There are three retirement goals to shoot for in order to comfortably walk away from your day job and remain retired. They are:
- Accumulate 25X your annual expenses
- Accumulate 20X your annual household income
- Be able to live off a 0.5% annual withdrawal rate
Instead of viewing these retirement goals as at odds with each other, view these retirement goals along a spectrum. They were all introduced at different times in history to address different economic conditions.
Let’s review each of the three retirement goals and see how they can apply on your financial journey.
Retirement Goal #1: Achieving 25X Your Annual Expenses
The baseline retirement goal is to build a liquid net worth equal to at least 25X your annual expenses before you retire. A liquid net worth excludes the value of your primary residence.
If however, you can generate income from your primary residence by renting out rooms, then I suppose you can include your primary residence’s value in your 25X calculation.
25X is the inverse of 4%. 4% is the longstanding safe withdrawal rate that has been espoused since the mid-1990s. I believe the 4% rule is outdated, which is why accumulating 25X your annual expenses is the minimum net worth amount to achieve before retirement can truly be considered an option.
Accumulating a net worth equal to 25X your annual expenses is the easiest goal, but it is also the most aggressive goal to live off. The reason why it’s the easiest goal is because expenses can be reduced to more easily achieve the goal.
For example, let’s say your desired lifestyle is spending $40,000 a year. You would, therefore, need to accumulate a net worth of at least $1 million to retire.
But if you wanted to cheat, you could lower your expenses to $20,000 and pretend your life would still be as great living on half as much. As a result, you may tell yourself that you only need $500,000 to walk away from your job.
You can pretend your ideal living situation is only eating boiled eggs with raw onion for dinner in a studio apartment in your 40s. However, deep down, you know you would love to live in at least a one-bedroom so you and your partner don’t drive each other crazy during future lockdowns.
25X Expenses Is Not Enough To Feel Secure
Here’s the thing. I don’t know anybody who retired with 25X their annual expenses who isn’t frantically working to make more money. The majority of people who only have a net worth equal to 25X their annual expenses have simply changed careers.
I also don’t know anybody who retired with 25X their annual expenses who is truly living their best lives. Besides lowering housing and food standards, there may be other sacrifices such as travel, charity, and even family formation.
Given these two big reasons, I recommended giving yourself a high-five once you’ve achieved 25X your annual expenses. Then, come up with a plan to accumulate a net worth equal to 20X your annual household income.
Related: The Curious Case Of Retiring And Living In Abject Poverty
Retirement Goal #2: Net Worth Equal To 20X Your Household Income
Achieving a net worth equal to 20X your household income is the main retirement goal everyone should shoot for today. It is a net worth target I came up with in 2016. The income to base your calculation on is the average of your three highest income-earning years.
Not only is the 20X income goal based on logic, I’ve also carefully monitored how it stacks up through the course of my retirement. So far, it’s held up reasonably well, although it’s being challenged in 2020+.
The significance of the 20X income goal is that it prevents you from cheating. You can’t lower your expenses to achieve your net worth target quicker. Instead, you are forced to always stay disciplined the more you make.
The Focus On Investment Income
There’s a natural tendency to spend more the more you make. By following the 20X income goal, you also become more focused on making more money through your investments.
Conversely, with the 25X expenses goal, you may be more focused on reducing expenses.
Since day one of this site in 2009, I’ve always emphasized making money over cutting expenses as the best way to build wealth. You can only cut so much, but the amount you can make is unlimited.
More Satisfying Achievement
The 20X income goal is also great because the more you make, the more challenging your net worth target gets. With the 25X expenses goal, the more you make, the easier your net worth goal becomes. As a result, if you achieve a net worth equal to at least 20X your income, you will feel more satisfied.
Not only will you feel more satisfied with your accomplishment, you will also feel more at ease in retirement. You won’t feel as great of a need to make supplemental retirement income if you don’t want to. However, you will probably end up doing something due to your interests and desire to be productive.
For example, I enjoy playing tennis, teaching, and meeting new people. Therefore, before I had kids, I decided to give private tennis lessons once or twice a week sporadically. Each lesson earned me $80, which was nice beer money.
Related: Target Net Worth Amounts By Age And Work Experience
Retirement Goal #3: Withdrawing Only 0.5%
The final retirement goal is one that is practiced after you leave your day job. Once you’ve accumulated a net worth equal to 20X your income, I recommend withdrawing no more than 0.5% of your portfolio during your first three years of retirement.
