Our clients are in their 20s, 30s, and 40s. They’re all well paid. Many have gone through big liquidity events (read: IPO) that have dumped a big Bucket O’Money™ in their laps. (That’s what we specialize in after all.)
So instead of putting their heads down and accepting that they need to do the 9-to-5 thing until they’re 65, they start thinking really early about:
“How much money do I need?”
By which they mean not “how much money do I need to buy a home or take a trip,” but “how much money do I need to be financially independent?”
And then they ask us that question.
I hope you readily believe me when I say: There’s no way I—or anyone else for that matter—can give you a reliable number. Tomorrow is unknowable, let alone the totality of the next five, six, seven, or eight (for the 20-year-olds among you) decades of life.
I mean, come on, that is half a century or more. Fifty years ago was 1971. How much has changed since then? Fifty years from now is 2071. I mean, heck, maybe we’ll even have self-driving cars by then…zing! One silver lining of the Covid pandemic is that I believe people are much more ready to accept that we can’t predict a damn thing.
Which certainly makes it hard to answer “How much money do I need?” The most fully honest answer anyone can give is, “I have no clue. No earthly idea.” But that’s not particularly helpful. How do we begin to answer that question in a helpful way?
Why We All Want to Know “The Number”
We humans love us some certainty. And despite us knowing, intellectually, that nothing is certain (yes yes, except death and taxes), we still instinctively and repeatedly seek it out.
“If I could only know and ‘hit’ that number, I could stop worrying!”
That would be very nice. I wholeheartedly agree.
We see clients approach this from two different financial positions:
- “Maybe I already have enough money, but I don’t know how to tell.”
- “I want more clarity about how much money I’ll need eventually, because that helps me make decisions about saving and investing and spending now.”
Situation #1: Maybe you already have enough
Let’s just take a moment to acknowledge how amazing and ahistorical and just plain weird it is that someone in their 20s, 30s, and 40s could be in the position of already having enough money to last them for the rest of their lives.
I mean, other than royalty or robber barons, I just don’t think this happened for humans for all of human history. And yet, thanks to the unbelievable wealth-creation machine that is the tech industry, many “regular” people are in this position. Most often, it’s because your company went public or you participated in a tender offer or you sold your private company stock on the private secondary market, and, almost overnight, you came into millions of dollars. Occasionally it’s because you work at public tech company and got a boatload of RSUs and the company stock went bonkers. (I’m looking at you, Apple and Amazon.)
(That said, remind yourself that it is in fact a minority of tech employees, especially at the individual-contribute level, who have received giant windfalls. Most tech companies simply don’t succeed in such a blow-out fashion. We just all like to tell these success stories, and that crowds out the far more numerous stories of the startups that failed or did “meh.”)
So, now you’re 35 and have three million dollars [insert your dollar amount here]. On the one hand, “Three million dollars! I’m rich!” On the other hand, “What does that $3M actually mean?”
Like, yeah, it’s “a lot.” I know it’s not “buy a yacht” a lot. I know it is “I can stop worrying about buying lattes” a lot. What kind of a “a lot” is it? How can it actually change my life?
For most people, the driving question is: Is it “I don’t have to worry about money any more” a lot?
Situation #2: You don’t have enough right now, and you want a target.
The second situation I find is when clients figure they aren’t on the cusp of financial independence/early retirement (even though sometimes that assumption is wrong!), and they want a sense of how much money will give them financial independence.
Knowing that number can help you in a few ways:
- It motivates you to double down on financial independence savings and investment.
- You can very basically reverse engineer how much you should be saving and investing each year to get there. This helps you more comfortably spend money now on other things that will make your life fulfilling. Travel, buying a home, donating to causes you care about, etc. It helps you create a healthy balance between Now You and Future You.
The Problem: We Can’t Know.
I cut my teeth in the financial planning profession working for firms that worked exclusively with retired folks. And none of that fancy “early” retirement, either. I’m talking good ol’ fashioned 65-years-old retirement.
The primary concern for those people was also (not surprise!): Do I have enough money?
(As I mentioned above, we all crave certainty. The craving doesn’t disappear magically at some age or milestone.)
And the usual answer was: Well, let me run this financial planning software that will project out your expenses and your various sources of income and your investment returns for the next 30-40 years. Oh, look! The software says you have a 95% chance of success. You’ll be fine!
Decades-Long Predictions Are Just Silly.
If that sounds silly to you, then it likely sounds even more silly to extend that projection window to 50-80 years. And it should!
Good financial planning isn’t “Run this analysis once and call it good for the rest of your life.” You want to use these projections as guide posts, and then regularly revisit them. See what has changed from the last check-in and determine if something in the plan needs to change in order to accommodate the new reality. This is what we call planning. 🙂
As Carl Richards (former financial planner and now consultant to the profession, most broadly known for his “Sketch Guy” column in the New York Times) describes it, we financial planners are a “guide in a changing landscape, not the defender of an outdated map.”
