Calculating your FIRE number PART I: Foundations

The general school of thought is to amass a nest egg of 25x your yearly expenses so that 4% can be withdrawn from your portfolio on an annual, inflation adjusted basis as your income for any particular year. This is of course if we’re following the Trinity Study. Let’s break it down.

The Trinity Study

The Trinity Study is a landmark research project that examined the sustainability of retirement portfolios, specifically focusing on the “4% rule.” Conducted by researchers at Trinity University in the late 1990s, the study analyzed historical data to determine how much retirees could withdraw from their savings without running out of money over a 30-year retirement period.

Key Findings:

1. Withdrawal Rate: The study concluded that a withdrawal rate of 4% per year, adjusted for inflation, was generally safe for a 30-year retirement, based on historical market performance.
2. Asset Allocation: The study emphasized the importance of asset allocation, finding that a mix of stocks and bonds could significantly impact the sustainability of a portfolio.
3. Market Conditions: It highlighted that retirees’ success could vary depending on market conditions at the time of retirement. For example, retiring during a market downturn could be more detrimental than retiring during a bull market.
4. Longevity and Flexibility: The researchers noted the need for retirees to be flexible with their withdrawals and to consider their unique circumstances, such as health care needs and lifestyle changes.

A Deeper Dive

The tables below illustrate the success rate given asset allocation mix and time horizon for withdrawal rates between 3% and 12%. For example, there is a 100% success rate (not running out of money) for a time horizon of 40 years with an asset allocation mix of 50/50 bonds/stocks.

The Criticality of Accurate Expenses

Success rates are based on annual expenses, therefore it is imperative that this number is estimated correctly. Everyone’s financial situations are unique, hence why it’s called “Personal Finance” – so it’s up to each individual to calculate annual expenses accurately on their own. As you draw up your numbers take into account both expenses that are incurred monthly such as rent, food, transportation costs, etc. As well as lump sum type expenses that occur, such as annual subscriptions, insurance that’s due bi-annually, etc. I recommend building a spreadsheet listing out all your expenses. I’d include sinking funds into ‘expenses’ as well. For example if you love to travel and want to stash away $200 a month ($2400/yr) for travel include this as an ‘expense’. Do this for any discretionary spending you anticipate.

Once you have all your expenses enumerated, add them up then multiply by 25. Voila! You’ve got your ‘FIRE Number’. Save this figure up during your working years, determine your time horizon, your risk tolerance and utilize the chart above.

Is the 4% Rule the only way?

I personally don’t think so. A future post will illustrate how I will be approaching and funding early retirement that utilizes a combination of the 4% Rule along with a portfolio of income generating ETFs. Until next time, the world is yours, you write your future. 

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