You want to stay conservative during your initial retirement years because you’re still trying to figure out how to live your new life and spend your capital. Further, the earlier you retire, the greater your uncertainty of whether you did the right thing.
Withdrawing only 0.5% a year may sound aggressive, but it is aligned with the times of permanently low interest rates. It takes much more capital to generate the same amount of risk-adjusted income. Therefore, it’s wise to lower your safe withdrawal rate accordingly.
As I wrote in my Proper Safe Withdrawal Rate post, one of the reasons why the 4% rule is outdated is because when it was proposed, the risk-free rate was between 5% – 6.5%. Therefore, it doesn’t take a PhD to know that withdrawing 1-1.5 percentage points below a guaranteed rate of return is safe.
After a lifetime of accumulating wealth, withdrawing money will feel foreign. Therefore, it might not be as hard as you think to keep your withdrawal rate at 0.5% or less.
Retirement is a very emotional process. It doesn’t fit neatly into a model.
200X Expenses Is Too Much
The flip side to a 0.5% withdrawal rate is trying to accumulate a net worth equal to 200X your annual expenses. In other words, if you are comfortable living off $50,000 a year, you would need to amass a $10 million net worth. If you do so, then you can more easily withdraw 4% or more.
Intuitively, we understand that $10 million is unnecessary for a $50,000 a year spender. Even if there is a 10-year bear market that wipes away 70% of your net worth, you’ll most likely still be fine with $3 million if you keep spending the same.
After all, to live off $50,000 a year is like making $70,000 a year in gross income. If you follow my 20X income goal, then all you would need is $1.4 million, let alone $3 million.
Therefore, instead of focusing on accumulating a net worth equal to 200X expenses, focus on lowering your safe withdrawal rate when you are retired. The only way to lower your safe withdrawal rate is to earn supplemental retirement income, hopefully through work that gives you purpose.
Further, the 10-year bond yield has been inching up and is close to 1% now. Therefore, instead of a 0.5 percent withdrawal rate, you can bump it up to a 0.8 percent withdrawal rate.
My proper safe withdrawal rate is calculated by taking the 10-year bond yield and multiplying it by 80%. Therefore, with the 10-year bond yield back up to ~1.1% in 2021, the proper safe withdrawal rate is closer to 0.88% now.
Finding Purpose Is Important
What the retirement models and researchers won’t tell you is that once you retire, your desire for having a purpose will dramatically increase. Given your identity is no longer wrapped up in your career, there is a void you will want to fill.
One of the best solutions is to do something purposeful that also provides income in retirement. This activity can be as straightforward as being a Walmart store greeter for three hours a day. It not only feels good to help people find their way, but it’s also nice to be part of a community.
The community aspect cannot be underestimated. Perhaps lockdowns have highlighted how important community really is. The desire to be a part of a greater group is why I joined a tennis club and a softball league. It is also why I became a high school tennis coach for 3-4 months a year.
You may wonder why people who come up with these retirement models don’t talk more about the importance of purpose and community. The reason why is because these modelers hadn’t experienced retirement yet when they came up with their models: they were all working.
I’m giving you perspective in real-time after not having a job for more than eight years. Withdrawing any amount of capital each year after spending 20+ years saving may be harder than lifting Thor’s hammer.
Related: The Negatives Of Early Retirement Nobody Talks About
Example Of Using Retirement Goals On A Spectrum
After reading more about these three retirement goals, I wanted to share an example of how you can implement using this below case study from a reader. He shares the following financial attributes:
$155k – annual spend
$90k – annual income from a side hustle
$3,000,000 – net worth excluding house and 529.Do you think that’s enough to retire comfortably?
Depending on age, this reader is very close to being able retire without much worry. Using the baseline retirement goal of 25X expenses, he would need a minimum net worth of $3,875,000 versus his current liquid net worth of $3,000,000.
However, his $90,000 a year side hustle is very significant income. If the side income is defensible, enjoyable, and has an equity component to it that can be capitalized, its value can be added to his existing liquid net worth to get closer to $3,875,000.
Alternatively, he could take his $155,000 annual spend and subtract $90,000 to get $65,000. 65K equals about $95K in gross income. Using my 20X income goal would mean he would only need a $1,900,000 net worth to retire comfortably.
By withdrawing 0.5% from his current liquid net worth of $3 million, the reader can add $15,000 a year to his $90K side hustle income and live off $105,000 for at least the first year post retirement. It’s not the $155,000 annual spend he is used to. However, he can challenge himself for at least one year post retirement to try and generate more side hustle income and/or reduce his expenses.