The morbid truth is that the closer you get to being dead, the more precise and reliable the calculation of “how much money do I need for the rest of my life, for complete financial independence?” can get. Just as the closer you get to any goal, the more exactly you can calculate how much money you’ll need for it, and also how much money you need to save to get there.
Why? Because the amount of time that these projections apply to is now shorter, which affords less opportunity for Sh*t To Happen that would render invalid the guesses/assumptions we used in our calculations.
So, what are we to do if it’s downright dumb to project out our income, expenses, tax rates, and investment returns for the next five to eight decades? How else can we figure out “how much money do I need?”
The 4% Rule Can Help.
Let’s start with what it is.
What Is the 4% Rule?
The 4% rule says, very basically, that you can withdraw 4% of your investment portfolio every year and have confidence that you will still have money left over after 30 years.
That 30-year time frame is relevant because this rule has typically been used to help retirees (at age 65, natch) figure out how much money they could take out of their portfolio each year, live until age 95 (by which time surely they’d die), and not run out of money.
The original research was done in the early 1990s by an investment advisor, Bill Bengen (full first name William, but his nickname provides such fun alliteration). (Listen to/read his story of the origin of the 4% rule.)
Adjustments to the 4% Rule
If you’re reading this blog post, I’m guessing you’re not 65 years old. (Unless you’re my mom. Hey, Mom!) In fact, I’m betting you have a few decades until you reach that age.
Which means, even if we believe in the reliability of the 4% rule, it probably doesn’t work for a period of time that is, not 30 years long, but possibly 60 or 70 or 80.
(When I say “even if we believe,” I am referring to the non-stop stream of industry commentary on and revisiting of this rule of thumb since it was first proposed. While it has found widespread adoption by financial advisors in their effort to figure out a “safe withdrawal rate” from their clients’ investment portfolios—and notably also in the FIRE community—there are also many many reasonable, trained professionals who think it should be higher. Or lower. Or honestly just ignored entirely. Pick your poison.)
In our firm, we usually adjust that 4% down to 3%, sometimes even a conservative 2.5%, as an “arbitrary but reasonable” acknowledgement of the fact that our clients are so young.
So, if predictions for how life will unfold over the next five to eight decades are silly to rely on for anything other than entertainment, why am I even mentioning it? Because
it’s the best we can do to get a ballpark sense of how much money you’ll need in order to live off of your investment portfolio for the rest of your life.
It’s the “best we can do” not because no one else has come up with more exacting models…but because pretending we can usefully get any more accurate is just dumb.
(And watch this short video from a well-known and respected financial advisor about how calling this a “rule” is silly because it’s actually a “finding.” Read: there’s no guarantee that the finding will repeat itself in the future! Ain’t planning fun? And by “fun,” I of course mean nauseatingly stressful.)
Use the 4% Rule to Help Figure Out Your Own Finances.
Here’s how we use the 4% (3%) rule in practice in our firm with our clients. You can do the same. (Prepare yourself for Advanced Mathematics.)
- Tally how much you spend on everything each year now. Say it’s $10,000/mo, $120,000/year.
(If you don’t know vaguely how much you’re spending, I kindly invite you to figure it out. How much you spend is one of the biggest influences on financial success. How you spend is one of the biggest influences on your happiness.)
- Divide 3% into that.
- Get $4,000,000.
You will reach financial independence when your investment portfolio is (very ballpark) $4,000,000.
Will you actually end up needing $4,000,000? Aw, hellll no. That’s about the only thing I can guarantee. But it gives you an order of magnitude to shoot for. It can help you know when you’re getting close(r) to “enough.”
As I mentioned above, this sort of analysis is more useful when you run it year after year. Revisiting it allows you to adjust your choices and behaviors based on the new reality: spend less (or more!), go get a job, change the price tag or timeframe for your financial goals.
The 4% rule can give you a useful, very basic framework for figuring out what your wealth means to you, in a practical way.
But I don’t want to leave the impression that Forever More Financial Independence is the goal. I don’t believe it should be for people in their 20s-50s, honestly. And I can’t speak to 60s and up…yet. 🙂
Financial Independence doesn’t have to mean you Never Have to Work Again for Money Ever Ever. I might be playing semantics here, but it is important to me that you believe:
Financial Independence can and I think should mean that you have the financial means to try something (drastically) new and still be financially strong even if it falls flat.
Take a sabbatical. Start a business. Go back to school. Financial independence is choice. It’s the ability to jump off the cliff…knowing that you have a parachute.
There are some intrepid souls out there who jump off cliffs without parachutes, trusting there to be a nice cushion at the bottom. Not me. And maybe not you. For us, we need that money parachute.
One of the really nice things about defining Financial Independence in this smaller way is that it comes with a much lower price tag. You need far less money to have choice than to live forevermore on your wealth. That, to me, is exciting, because it means way more people can reach Financial Independence, and it doesn’t depend on a giant IPO or other stroke of fortune.
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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.