How much do you need to retire? (the 25X rule)

Retirement. Kicking it back and taking things down a notch. Relaxing by the beach and really living life. How many of us dream of that on a daily basis as we stare at our excel sheets and grind away at work? But exactly how much do you need to retire?

A lot of people don’t really think about it, because it seems like such a difficult task to achieve, and so people defer it, or defer properly thinking about it and strategising a way to reach it. Until it’s too late.

Before you know it, you’re 60 and nowhere near retirement ready. Let’s not go there.

Here’s a really simple way to know how much you need, and that’s really step 1 of the plan. Know how much you need. And then work on a plan to work towards it.

The plan is in the title.

25X rule

Now, when people get asked the question, how much do you need to retire? We don’t necessarily have an answer, and we like to throw out arbitrarily big numbers, like “Oh, I don’t know.. $5 million? hur hur hur”.

And then they think $5M is such a huge number, they’re never gonna make it, and then stop pushing for it. This is why so many people think retirement is never gonna happen for them.

Thank god for FIRE bloggers to clear up the air, eh?

So, what is the 25X rule? Very simply, if you take your annual expenses (the amount you’ll spend every year), and multiply it by 25 years, that’s the amount to gun for to be able to hang up your cowl and say enough is enough.

And that amount, depending on the lifestyle you want to lead, may not be all that unattainable. Note that annual expenses is very different than annual income. Some simple math follows.

Say you spend $2,000 a month. Your annual expenses will be $24,000. To be able to retire, you will need $600,000 invested.

If you spend $5,000 a month. Your annual expenses will be $60,000. To be able to retire, you will need $1,500,000 invested.

If you spend $10,000 a month. Your annual expenses will be $120,000. To be able to retire, you will need $3,000,000 invested.

See how that stacks up? See how in the initial question, people tend to over estimate the amount needed? Sure, $1.5M is not a small sum, but it’s far smaller than the $5M casually tossed up in conversations with people who brush off retirement as an impossibility. Also, once you reach a certain threshold, the power of compounding interest kicks in and really helps do a lot of the heavy lifting for you.

But what happens after 25 years?

Noticed the formula is only for 25 years and worried what happens if you live beyond that? Sure, that’s a concern, especially among the early retiree community.

The thing about 25X rule and the rule of 4% (You can see them as interchangeable pretty much) is that these guidelines also help ensure a level of capital protection.

The assumption is that your capital will be invested in a 50:50 equities and bond allocation, with the further assumption (thus far proven under rigorous backtests) that over the time span of 30 years, your average return is 6%.

With these assumptions in place, at the end of 25 years, not only is your capital still intact, it should actually increase if market performs at an annualised 7% return or more and rate of inflation is held steady.

So the 25X rule is actually a pretty darn strong guideline, if you ask me. You’re able to retire and spend your returns on investment, and at the end of the day, if you so choose, you still have your original capital to do as you choose. As asians, we typically try to leave something for our children, so that they can get a headstart in life. If that’s something you prioritise, then know you can retire early, and still do that, if you do your numbers right.

Here’s a cool visualisation of the 4% rule at work.

Looking at the visualisation example above, I took an investment capital of $2,500,000 and an annual spending of $100,000, which I believe is very comfortable for a family of four living in a high cost of living city with some light travel thrown in.

With the back testing, there were only 4 instances (or 4 years of retirement starts) of failures, where the your money goes to zero. Those are the ones in red. Yellow numbers signify where you end up after 30 years with less thn $2.5M (your initial capital). Years in green reflect when you end up with even more than $2.5M at the end of 30 years of retirement.

Asset allocation was 60% stocks and 40% bonds. If you are a bit more risk averse, you can adjust it up to 28X or even 30X, to ease your mind. For example, when I tweak the $2.5M figure to $3M, non of the years backtested will result in me running out of money.

What’s your take on this, and will you start to plan your retirement, and have a number in mind to work towards?

Disclaimer: Of course, publishing this article in the middle of possibly the greatest pandemic and racial tension in human history may not be the most apt, but I think in times of generational change, lies some great opportunities to discover and make some internal perception changes of your own.