A Plan Before Retirement
If I were the reader and wanted to retire soon, I would circle a date one year into the future. During the next 12-months I would:
- Save and invest a record amount
- Boost side hustle income
- Develop better relationships with my manager and HR
- Reduce risk exposure
- Strategize a severance negotiation
Getting a severance package could be the x-factor that makes retiring a no-brainer. If the reader can get a severance equal to at least 6-12 months of living expenses, that will significantly reduce downside risk and worry. Further, it will provide for a nice winning sensation that he will have left on his terms with money in his pocket.
Retirement Will Be Different Than You Imagine
However much you think you will need in retirement is likely not what you will actually need in retirement. Our minds never properly calibrate reality. And I’ve been living and chronicling my stages of early retirement monthly since 2012. Here are some things I would differently before retiring.
Personally, I found that I needed less money in retirement because there were so many free things to do. Further, once you retire, you don’t have to save for retirement. However, after retirement, I had not one kid but two kids. Each were miracles. The amount of money I needed for both my wife and I to stay retired ballooned higher.
Whatever you think your retirement life will be like will probably not be what your retirement life will really be like either.
Before I left work, I imagined going surfing and snorkeling every morning in Hawaii. Then I envisioned I’d eat an amazing lau lau for lunch, take an hour nap, and go play tennis or golf in the afternoon. My body would be ripped, my skin would have a uniform golden brown color, and I would be free.
Instead, I’m still in San Francisco eight years later. I’m certainly not ripped either. My days are mostly spent taking care of my two kids and writing. I still play tennis and softball 3X a week, but it’s a different life than what I had managed. Inertia is hard to break.
Expect an unpredictable journey. Don’t think about these various retirement goals or “rules” as absolutes. Instead, think about them as part of a spectrum. Over time, your retirement goals and the amount of money you feel comfortable having will evolve.
Stay flexible in your beliefs. And most of all, please enjoy the journey!
Use A Retirement Planning Calculator
Another reader mentioned that the only way he gets clarity of his financial projections is to do a long-term cash flow forecast. He accounts for every dollar coming and going, which he says is useful with ad-hoc income such as income from alternative investments and ad-hoc costs such as a roof replacement. He asked me my thoughts on this approach.
It sounds tedious, but I agree that doing a long-term cash flow analysis with potential ad-hoc income and cost items is smart. But instead of doing so manually, I use Personal Capital’s Retirement Planner, which was created exactly for this purpose. It automatically tracks your income and expenses. You can also add projections as well.
The tool is excellent because it uses real expenses and income that have been tracked for however long you’ve been using the tool. Then the tool compiles the data and runs it through a Monte Carlo simulation to give you a numerical and graphical data of your future cash flow needs.
Below is an output example of the Retirement Planner that shows what will happen if this 41-year-old keeps on saving and investing based on his usual amounts and retires at age 50. The Retirement Planner says he has a 99% chance of retiring just fine because his projected cash flow is $18,416 a month versus his desired expenses of $12,500 a month.
Your goal is to get that percentage chance of having a great retirement to be above 95% while also being conservative in your income and expense forecasts. Sign up for free and see what the Retirement Planner spits out for you.
Readers, what retirement goals do you have before you retire? What safe withdrawal rate have you followed if you have already retired? Did you find some part-time work to give you purpose? Was it hard to withdraw funds? How did your retirement life turn out versus expectations?
Greetings!
I’ve been enjoying reading through your blog for a while now and as I read through your book, I’m finding myself continuously returning to this same question…
My husband and I own a company (no employees). Would our gross annual household income be our “net pay” from the business or what the company grosses?
Thanks for supporting my book! If you don’t mind leaving a great review on Amazon or wherever you bought it, that would be great.
Regarding your question, I think it’s best to use operating profit from your business. It’s the cleanest line. So revenue minus operating expenses. But you can certainly use your net profit or salary as well to help calculate the net worth targets.
There’s no harm in using all of the variables. But using revenue is a mistake.
Thanks!
