It doesn’t matter if you’re 16 or 60. You are never too young or old to start planning for retirement, and if you’re crazy like me then you would have wished you had started planning from your early teen years. But how do you know when you can transition to retirement? To answer the common question of ” How much do I need to retire ” there are basically two things that you need to measure before we can use the retirement calculator.
How much do you spend?
And I don’t want to hear rough estimates here. In order to accurately measure and plan for retirement you gotta know exactly how much money you spend each year in order to live at your current life style. This does two things. Firstly it will give you a quantifiable number (needed for the retirement calculator). You can now accurately say that I need $X.00 amount of dollars to live my life as it is right now during this time in history. Notice I mention this time in history because inflation matters, for example someone living in 1970 might have been able to live off $5,000 that year. But they might struggle to buy just coffee for a year with that sort of cash now days.
Secondly you will become aware of where every dollar that you earn goes. And this is going to really open up your eyes trust me on that! Even for someone who has been financially responsible their whole life. When you track your spending religiously you see just how many holes you have in your pocket and that money is constantly flowing in the outwards direction for heaps of shit that doesn’t really improve your life, I’m looking at you alcohol/smokes/designer clothes. Plugging these holes is another post altogether so lets just stick with tracking money for now.
So how does one exactly track their spending accurately? Well there are a few different methods depending on how trust worthy you are. The first is to simply keep an excel spread sheet/journal and fill it out as you go. Export your bank statements to a CSV file and add each transaction on your statements to your spreadsheet with a date, transaction detail, amount in $ and a category column so you can break down what you spent your money on. Something like this will work
|05-Aug-15||BP Petrol||$ 54.36||Car|
|07-Aug-15||Revolvers PTY LTD||$ 281.52||Entertainment|
And with a bit of excel magic you can create a pie graph of your 3 day bender.
The other alternative (my preferred method) is to get browser based software to do this for you for free. There are a number of different Australian options you can choose from: Pocket Book, ANZ Money Manager and for any US readers I’m sure you have already heard of Mint. They all do basically the same thing when it comes to categorizing your transactions. You can log into your online banking and export data between two different dates and then upload it into the software. Once there the software will automatically try to categorize transactions based on common names in the transaction details. For example if the transaction detail has Woolworths in the description than odds are that this transaction should be categorized as groceries. You can always manually go through them to make sure that they are right, and the software is smart enough to remember your changes in case it gets it wrong first time. The only down side to this is that you have to export your data and upload it every time you want up to date info. To make this easier you can add you banking details to the software that enables it to have read only access to your data. This means that the software is always up to date with your transactions without you having to export/import all the time. If you are worries about security you can read up how it works here.
Once you have all your transactions in the software and categorised correctly you can really start to paint a picture on how much you spend and what you spend it on. Pocketbook has a great feature called ‘Analyse’ that creates a pie chart for you between two dates and splices it up based on categories. You can then deselect certain categorie and the pie chart will automatically re-size and show you what your spending would look like without that category for that week/month or whatever the time frame is that you’re measuring. It’s a really easy and quick way to sift through all the junk and find out how much you can actually live off without all the bells and whistles.
Now the last part to this question is all about that cash flow baby! How much does your investments make you? This can be a bit tricky because it depends on what you invest in and how volatile it is. Lets just assume that you are getting a solid return of 9% per annum forever with no fluctuations. Highly unlikely but for the purposes of this example lets just go with it. How much will you have to have invested before your portfolio generates your annual expenditure? Just plug in your figures to the following formula
E / R = FI
E = Yearly expenditure
R = Return rate as a percentage
FI = Financial Independence
Example: I spend $45,730.87 dollars and my rate of return from investments are 9%
$45,730.87 / 0.09 = $508,120.77
So based on the above I would need a portfolio valued at $508.120.77 that returns 9% per year and I would never have to work again!… Not quite. Inflation is the silent killer here. The Reserve Bank of Australia’s (RBA) inflation target is 2-3 percent, lets just use 2.5% for our calculations. We need to minus this percentage from our return rate of 9% and redo the formula.
$45,730.87 / 0.065 = $703,551.84
God dam inflation. Factoring inflation in has just increased our hypothetical FI number by nearly $200K 😐 … This is an evil necessarily though because it will enable your portfolio to grow along with inflation, enabling you to have the same purchasing power in 30 years time as you do today.
I have not covered everything* here but it should give you a basic idea of how to start calculating your FI number. Have a play with the retirement calculator below and see how drastic some simple changes can be such as lowering your living costs by as little as 5K or how much an impact your FI is affected by rate of return.
*All calculations have not factored in tax because it’s just too hard to cover all aspects. You should be calculating using after tax money
Just wondering if you recommend getting into property investing as a means for retirement. Is this the only market you invest in?
Considering around 45% if my portfolio is in Real Estate I do recommend property as an investment for generating passive income to retire on. If you check out my portfolio you can see exactly what I’m invested in. If you have Super Tom odds are you are invested in multiple markets including some exposure to Real Estate too 🙂
Will you include your superannuation fund money in your financially free number? Or we shouldn’t because we can’t access the fund anyway until our preservation age.
Super play a big part in the race to FIRE. Super will eventually turn into your true FI number. BUT because you can’t access it until your preservation age, you only need to have $X amount in there and let it compound into your FI number by the time you reach your preservation age. My calculator calculates what number you need in your Super before you can stop contributing and still have it reach your FI number.
You Pre-Super number is what is needed to live until you reach your preservation age.
The calculator seems to not be working anymore.
Haha your revolver comment here cracked me up.