In a previous post, I discussed the futility of working when your net worth is declining. During a stock market crash or recession, your Return on Effort (ROE) for working drops significantly. Therefore, the only way to increase your Return On Effort is to work less, not more.
At some point in your life, you’ll reach an investment threshold where you may regularly start making (or losing) more from your investments than from your annual job income. When this happens, work begins to feel optional as you start questioning the trade-off between time and money.
Since stocks and real estate prices tend to rise about 70% of the time in any given year, your desire to retire early or pursue a less stressful and more exciting profession grows stronger. As time becomes more valuable with age, your tolerance for workplace frustrations diminishes.
This post will help you identify the minimum investment threshold to aim for, keeping you focused and motivated. With a clear financial goal, achieving it becomes much easier.
Once you achieve the minimum investment threshold amount, that is when you should have more confidence to change your life for the better. For those of you far into your financial journey where you already have a lot of money, my formula can serve as a wake up call to stop wasting time.
Author Background
I helped kickstart the modern-day FIRE movement with the launch of Financial Samurai in 2009. In 2012, after a 13 year career and investment banking, I semi-retired at the age of 34 with a $3 million net worth. I haven’t had a day job since, but I have done part-time consulting work for startups in San Francisco, as well as written a couple of best-selling books to keep me busy.
In 2013, I had a free, no-obligation consultation with an Empower financial advisor that helped me identify a significant financial blind spot. At the time, I was conservative, holding a 52% cash allocation in my taxable portfolio after leaving my job the previous year.
In my mind, I had to invest like a traditional 65-year-old retiree. The advisor pointed out that I was still young (35) with many financial opportunities ahead. Following that advice, I invested my cash into stocks and real estate, which has paid off well over the past 11+ years.
The Minimum Investment Threshold Formula
The minimum investment threshold where work starts to become optional is calculated by taking the inverse of the historical return of the asset class you own and multiplying it by your gross annual income. The formula visually looks like this below.
When you reach this investment threshold, the annual return from your investments has a high chance of equaling or exceeding your annual salary. Additionally, since long-term investment income and capital gains are generally taxed at a lower rate than W-2 job income, you’ll have an even larger after-tax cushion.
Once your investments can regularly match or exceed your annual gross income, you are free to change jobs, take a sabbatical, or potentially even retire early. I'll share three examples below, but first, some key assumptions.
The beauty of my investment threshold formula is that real-time inflation assumptions are included given incomes are correlated with inflation. Simply run the numbers every time your income changes. Further, investment returns are also helped by inflation and historically return greater than the rate of inflation.
Please note my Investment Threshold Formula is meant to be used as a baseline reference point to help measure where you're at or help you come up with an investment target. Once you come up with the figure, you can then plan accordingly based on other variables.
Key Assumptions for My Investment Threshold Formula
In my investment threshold formula, I assume the financial freedom seeker lives within their means, doesn’t carry revolving credit card debt, and saves at least 20% of their after-tax income every year.
Another assumption is that the financial freedom seeker maintains their usual spending habits. Of course, if you choose to spend less, you’ll need a lower investment threshold, and vice versa. However, I view spending less as “cheating,” which is why I use a multiple of gross annual income instead of annual expenses.
I want you to achieve financial goals without overly-compromising your desired lifestyle. There’s no point in retiring early only to live near poverty. It’s also not ideal to live near poverty just to retire early and continue living that way.
After helping kickstart the modern-day FIRE movement in 2009, I’ve seen and profiled numerous people who decided to live like monks, shun travel, rent, live on a boat or in a van, avoid having children, and force their partners to work so they could be financially independent. Not being free to live fully is suboptimal.
Instead, I encourage everyone to live well. When you decide to step away from work, you should be able to maintain or even improve your quality of life.
Investment Threshold Example #1: High Risk Tolerance, 100% Allocation in Stocks
Let’s say you earn $100,000 a year. The S&P 500 has historically returned about 10% annually since 1926. The inverse of 10% is 10. Multiply 10 by $100,000, and you get $1 million. As a $100,000-a-year income earner, once you have $1 million invested in the S&P 500, you should feel free to explore other options if you no longer enjoy your job.