Sam
Very good article. My thoughts are that the SWR definitely needs to be reconsidered in the current interest rate and equity yield environment. The crux of passive investment valuation (beit bonds or equities) is yield. For bonds, the connection is obvious. For equities, it is not so obvious, but still applied. Refer to the Gordon model of equity valuation based on the value of future dividends discounted to present value based on inflation. At any rate, the laws of investing mandate that higher yield = lower valuation and lower long-term future growth. Given the current interest rate environment, bond valuations have only one way to go (down). If bond yields go negative, then it is better to hold cash. Equity values are getting close with the S&P 500 yield at about 1.65%. There is little room for the upside of either asset class. The tie in to the article is that a 4% safe withdraw in the current environment is irrational. 3% is even aggressive given bond and equity valuations. I’m targeting the lesser of 2% or my net financial assets divided by my expected remaining life expectancy. And that is based on not leaving anything to heirs. Now that means that I likely will not early retire, which sucks but is reality. Side note: Net worth of 25x expenses is great (I am very proud to have achieved that), but really just means you are financially secure. 20x income just seems arbitrary. .05% withdraw rate seems overly aggressive unless you are planning to live for another 200 years or want to leave a fortune to your heirs to blow on whatever.
I read your post thinking it makes a ton of sense that the interest rates being low are impacting returns on capital.
Have you seen the interview with Bill Bergen in MarketWatch that came out in the past few days? He seems to come to a different conclusion; the new safe withdrawal rate is 5%.
I’m not saying your .5% withdrawal rate is wrong but I’m curious about how you are reconciling his conclusion with yours.
If you have had four careers after retirement like Bill, and still make consulting money, you’re free to withdraw to 5% or higher rate if you want.
But for most people who retire without working (funny we have to say this) and don’t have a working spouse, a lower withdrawal rate is more pertinent in the initial years of retirement.
You’re right, the 4% rule is outdated. Bill Bengen just updated it to … 5%.
I just wrote about it on my blog.
According to Bill Bengen, the creator of the 4% rule, you’re looking at the low-interest rates environment wrong. Low inflation is one of the best things that can happen for retirees. Your portfolio holds its value much better with low inflation. You can withdraw more in this environment, not less.
Also, the old 4% rule is for the worst-case scenario. Only a few retirees will exhaust their portfolio after 30 years. Most will have a lot of money left over. The rule is very conservative. It’s still a good guideline. IMO, 0.5% is way overkill.
Lastly, do you really need to give $10 million to your 65 years old kids? By then, they should have made their own fortune. They need help when they’re in their 20s. I don’t see why I need to pass on that much money when I die, assuming I live until 95.
Joe – There is something you and Bill have that many traditional retirees do not. Gainful employment and a working spouse. At the same time, hopefully traditional retirees can access Social Security.
Bill commented on my Property Safe Withdrawal post that he has had 4 careers post retirement and is doing consulting. Please feel free to read his long comment to my many questions yourself. Therefore, of course he can raise his safe withdrawal rate to 5% or higher.
And of course, if you have a working spouse and supplemental retirement income from your site, which I fully encourage, then it is safer to have a higher withdrawal rate.
But if you don’t have multiple careers after retirement like Bill, a working spouse that provides income and subsidized health care, and supplemental retirement income, then it’s not an apples-to-apples comparison.
Here’s an exercise. Pretend both you and your wife retired in 2012 and you didn’t have the $420,000+ in blog revenue you reported since the start. Would you honestly withdraw at 4% or 5% for the first year or two? I think you’d say no based on your frugal habits. Instead, what you guys would do would be to try and make more money and/or spend less.
People in the finance community must remember we are living in different worlds compared to the majority.
Build your passive income, supplemental active retirement income, and convince your spouse to work for years after you retire, and THEN feel free to withdraw at a higher.
But if not, it’s best to keep working or be more conservative, at least for the first few years of retirement.
Sam
People love to comment on situations that they are not in, don’t they Sam?
Sam,
My Husband and I are both in our early 40s with a net worth of ~ $2.3M (we started accumulating 10 yrs back only). Our total annual income is ~ $500k/yr (before tax) and and spending is ~ $60-65k/yr. no kids; house paid off. definitely a long way from 20X annual income or a 0.5% withdrawal rate yet. planning to retire in 2-3 years. Any major problem you see with this?
What is your target net worth in 3 years? Should be fine if you guys won’t have kids and have something else you want to do.
Thanks. Targeting ~$3.0M+ before retirement. One of us will have a pension plan from employer that we can start withdrawing when we turn 55 (not much, ~12k/yr). No plan for kids. Want to spend time in teaching underprivileged kids.
Cool. I think you guys will be fine at 50X expenses plus a lifetime pension. Further, I bet one one or two of you will find fun ways to make supplemental income as early retirees.
The thing to watch out for are massive bear markets that last for several years. This is why I encourage a low withdrawal rate the first 1-2 years of retirement. You just don’t know how you will react until you get there. So why not play it safe.