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# How Much Money Do You Need?

How do you know how much money you need to invest in order to be financially independent?

The total amount you need to have invested in order to live off of the interest is known as your FI number.

The simple formula is:

Annual Expenses X 25 = FI Number

This is based on the 4% rule that is well known in the financial independence community, and widely used by retirement planning professionals. It's based on the Trinity Study which analyzed historical data to arrive at the 4% number for a 30 year retirement. There is updated data showing that 3.5% is safe over the long term (up to 50 years), and the originator of this rule of thumb recently said 5% is more realistic, but overall 4% is still the standard for estimating how much you will need to invest in order to maintain your current lifestyle through retirement, no matter how long that is.

How does it work?

Once you have a "nest egg" invested in low cost index funds, you can expect your investment to grow around 9-10% annually on average over time. This will not happen every year of course. Some years your portfolio will grow by 31% (like 2019) and some years it will lose 20% (like 2022), but over the course of time, the average will be around 10%.

Of course, we need to take inflation into account. This is why most retirement planning models predict 5-7% returns. This accounts for not all of your portfolio being in equities and for an average of 3% inflation.

Once you reach your FI Number, you will then sell a small portion of your portfolio, around 4% per year. This will ensure that, on average, you're not selling more than you gained. This means that your portfolio will still grow, even while you're living off of it.*

How Do I Calculate My FI number?

Step 3, multiply this number by 25

1. Find your total expenses

Expenses tend to come in waves, so don't use just one month and multiply it by 12. Instead go back and find the data for a 12 month period.

Start by looking at your monthly bank statements, credit card statements, or statements from any other payment app you use. You're looking for a total number here for each month.

Be sure to include expenses that your company pays for, like flights, housing, or schooling. These are expenses, they're just currently covered by your job. If you don't know exact numbers on these, estimate how much they would be if you had to pay for it yourself.

Once you have an annual number--that's based on real data--go on to step 2.

2. Subtract Passive Income

Pensions

Do you have a pension in any form? When will you be able to access it? If you're planning on retiring long before you can access your pension you may not want to include it in this calculation. But if you're planning on retiring around the time you'll be eligible to access your pension, it's worthwhile to include it.

If you do want to include this, calculate the annual payments you will receive from your pension and subtract it from your annual expenses. Keep in mind that you'll need to make this amount up if you start to draw down your investments before your pension goes into effect.

Property

Subtract your annual profits from rental income. You can calculate this by multiplying rent you collect by 12, then subtracting annual insurance, mortgage payments, taxes, management and maintenance costs. It's best to use actual data from last year's bank statements when doing these calculations.

Miscellaneous Income

Don't include income that you have to trade your time for. We're looking for truly passive income. Royalties from a book you wrote, ad revenue from a blog you've already written, or profits from a business you invested in, but don't actively run. It's best to use receipts for these annual amounts. If you don't expect to continue receiving this income in the future, don't include it. (Ie, your blog revenue is tapering off)

3. Multiply by 25

It's as simple as it sounds. Once you have your actual annual expenses minus any expected passive income, you just multiply. If you're planning on retiring early and anticipate living off of your investments for more than 30 years, it's a good idea to plan on withdrawing closer to 3.5% per year, in which case you might choose to multiply by 30.

4. Subtract Investments

By investments, I'm referring to assets that earn interest. A 401k, stocks, bonds, or other ETFs you already have. The house you live in, your car, luxury goods etc should not be considered in this calculation.

That's it. Once you actually do the calculations, you have your FI number. This is how much you need to have invested in order to generate enough money to maintain your current lifestyle, indefinitely.

Once you have your FI number your next step is to make a plan to get there. Remember that you don't have to save up the entire amount, your money will grow as long as you have it invested.

If you already have some investments, you've already started your journey towards financial independence! Well done.

If you need help getting started or figuring out what's next, why not schedule a free 15 minute call with me today?

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*The only exception to this is if you just happen to retire at the start of multi-year slump in the market. Thankfully that's rare, and somewhat predictable. In fact, using historical data for a 60% equities portfolio with a 4.5% withdrawal rate there is a 96% chance you end up with MORE money than you started with. For a less technical overview read the MadFientist's post on SWR. For greater detail see this detailed analysis of the Sequence of Return Risk by Michael Kitces.

**3.5% is the floor, meaning that even if you plan to live off of your investments for more than 50 years, your portfolio will never get to 0 with a 3.5% withdrawal rate, so long as you're invested in at least 60% equities.

Here's a detailed Portfolio simulator for those interested

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