The idea of financial independence has been growing in popularity over the years, and it is not without good reason. Many fiscally responsible millennials have discovered that their financial destiny is rife with the uphill battle of an uncertain economic future. Similarly, people closer to retirement continuously wonder whether they are in a financially secure enough spot to pull the trigger and quit working. With that in mind, I hope to instill some semblance of hope as retirement may not be as far away as you think. Even for those who have not started saving, I hope that this post can inspire you to begin taking control of your future and help in prioritizing what your long-term goals in life may be.

I won't be providing you with any particular investment advice, nor am I a financial planner, so don't start calling your stock broker just yet. Instead, I happen to be someone passionate about quitting the rat race and will be focusing on some general methods that I think can help anyone achieve their financial independence.

The 4% Rule

The 4% rule is a classic guiding principle for a lot of hopeful retirees. It is a shorthand for those who would want to retire early and become financially independent by living off their returns after making substantial financial investments. What the rule describes is a method of calculating how much you need to invest to withdraw 4% of your total balance yearly for the rest of your life. If invested correctly in items like stocks and bonds (not just a regular savings account), this should be able to sustain you almost indefinitely in most cases. The Trinity study validated this approach to retirement and inspired many financial independence seekers.

For example, if you can budget yourself to survive off of $50,000 a year, you should be able to quickly work out exactly how much money you should plan on saving.

$50,000 = 4% * X

With X being the total amount of capital needed, we can quickly decipher that $1,250,000 would be required to retire and maintain that wealth. Once you hit that dollar mark, you could, in theory, retire right away and live the rest of your days work free and spend your time as you please.

Great right?

Well yes, it sounds incredible, but there are some problems that anyone pondering this method must consider.

Budgeting:

With the previous example, the 4% rule should work even accounting for inflation, but it requires that you do not exceed your yearly budget of $50,000. Once you reach the target investment amount of $1.25M, you have to make sure you stick to only pulling out $50,000 a year or else you will start reducing the money-making potential of your investments because of lost capital. The lost wealth will cause your earnings to decrease over time, and you will have less money year after year to live off. For this reason, be realistic with yourself, and determine a retirement wage that you can honestly be happy living with for the length of your retirement.

Risk Tolerance:

The 4% rule can work flawlessly for some, but not for others. In fact, the Trinity study that put this rule to the test only worked in 95% of cases. Depending on the year you retire, the performance of your investments, and the number of years you will live past your retirement year, the results can vary wildly as well. To get a sense of this, I would recommend checking out sites like FireCalc that lets you predict what your plan will look like based on historical projections. Tools like these should give you a sense of what is reasonable. For those who are more conservative, a 3% rule should provide a very safe buffer for these uncertainties. I'm pretty conservative so will be erring towards the 3% end of things, but if you plan on going with 4%, I would recommend having a backup plan in case of an unusually severe downturn. A part-time job or monetizable skill can let you make money to augment your retirement when or if needed. If you would like to see just how big of a difference this percent change can make on your success rate, please give this page a read.

If you do end up changing to a 3% withdrawal rate, the same equation applies and can increase the total capital needed pretty dramatically. For example, the same $50,000 a year withdrawal rate at 3% requires $1.67M. Quite an increase, but that extra security may very well be worth it.

Life Stage:

If you are planning to retire early, make sure you take into account any potential future expenses you may need to make. While you may be able to live off of $30,000 years today as a single 20-something, things may change once you become married, have kids, and want to start planning for a college fund. If you plan on changing your living expenses dramatically in the future, make sure to keep these things in mind as you craft your life plan. All of a sudden taking on a new mortgage or making a down payment on your house can dramatically shift your cost of living, and it will have to be factored in before you pull the trigger.

With those caveats out of the way, this should give you a good sense of how to approach retirement and determine your plan. In my next post, I plan on covering some of how you can start figuring out what your real goal amount should be.