At 38 years old, you may feel you have a high risk tolerance and are comfortable with a 100% allocation in stocks. Suppose you’re tired of working for the government and want to try your hand as a writer earning $40,000 a year. You can do so because you have $1.1 million in stocks, thanks to saving and investing 50% of your after-tax income for 15 years.
If you are able to survive off a $40,000 a year salary and not touch principal, you only need $400,000 invested in stocks using my investment threshold formula. However, since you decided to switch your career at 38 years old with $1.1 million in stocks, you have a $700,000 investment buffer. As a result, you might feel incredibly rich and free in your new lifestyle.
If you prefer a different asset allocation, you would calculate a blended estimated historical return to find a new gross annual income multiple.
Income Threshold Example #2: Ready to Retire, 60/40 Stocks/Bonds Portfolio
Now, let’s say you’re 45 years old and tired of working after 23 years post-college. You earn $300,000 a year in tech, a notoriously volatile industry. Instead of 100% in stocks, you prefer a 60/40 stocks/bonds portfolio. When can you retire?
Given that bonds historically return about 5%, the historical return of a 60/40 portfolio is around 8%. The inverse of 8% is 12.5. To find your investment threshold, multiply $300,000 by 12.5, which equals $3,750,000.
Unfortunately, you “only” have about $2.5 million invested in stocks and bonds, with no other assets. Given that you can save $100,000 a year after taxes, a compound return calculator estimates your portfolio will reach $3.75 million in three years and ten months, assuming an 8% annual return. Of course, a bear market could extend your timeline.
You feel good knowing that after using my investment threshold formula, you have a high probability of retiring in the next 5-7 years.
Income Threshold Example #3: Prefer Real Estate Over Stocks or Bonds
Let’s say you grew up in a culture that values real estate more than stocks or bonds. Real estate is tangible, provides shelter, generates income, and is less volatile than stocks, so you invest all your money in residential real estate for retirement. Bonds are boring and simply don't provide enough upside.
Historically, real estate has returned about 4% annually on average, or 2% above the long-term inflation rate. Some sources, like the San Francisco Fed, suggest that real estate has historically returned 7% annually since 1850. You earn $200,000 as an associate in banking and are already burned out after three years at age 26.
To calculate how much real estate you need to make work optional, use the same formula. The inverse of 4% is 25. Multiply 25 by $200,000, and you get $5 million. Now you must do your best to live off of $200,000 or less and save and invest as much as possible on any income earned above $200,000.
The Ability To Borrow To Reach Your Real Estate Investment Threshold
While $5 million worth of real estate might sound like a lot, our system allows people with good credit and stable income to acquire real estate with only a 20% down payment. So, you only need to come up with $1 million to buy $5 million worth of real estate over time.
$1 million is $1 million less (50% less) than you would need if you preferred to have 100% of your portfolio in the S&P 500. Of course, you’ll spend more time and money managing your properties. Additionally, with significant debt, your real estate equity could fluctuate more dramatically.
The key is to own rental properties that generate strong cash flow. Fortunately, rental yields are usually much higher than stock dividend yields. When combined with ~4% annual real estate appreciation, you’re likely to earn enough to make work optional.
For those who want to get their hands dirty, they can always expand a property to boost its value and increase rental income. And for those who want to be completely hands off, they can always invest in a public REIT or private real estate fund that does all the work for them.
Invest In Real Estate More Passively
Once I had children in 2017, I started investing more aggressively with the likes of Fundrise ($275,000 so far, and $970,000 total in private real estate). I didn’t want rental properties to take any more time away from raising my son and daughter.
In addition, I wanted to invest in the long-term demographic trend of people relocating to lower cost areas of the country. Thanks to 11 aggressive Fed rate hikes since 2022, there are a lot more commercial real estate deals to be had. Now that mortgage rates are coming down, I expect real estate prices to catch up to stock price performance in the coming years.
