Oct 07, 2016

How much do I need to save to retire early?

[2016-10-09 Update] Ben suggested two changes:

1. Assuming a consistent 6% on capital is optimistic. 5% is probably more realistic, and it's the rate used by some people I respect (person 1, persons 2 & 3, h/t to Ben for the sources).

2. Long-term capital gains tax is roughly 20%. State taxes might be another 10%. After accounting for long-term capital gains and state taxes, the post-tax rate of return is around 3.5% for a 5% pre-tax rate.

The upshot is that early retirement is substantially further away than I originally estimated: saving aggressively, we get there at age 53 rather than age 45. I've updated the spreadsheet to use a 3.5% effective rate of return, and rewritten some of the below to reflect these changes.

One of my goals is to have enough money to retire early. I use the word "retire" loosely here – I'm not interested in retirement in the "old people hanging out in Florida" sense, nor in the "100% of my time is leisure time" sense.

I want to be "retired" in the sense of "not having to work on something unless I want to" or, more precisely, "not needing to have a job in order to support myself". ("Fuck you" money is a coarser term for the same concept.)

Mr. Money Mustache does a much better job at explaining the philosophy (a) and method (a) behind this sort of thing, but I was interested in how this cashed out for my own situation, so here's a quick look at that.

First question: what age do I want to target for retirement?
Let's say age 45.

How much money do I need to retire?
In the Bay Area, I can live comfortably on $3,500/month. If I adjusted my current standard of living (or moved to a more affordable housing market), this could be substantially less. (Obviously the calculus changes if we throw a long-term partner or some kids into the mix.)

Let's work with $3,500/month for now.

$3,500/month * 12 months = $42,000/year to support myself.

What annual return can I expect on my capital?
I think it's reasonable to assume a 6% return on investment (after inflation), on average over the long run. (Here's some thinking on that which I'm not going to engage with here (a).)

[2016-10-09 addition: 5% is probably more reasonable, and this becomes 3.5% after taxes, see note at the top.]

How much do I need to accumulate in order to generate $42,000/year?
With a 3.5% return on capital, the math is simple: $42,000 / 0.035 = ~ $1,200,000

So I need to accumulate $1,200,000 in order to generate enough money to support myself indefinitely.

So how much is that per month?
I'll be 45 in 21 years. Saving $3,083 a month, every month, will get me $1,200,000 in the bank by then. This spreadsheet gives my work.

$3,083/month is lot of money, and probably infeasible given my current means. So, what's a more reasonable retirement year to target?

Working this time from the amount saved per month, let's say I can sock away $2,000/month if I'm frugal. Saving $2,000/month gets us to retirement by age 53 (again, work in the spreadsheet).

$2,000/month is a sizable amount, but it's definitely doable. And the payoff – being able to not have to worry about money from the age of 53 onward – is huge! Saving money is hard, but keeping the payoff in mind is motivating.

[rereads: 4, edits: tightened up the prose, style tweaks, added the caveat, added intro and comments in response to Ben's suggestions, significant rewrites to the "So how much is that per month?" section, cut the capital-gains caveat at the end, changed the title from "...by age 45?" to "...early?", cut some extraneous clauses at a later reading]