How much money do I need to retire early?

How much money do you need to retire if you plan to retire early?

This is one of those big big big questions that has got to be on the minds of the masses. Why? Well, because according to research by Gallup, only about 15% of the global work force like their jobs. This leaves a whopping 85% who don’t.

In the UK and US it’s more like 50/50. Not quite so bad, but bad enough, and personally I’m inclined to take these figures with a pinch of salt. A lot of my friends claim to like their jobs, but when you ask them why, they talk about things like salary, benefits and practical aspects like being close to home. In many cases it’s pretty obvious for anybody listening they don’t really like what they actually do from day to day.

An example, from just last week Bob (not his real name) said he liked his job, and only hated the meetings, only to reveal later on that he probably spends about 75% of his time in, you guessed it, meetings!

That said, there are evidently people who do like their jobs. If you are one of the lucky jobsworths that really does actually truly like their job then you may as well stop reading now. What’s the point of stopping doing something that you enjoy. I’m sure it goes without saying that you should try and continue as long as you can.

Let’s get in to it.

Number crunching

For most people, deciding how much money they need to retire early should be top of the list of retirement planning questions.

Answer this, and the entirety of your financial life should become clearer. It will help you determine how much you should be saving. You’ll also have a better idea how long you need to save for. In fact, it could help you with seemingly unrelated questions like what job to do.

Doing a job you hate for two years to save money, may make more sense than doing one you think is just OK for 10 years. You might hate the idea of renting a room out, but doing it for a couple of years to enable you retire 10 years earlier is probably going to make sense for the majority.

So working out how much money you need to retire really is important for most people. And the great news is, there’s a straightforward two step approach to calculating it. You simply estimate how much you are going to spend each year and then you multiply that value by 25. It really is that simple!

Step one can be as easy as using what you currently spend in one year. If you earn £40K after tax and spend it all, then that’s how much you need.

Of course you can make it more complicated if you want. Adding and subtracting costs you think you will/won’t need in the future can add another level of clarity. Perhaps you plan to take a couple of extra holidays a year costing 2K per pop, but won’t by paying kids University fees costing 14K a year. In that case you only need 30k. Likewise if you earn 40K per year but save 10K you still only need 30K.

You get the picture. You really don’t need to be accurate to the penny. You just need a ball park figure, which shouldn’t take more than an hour or so of bank statement scanning for most people.

Once you’ve got your annual figure sorted you simply multiply that number by 25 and you are there so in this case 30Kx25=750K.

In case you are wondering where that 25 comes from it is based on a sustainable withdrawal rate of 4%. In other words you can withdraw 4% of your money every year without ever running out (4% of 750K is 30K). This is in turn is based on lots of research and on your money being invested (typically in a portfolio of 60% stocks and 40% bonds).

Problems with retirement calculations

A couple of things to say here is the fact that a lot of non-Americans complain that the research was competed in the US where stock markets have performed better than elsewhere, so for those outside maybe you should be using a lower 3.5% withdrawal rate (which equates to multiplying by 33). And for those conservative in nature, why not? But for others you’re probably thinking £750,000 is too much never mind multiplying by 33!

So hopefully you’ll be reassured to hear I’m not totally convinced this is a good idea.

And there are 3 key reasons for this.

3 reasons the 4% withdrawal rate is still valid

First, though over the last decade or so US stocks have outperformed other global stock markets, over a very long time period they haven’t. In “Triumph of the Optimists: 101 Years of Global Investment Returns” Professors Dimson, Staunton and Marsh show the UK in nominal terms has performed about the same as the US. Both around 10%, and lots of other world markets haven’t been far off. Some, like South Africa have actually done better.

(Incidentally, they also show that UK property prices have historically risen about 2% over inflation and we’ll be using that figure later).

And the fact that the US stock market has outperformed other markets in the recent past actually increases the likelihood that it will underperform over the coming period. A characteristic of stock markets termed reversion to the mean, describes the fact that historically one usually does well for a while and then takes a back seat for the next time period. Whether or not this will happen is anybodies guess.

Nobody knows what the future holds. All we can do is look at the past and make our best guess and for the UK and US markets the past says about 10% returns. Most of the big global stock funds are at least 50% US companies anyway! What I’m trying to say here is, if it’s good enough for Americans to use, it is probably good enough for us (non Americans) too.

Second, in my experience once people start down the path of saving up for an early retirement they find themselves saving more than they need not less. You just need to get going. The more you get into it, the more you save and the easier it all becomes. On the other hand, if the number you aim for is too high you won’t even bother starting.

And finally, When you look under the hood 4% is actually a pretty conservative number. If you look at the data in a bit more detail you’ll see most people who withdrew 4% a year throughout retirement ended up with more than they started with. And think about this for a minute. We’ve already established the US & UK markets have been going up 10% a year so why can’t we just subtract 10% a year? And the answer is because from time to time stock markets plummet double digits. In fact they were almost cut in half in 2008. The 4% accounts for the fact that the market may crash by a similar amount in the first few years of your retirement. And let’s face it, the chances of this happening are pretty slim.

Property vs the 4% rule

If you are worried about a mega stock market crash think about this for a moment. What if you invested your money in buy to let property? As mentioned above, according to some serious in-depth research UK property prices have increased 2% above inflation over time. And historically, inflation has been around 3% and as we aren’t too far away from that right now assuming 5% house price growth over the long term is probably pretty justifiable.

Notice we are already above 4%, but what about if we take into account our rental income. I’ve just spent half an hour on Rightmove and it didn’t take long to find properties that are already let to tenants generating 6% gross yields, and I’m sure if you look hard enough you could find higher. Average rental yields in Middlesbrough, East Ayrshire, North Ayrshire and Inverclyde are all nearer 8%.

Now, in my experience fees and associated costs will cut a third of these figures so around 4% (for the 6 percenters I found) is more like the actual yield you’ll receive as cash to spend in your bank account, but again we are in the ball park of our sustainable withdrawal rate here.

The bottom line being, you should be able to generate 4% from a buy to let after fees, whilst in the background the value of buy to let may be able to grow by around 5%, and unlike with stock markets the likelihood of a 50% crash screwing up your withdrawal rate has got to be almost non existent. Even during the financial crisis (that was all about property by the way) UK house prices on average dropped just 20% and rental yields dropped just 2%!

So it probably comes as no surprise if I say, I feel pretty confident investing your money carefully in property will ensure the 4% rule stands.

And just to be clear here, I’m not saying property is necessarily a better investment than shares, because I don’t think it is. These days, anybody with a brokerage account can put together a strong globally diversified stock and bond portfolio with just a couple of ETFs. Investing in the stock market is probably the best way to grow your wealth for most people. It’s simple, you get access to your money easily and there’s practically no work involved. If you haven’t got a brokerage account you should open one A.S.A.P. (we’ve compared a few here).

I’m just saying once you’ve grown it and are ready to retire, it may make sense to transfer it into buy to let property.

How much money do you need to retire early – The bottom line

If you don’t like your job and you haven’t asked yourself figured out how much you’ll need to fund retirement what are you waiting for?

It’s easy to estimate and though some naysayers query the numbers behind it, I’m pretty sure its still valid for most people, especially if you have your money invested in rental property by the time you retire.