Welcome to the first step in your financial journey: knowing your number.
The era of the American pension is dead. The military and a few unionized private sector jobs are some of the last remaining hold outs. However, if you’ve decided you don’t want to do 20—no shame, I left active duty at year 5—then you’re still in the community of DIY Retirees.
Do you know your financial independence number? Many–maybe most–of Americans do not. Fortunately, it’s pretty simple to calculate.
You may be thinking, what about federal service? I’ve purposefully excluded federal service as a serious pension-earning career, and you can read why in my “The Federal Pension is Dead” post.
Regardless of what our post-pension nation says about our economy, the new reality is retirement in America is no longer an age, it’s a number.
The Era of the Pension is Gone
The era of the pension brought with it guaranteed financial security into one’s “golden” years. That guaranteed pension combined with national healthcare program, Medicare, and social security benefits were once the financial independence goal Americans relied on to “retire,” and live out their life on a country ranch or southern beach, taking annual trips on a European river cruise line.
Perhaps I’ve been on the receiving end of too many ads targeted at people age 50+.
In the absence of widespread pension programs and reliable long-term social security access, the United States has entered the era of the DIY Retirement, where individual Americans are responsible for planning and funding their own retirement strategies if they ever want to not work one day. In the absence of mandatory financial education as part of our public education system, many Americans may not realize this DIY requirement until well into their high-earning years, once the idea of turning 55 becomes an actual possibility instead of a separate lifetime.
We can debate the equitability of the new mandatory DIY Retirement in the absence of standardized financial education—and we should—but in this post, I want to focus on one idea in particular: retirement is no longer an age, it’s a number.
Retirement is Not an Age, it’s a Number
Retirement is no longer a magically level you unlock once you hit a golden year. It’s something you must achieve through several years of dedicated financial planning and investing. At first, this may seem very depressing, but hear me out.
First, calculate your current annual cost of living. Second, multiply that number by 25.
Now, retirement is whenever you say it is. It’s whenever you’ve hit your retirement number—the value of assets you’ll need to have saved to maintain your desired lifestyle indefinitely.
Do you know your number? Many—maybe most—Americans do not. Fortunately, it’s pretty simple to calculate.
How to Calculate Your Financial Independence Number
First, calculate your current annual cost of living—the amount of money you need to sustain your desired lifestyle for one year. Include everything: mortgage/rent, health insurance and co-pays, groceries, entertainment, travel, hobbies.
Second, multiply that number by 25. This total value, likely in the 1+ millions range, is the necessary total value of your retirement investment portfolio to sustain your current lifestyle without ever drawing down your principal investment portfolio balance. This assumes an average annual withdrawal rate of 4% (i.e. 1/25th) of your total portfolio.
This is financial independence–the ability to live indefinitely without working–and it’s how we build generational wealth.
In this way, we live off our portfolios interest earners, rather than treating it like a savings account we ration, trying not to spend it all before we die. This is financial independence—the ability to live indefinitely without working—and it’s how we build generational wealth.
That’s it really, at least at a basic level.
To be extra conservative in your financial planning, I like to add about 20% to my total financial independence number to account for taxes and an exponentially increasing cost of living.
It’s possible to avoid the brunt of your retirement account income tax if you take advantage of Roth 401K and Roth IRA accounts when you’re younger, but we must still prepare for cost of living to continue to rise significantly between now and age 60.
What are you willing to spend for and what are you willing to invest for?
There’s some flexibility in this investing strategy. You can adjust your retirement number based on your desired lifestyle. The lower your cost of living, the faster you can reach your number and achieve financial independence. You can also plan to hold a parttime job to pay for the fun, non-essentials while your investment portfolio is only enough to cover necessities—thus allowing you to achieve your financial independence goal faster.
Conclusion
The whole advantage of the DIY Retirement is you get to decide what your financially independent life looks like—instead of letting your pension dictate what you can afford and where you can afford to live.
For better or worse, your financial future is up to you. It’s your decision what’s most important in your life. What are you willing to spend for and what are you willing to invest for? Make deliberate decisions, not decisions by default.
Leave a Reply