Freedom Fund: What’s your number?
So, you want to retire early? How will you know when you can? Retirement isn’t an age, it’s a financial number! What’s your number? Even if you’re not looking to retire “early”, these are good questions that I’m going to answer for you today. There are some “mysteries” around early retirement and financial freedom. I’m going to break them down and help you realize that being financially free is as simple as making a plan and sticking to it. Financial freedom, early retirement, freedom fund, financial independence; don’t get bogged down in these buzzwords, it’s really about simple math and a simple lifestyle.
What’s a freedom fund?
My “freedom fund” is simply my investment portfolio, which could consist of stocks, bonds, real estate or cash. I will then let my money work for me and will live off of the growth and earnings of the freedom fund.
As many of you know, my goal is to retire by the age of 40. When I say “retire”, I am talking about retiring from my full time job and focusing on things that bring me joy and I’m passionate about, like real estate or personal finance.
For me to “retire” by 40, I will need about one million dollars in my freedom fund. When I first explained what a freedom fund was to my wife, and that we would need one million dollars in investments to retire, her biggest question was, “how do you know”?
How do I know that one million dollars in my freedom fund will last us without knowing how long we’ll live?
That’s a great question! I told her, there’s two major components to knowing how much you’ll need to retire. The first component is understanding your yearly spending, and the second component is understanding the 4% rule.
The 4 percent rule
I explained to Emily the results of a study conducted by 3 professors from Trinity University, in 1998. This study concluded that withdrawing 4% of your investment portfolio (mix of stocks and bonds), would be considered a “safe withdrawal rate” . The study demonstrates that you could withdrawal 4% of your investment portfolio and, 95% of the time, sustain your spending for 30+ years. Trinity university only looked at a 30 year horizon, but in 95% of the cases, after 30 years, the portfolio was not $0, the principle value actually stayed the same as it was in the beginning!
Hopefully, you understand that your portfolio WILL, in 95% of the cases, last as long you live. Now we need to get to the amount that your portfolio (freedom fund) should be. How do you calculate how much your freedom fund should be?
It all depends on your yearly expenses! Your annual spending will dictate how big your freedom fund will need to be. Now that our house is paid off, our family currently spends about $33,000 a year or $2,750 a month.
Although we don’t have kids now, we are anticipating our yearly expenses to go up about $7,000 a year when we have children. If we have money left over, that will go towards their college fund. In expectation of children, then, we will need to withdraw / spend about $40,000 a year.
Calculating my Freedom Fund
To calculate how much I need to have in my freedom fund using the 4% rule, I divide my yearly expenses by .04:
$40,000 / .04 = $1,000,000
Another way of calculating this is to multiply my yearly expenses by 25:
$40,000 x 25 = $1,000,000
So, there you have it! My freedom fund is one million dollars ($1,000,000)!
If you want to calculate how much you need to retire, simply calculate your yearly expenses, multiply that by 25, and that’s how much you’ll need in your freedom fund!
Your freedom fund may yield higher returns some years, and lower returns other years. The key to maintaining a healthy freedom fun is that, on average, you withdraw about 4% each year. We are working hard to build our freedom fund to 1 million dollars, and in this blog we’ll provide periodic updates to our freedom fund status.
Do you have a freedom fund? Do you keep track of your expenses? What are your plans after retirement?