE number is a critical step in planning for financial independence and early retirement. By estimating your expected expenses in retirement, determining a safe withdrawal rate, and accounting for additional factors, you can determine how much you need to have saved or invested to achieve your financial goals. Regularly reviewing and adjusting your plan will help ensure you stay on track to reach financial independence and retire early.