My favorite time to invest in real estate is before the start of a multi-year interest rate cut cycle. That time is now.
You’ll Likely Still Be Working After Reaching the Investment Threshold
My investment threshold formula represents the minimum amount you need before feeling comfortable transitioning out of your current job. It’s unlikely to be enough to retire, unless you do so when you're eligible to receive a pension or collect Social Security.
After all, there's roughly a 30% chance of your investments losing money in any given year. Therefore, you'll likely aim to accumulate more investments or continue working even after reaching the investment threshold.
Let's say you expect a 30% decline in your investments, to give yourself a buffer, aim to achieve 142% of the threshold amount. This way, you have a 30% downside buffer. And if you think there will be back-to back years of 30% declines (highly unlikely), then you can accumulate 204% of the minimum threshold.
Please note that a 30% decline in your investments is different from a 30% chance of your investments losing money. Your investments could lose money one year, but could decline less or more than 30%. It’s usually far less.
Have The Courage To Change Your Life
Once you reach the investment threshold, at the very lease, you should have the courage to change your life for the better. This means not wasting another minute at a job you dislike. Changing your life means you’re no longer financially dependent on someone else, so you can leave a terrible relationship behind. You also no longer have an excuse not to pursue your dreams, whatever they might be.
Too many people work at jobs they don’t enjoy mainly for the money. Think about all the starry-eyed high school students writing in their college applications about wanting to change the world, only to end up in an industry that pays them well, but has nothing to do with their dreams.
I understand it’s hard to walk away from the money, but you must, to pursue what you really want to do. If you don’t quit the money once you have enough, you might look back on your life with regret. The older I get, the more I realize regret feels more painful over time.
Back in 2012, I was absolutely miserable working in finance. I had chronic lower back pain, sciatica, and TMJ. My job was literally killing me. Six months after I negotiated a severance package, all my chronic pain went away. Even my white hairs, which began sprouting more often a year earlier, went back into hibernation.
Making a lot of money is nice, but health and happiness are way more valuable!
The Ideal Net Worth Target To Retire Or Declare FI
My investment threshold aligns well with my net worth target before declaring financial independence. My investment threshold formula is simply a more granular way to calculate the beginning of enough.
Instead of using 25X your annual expenses to consider yourself financially independent, I use 20X your gross annual income to determine true financial independence. Expenses can be easily manipulated to make your financial independence number easier to achieve. However, with income, you are paid what you are paid. As you earn more, you’re forced to save and invest an equal or greater amount.
I’m not a fan of shortcuts to achieve financial independence. Therefore, I’m not a fan of Coast FIRE or any other sub-FIRE strategy that awards you a trophy before you’ve finished the race. Because at the end of the day, you’re only cheating yourself and your family if you take shortcuts.
The greater the percentage of your net worth is allocated towards risk assets, the closer my net worth target multiples are aligned with my investment threshold amount formula.
Be Dynamic In Your Financial Calculations
After more than 15 years of writing about personal finance and leaving work in 2012, I can confidently say that following my investment threshold formula works. If you own multiple assets, then come about with the blended historical average return and make the appropriate calculation.
On your FI journey, you will undoubtedly experience fear and doubt as economic and personal circumstances evolve. The key is to remain flexible with your financial goals and adapt to changing conditions.
When my wife retired in 2015 at age 35, I believed we could live happily ever after in less expensive Honolulu on ~$120,000 a year. Based on my conservative investment return target of 2-3X the 10-year Treasury bond yield, retiring early with $3,000,000 – $4,000,000 invested seemed like enough.
But in 2017, our son was born, followed by our daughter in 2019. A year later, the pandemic hit, prompting the government to inject trillions of dollars into the economy, which fueled inflation.
Relatively quickly, $120,000 was no longer enough to raise two kids in San Francisco. To live a middle-class lifestyle in an expensive coastal city now requires closer to a $350,000 annual household income. If we use a conservative 5% rate of return on our investments, that means needing at least $7,000,000 invested where work becomes optional.
