How much money do you think you need to be considered “rich”? Most Americans define ‘rich’ as anyone that makes more money than they do. Really? That’s actually pretty funny. I define it like this:
WHAT DOES IT MEAN TO BE RICH?
- the point at which your investments generate enough income to cover your expenses; freedom
“all my bills can be paid from the income that my investments generate!”
Synonyms: financially independent
See also: f**k you money
Rich is NOT cruising around in your limo, dressed up like Mr. Peanut or Rich Uncle Pennybags. Rich is NOT living like the upstairs people at Downton Abby. Rich IS having enough money to buy your freedom. Freedom is the ability to do whatever you want to do with your time. Freedom is the best thing your money can buy and figuring out how much that freedom will cost you is pretty easy thanks to the 4% rule.
WHAT IS THE 4% RULE
The 4% Rule says that on average our investments will grow at 7% per year. From that 7% growth, you’ll be able to spend 4% and leave the remaining 3% invested in order to keep up with the average rate of inflation.* In theory, you never touch your principal investment, only a portion of the growth.
As you can see from the table below, if you only spend 4% and leave the remaining 3% invested, you’ll have enough money to live on for the rest of your life, while keeping up with inflation.** And this is important because we know that a dollar today is worth more than a dollar tomorrow!
HOW MUCH DO YOU NEED TO RETIRE?
It turns out that your financial freedom will cost you about 25 times you annual expenses. Take your annual expenses and multiply that by 25 to get your magic number.
If you can live on $20,000 per year, then your magic number is $500,000 (20,000 x 25). If you need $100,000 per year to get by, then your number is $2.5 million (100,000 x 25). Easy peasy.
The time it will take you to become financially independent depends upon a few things, namely:
- The amount of money you need to live on. The more money you need to get by, the more you’ll need to save in order to meet this need. Inversely, the less money you need to get by, the less you need to save up.
- The percentage of your income that you save. If for some reason you can’t save any money whatsoever, then your savings rate is 0% and you’ll never be financially independent, because you’ll always need a paycheck to get by. If you’re on the opposite end of that example and you’re able to save 100% of your income, then you’re already there. Congratulations!
With this information you are now in total control – figure out how much money you need to get by each year, then save up 25 times that amount! The second your expenses are covered by your investments, you are free to do whatever you want to do with your time because once you’ve reached this point, your money has purchased your freedom and you are officially rich!
Want to keep grinding away at your current job? Go for it! Want to become a Walmart Greeter? Knock yourself out. Lie on a beach doing nothing? Volunteer at a non-profit? Search for Bigfoot in the Pacific Northwest? When your assets generate income that is greater than your expenses you can do whatever. you. want!
* The stock market is like an EKG machine and not like an up-moving escalator. Some years your investments will not only miss the 7% growth rate, but you’ll actually LOSE money that year. Yikes – that’s scary! But don’t panic just yet because other years your investments will grow at a MUCH greater rate than 7%. That’s why I’ve bolded the word average, because it all evens out. Over time the stock market always goes up. By an average of 7% annually, after adjusting for inflation. If you want to read and learn even more about how simple and easy saving and planning for retirement can be, I highly recommend this book, The Simple Path to Wealth, by Jim Collins, which is easy to read and understand. I own it and refer to it often:
**The 4% rule is also sometimes called the Safe Withdrawal Rate, which is to say “how much money can I safely withdraw from my account without fear of every running out?” 4% is that amount, but I’ve only scratched the surface of the 4% rule in this post. Here are some additional posts on this controversial topic, some with differing points of view, that I recommend you check out:
- The 4% rule: The easy answer to ‘How much do I need for retirement?’ by Mr. Money Mustache
- Safe withdrawl rate for early retirees by Mad Fientist
- Understanding sequence of returns risk – Safe withdrawal rates, bear market crashes, and bad decades by Michael Kitces
The 4% Rule can be a bit controversial – what do you think about it? Please leave a comment (with a link back to your own blog) and let me know your thoughts.
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