As a result, we had to reinvest more of our investment income than originally planned, instead of spending it. Additionally, we needed to generate supplemental retirement income through writing, Uber driving, tennis coaching, and part-time consulting.
Doing What You Enjoy Makes Your FI Journey Better
Fortunately, I genuinely love writing and creating actionable ideas to help readers achieve financial freedom sooner. I also enjoyed coaching, which helps me prepare for when my kids become teenagers.
Although achieving financial independence can be a grind, transitioning to doing what you love makes the journey much more enjoyable. Everybody needs to have a reason for being, or ikigai, as they say in Japanese.
Much of living your desired life involves overcoming mental barriers. However, if you consistently break through, I’m confident you’ll build more wealth and live a more enjoyable life than you ever thought possible.
My Conversation With 4% Rule Creator Bill Bengen
If you want even more courage to retire sooner, listen to my conversation with Bill Bengen, creator of the 4% Rule. He suggests that a 5% safe withdrawal rate or even higher is fine to last a retiree for 30 years without running out of money.
Thanks for your reviews and shares of my podcast. Every episode takes hours to record, edit, and produce. Each review means a lot. You can subscribe to the Financial Samurai podcast on Apple or Spotify.
What is the minimum investment threshold you need to ease up at work, switch to a lower-paying job, or retire early? How do you calculate this minimum threshold? And if you have far more investments than you need, what’s holding you back from doing something more enjoyable with your time?
Free Wealth Management
Empower is the best free wealth management platform for investors. You can x-ray your portfolio for excessive fees and get a snapshot of your asset allocation by portfolio. Empower's free tools also let you easily track your net worth and plan for your retirement.
When there is so much uncertainty in the world, you absolutely must stay on top of your finances. Understand where your risk exposure is and stay on top of your cash flow. Empower's free wealth management tools will help you bring calm to the chaos.
I've been using Empower since 2012 and it has helped me growth my net worth tremendously since retiring. It is the best free wealth management platform today.
Subscribe To Financial Samurai
Listen and subscribe to The Financial Samurai podcast on Apple or Spotify. I interview experts in their respective fields and discuss some of the most interesting topics on this site. Your shares, ratings, and reviews are appreciated.
To expedite your journey to financial freedom, join over 60,000 others and subscribe to the free Financial Samurai newsletter. Financial Samurai is among the largest independently-owned personal finance websites, established in 2009. Everything is written based on firsthand experience and expertise because money is too important to be left up to the inexperienced.
The Investment Threshold Amount Where Work Becomes Optional is a Financial Samurai original post. Fundrise is a sponsor of FS and FS is a investor in Fundrise. Everything I write is based off of first-hand experience. To achieve financial freedom sooner, join 60,000+ others and sign up for my free weekly newsletter.
Fascinating discussion and valuable information. Reasonable people with rational questions and ideas…what a novel concept!
Sam..while I’ve come across some of your writings earlier, I was never comfortable with the whole FIRE concept. As an immigrant now living in a mid-large midwestern town, I guess my parents’ and relatives’ work ethic / decades of upbringing is hard to shrug off. But I’m trying …cos my wife wants me to!
Any words of advice for a couple (me 59, wife 52, both working, no kids) making $260K annually with $2.8M in 401, Roth and IRAs, with an anticipated pension of $60K beginning next year, 2 homes worth (net) around 700K? Give me the courage to take the plunge (even at this late stage in my life) and tell me it’s OK to quit!! But don’t tell my wife…yet :-)
Welcome to my site! How did you get here? I’ve been writing about FIRE since 2009.
I’m happy to give you permission to retire and enjoy your life. But don’t do so if you love your job! And if you do leave and find it to be a mistake, you can always try to go back to work again.
Here’s another helpful article to help you calculate how much is enough to take things easier. https://www.financialsamurai.com/minimum-investment-threshold-amount-work-optional/
Thank you! And how did I get here? By plane of course. Jokes aside: as I’d mentioned earlier, FIRE was an interesting idea, but you were the only one who dared to change your mind (oh the horror of ever evolving when circumstances change) and reset your plans. That was what intrigued me the most, since we as a population are chastised for ever changing our minds. Courage of conviction with the ability to shift plans, gears and if needed, directions is a rare talent. Hence my reason for being here. And thank you for allowing your readers to engage in meaningful conversations. Keep going…you have an army rooting for you.
Sam,
Long time reader and bought at least 6 books of “Buy This, Not That” for friends and family. I really appreciate all your material which has helped me on my financial journey.
45, single dad of 3 young kids, wife passed away from cancer 1.5 years ago. 150k salary, 70k in SS survivor benefits for kids, 3.8M in investments, 550k in home equity, 122k left on mortgage. 110k minimum to meet budget.
On one hand, the schedule is definitely busy and I would love to dial it down while I still have the kids. On the other hand, I don’t feel like I can give up the steady income and health insurance given that I have young kids.
Minimum Investment Threshold for me if I include SSSB is 2.75M (1/0.08. x220k). In your past posts, I’ve read that 5M is the minimum number to retire if one has kids. Does that still hold true? I’d be grateful for any thoughts or insight. Just trying to make the best of life and the cards that were dealt to me.
Hi M – Thanks for reading and sharing my work. If you don’t mind leaving a review on Amazon when you have a moment, I’d appreciate it too.
I’m sorry to hear about your wife. It must be hard to be a single parent to three kids, but I know you’re doing your best.
With $3.8 million investments and a $110K annual spend, you have enough to retire fully right now if you want. At the same time, it’s tough to do so given it seems inherent in fathers to want to provide and earn.
My $5 million number is a ballpark if you live in a high cost of living area. Where do you live? But my Investment Threshold Formula provides a more precise estimate for when you can take things down. With you having $1 million over the threshold, you’ll most likely be OK.
You might consider taking a more flexible job or part-time job for less pay to spend more time with the kids. If so, I don’t see a problem with you enjoying more time with the little ones. You won’t regret it. And if money feels like it’s getting tight again, you can always go back to work if you fully leave.
Just don’t forget to try and negotiate a severance package if you do leave work! And if you’re interested in discussing further, you can check out this page.
Sam,
Sorry for my delayed response. The beginning of the school year has been incredibly busy and I wanted to write that review on Amazon before I responded. Hopefully, Amazon will post it soon.
I lived in the Dallas area for 23 years now. Home appreciation has been great. But the property taxes and insurance have been a bummer.
It hit home for me when you wrote, fathers inherently “want to provide and earn.” I definitely have a strong desire to provide for my children, especially now. For me, that means giving them a stable environment where they can grow and be their best. I know that this largely falls on me and the decisions that I make.
If I could go part time at my current job, I’d take it in a heartbeat. But unfortunately, it’s not possible. Working part time at another company doing the same thing. Definitely doable. But I foresee that the stress would be much more than where I am at working full time. So, I think, I don’t want to leave my current job, until I’m very certain that the finances are in order for me to fully leave work.
I would be kicking myself so hard if my desire to take things down a notch ended up destabilizing things and causing undue stress on me and the kids. Having that stable income with insurance is a big security blanket and the thought of letting that go with the possibility of things going wrong just seems so scary and risky.
Thank you for your kind words, thoughts on my situation, and the links. It gave me a lot to think about and consider. I really appreciate it.
Keep up the great work! You’re helping so many people make better lives for themselves and their families.
No problem! As the only provider, it would feel irresponsible and uncomfortable to stop working. So if you have the appropriate childcare and can still enjoy your family, it’s probably best to do that for as long as possible.
It does feel good to have a goal of nurturing and providing for them until they go to college. When there is a purpose and a goal, there is an easier way.
Question: In the case of a high income earner but low spender, doesn’t your formula then materially overstate the amount needed and hence time required to get there?
For example: if you earn $1M a year but only spend $150-200k, then 20x gross income means you need $20M invested before you’d even consider retiring – which is unnecessary.
Also, incomes generally rise over time as you progress in your career, so it’s an ever moving target. A fresh grad starting out would be making anywhere from $50-100k+, whilst someone in their 30-40s could be making multiples of that. How do you determine what’s sufficient in that case? Shouldn’t expenses required to fund your ideal FIRE lifestyle be a driver rather than current income?
Yes it would. But it would also serve as a wake up call for what’s the point of continuing to work for $1 million a year when you’re only spending $200K a year. The wakeup call will force you to rethink how you spend your time and money. This is a critical point about my formula.
And if you want to use my Investment Threshold Formula with your example, you’d only get 20X gross income if the asset you want to own, or the blending return, only returns a 5% historical rate of return. If we’re talking only stocks, then the formula would show 10 X $1 Million = $10 million.
If you’re making $1 million a year, $10 million in investable assets is certainly doable. It is even preferably if you talk to anybody making $1 million a year.
For more on expenses versus income, see: Net Worth Targets To Shoot For By Age, Income, Work Experience
What’s your financial situation? Don’t be shy!
Great and timely article. I plugged my numbers into the equation and the results made me feel better about my recent conclusion that time is more valuable than chasing additional money via continued employment at this point in my life. I just retired at 47 with 4.3M net worth. Cash flow from residential real estate (SFHs) more than covers my living expenses and I will still have 10’s of thousands to invest into the stock market each year. I won’t have to withdraw from my brokerage account and the 401K and Backdoor Roth IRA can continue to compound over time. Although, I might try to find part time work (2 days per week max) just to acquire guilt free spending money. I am starting to realize it’s hard to turn off the “save/invest-don’t spend mentality” and might need to wean myself off earned income.
Congrats! Spending more is definitely tough after decades of saving and investing. But you gotta do it!
Here are some ideas:
https://www.financialsamurai.com/how-to-decumulate-wealth/
Interesting perspective.
But I have a couple major issues with it:
1) Bengen’s 4% rule of thumb was developed to counter exactly the above prevalent (before Bengen’s paper) oversimplified analysis using average returns rather than worst case to properly factor in sequence of returns risk. He proved, and Trinity study confirmed that you cannot rely on average returns, but must factor in sequence of returns to determine highest Safe Withdrawal Rate (SWR) to last 30 years based on the worst sequence risk since you have no way to know how good or bad a sequence you’ll experience in the future (he later concluded you may be able to predict a higher SWR in his dataset if Shiller CAPE is historically low at the start of retirement). That is the precise reason Bengen did the study and published it – to counter the overly optimistic narrative that advisors had been touting using average returns to live on. In fact, all the scholarly SWR research I’ve seen that considered the longer time horizons relevant to early retirees (by Bengen, Kitces, Blanchett, Big ERN/Karsten) conclude that SWR needs be lowered by at least 0.5% for longer than 30 year spans. So, that’s 3.5%, not 8% for the 60/40 split (in line with SWR research above) for early retirees.
2) Income while working is poorly correlated with expenses for early retirees, since by definition, early retirees must have a decent gap between income and expenses to save and invest for early retirement. Without a clear correlation between income and expenses, income is not predictive for the calculation, since expenses are what matter in SWR retirement calculations.
It happens that my above objections make the numbers off in opposite directions, but that doesn’t mean they’ll cancel out (that would be coincidental).
You did say this is the point you can start thinking about work being optional or to downshift earned income for a job you prefer, so that’s some wiggle room. But using average return ignores sequence of returns risk, and that is a huge risk in retirement. You paid lip service to sequence risk with the comment about 2 subsequent 30% drops, but that is too oversimplified to predict sequence risks effect on SWR compared to the scholarly SWR analyses I mentioned above. If you want citations of the studies I mentioned above, let me know and I’ll gather them and send them along.
Sure, no problem. What formula would you propose? Also, when did you retire and how did you decide to walk away from your day job? I’m always curious to know how readers have navigated retirement and survived during volatile times.
Bengen’s SWR is way outdated given it’s from the mid – 1990s.
Here’s a better way to think about SWR for modern times. https://www.financialsamurai.com/proper-safe-withdrawal-rate/
I would set presumed minimum investment threshold for work to be optional for early retirement at 29X-33X estimated retirement annual expenses not covered by inflation adjusted other income sources.
That’s simply inverting 3%-3.5% SWR, and the typical 25X for a normal (non-early) 30 year retirement timespan. Not my invention, of course.
Above assumes worst case portfolio depletion (which I am aware is not your assumption), but in any but the worst case, likely substantial legacy.
However, I would recommend tailoring SWR to an individual situation which incorporates both backwards (historical data for all available timeframes) and forwards (Shiller CAPE to predict equity performance over next decade) SWR, as well as Social Security (which I recommend maximizing in most cases), any other cashflows such as pensions, rentals, etc, and any residual legacy you want reserved.
I retired somewhat early a few years ago, several years after I would need to draw well below 3.5% SWR, but also with some other post retirement income sources to cover some expenses. I used multiple retirement calculators including Monte Carlo (90% success threshold), a Funded Ratio (similar to what pension funds do, but for personal retirement funding levels), and the SWR tailored spreadsheet above. Having 3 independent analyses (calculated entirely different ways) showing the plan works provides confidence.
I view above SWR as “my means” for “live below your means” calculations. In other words, I certainly don’t withdraw an exact SWR amount every year (that’s too rigid), but understand that every year I remain below SWR threshold, my risk of running out decreases each year, and any year I go over, it increases.
For now, I’m recalculating SWR periodically, which may allow it to rise as time horizon shrinks, depending on market performance.
By the time I need to start taking RMDs, I might switch to an RMD based (rising) SWR.
Bengen’s research has been duplicated and reconfirmed multiple times over the decades in multiple peer reviewed academic researcher papers by several different researchers since he did it. Note it assumes US investments, though and wouldn’t work well with most other country biased investments as Dr. Pfau showed.
As to your proposed alternative, a fluctuating SWR is an oxymoron, and not practical to implement in my mind. It’s too much of a moving target. There are various established flexibility rules for adjusting SWRs if I want to go there.
Sounds good. You’ve got to do what works for you.
I understand how my dynamic safe withdrawal rate formula might be tough to follow. But given your calculating your SWR yearly, I’m not sure why mine would be harder
Simply find the 10 year bond yield and multiply by 80% to get your latest safe withdrawal rate.
Since you are retired, this article, using my dynamic safe withdrawal rate formula in retirement should make things clear as it’s a case study.
I would allow for the link you mentioned, but given how rude the writer is, I won’t. He also doesn’t address the dynamic part of the safe withdrawal rate, as it increases as the 10 year bond yield increases and vice versa. Instead, he’s stuck at 0.5%, when the world was falling apart in April 2020.
The guy had to leave San Francisco to afford to retire and he limited his family size to 1 kid. Since then, he’s seems to be bitter toward anybody who has a different opinion of his. I’m not sure whether he has some type of superiority complex as an academic. But it’s sad and also fascinating to see. Happy people don’t go about calling people names for having a different opinion or way of life.
The SWR calculation isn’t hard. The issue is the radically fluctuating spending level that your variable SWR would require. It is too much to absorb. Other variable spending strategies at least have milder swings.
If I choose to (my approach does not require it) recalculate the SWR periodically, I can optionally raise my SWR as a result of a good sequence of returns early in retirement. If it drops, while it would be a cautionary note, I don’t need to lower spending as the old SWR remains valid.
I understand why you are uncomfortable including the direct link to his criticism of your 0.5% SWR article. His criticism style comes across as very harsh (I’ve been on the receving end of it myself, so I recognize what it feels like). I think it comes from him being an instructor of at least one PhD level university subject along with being a former quant for the Federal Reserve. His criticisms definitely come across as him being the teacher with others being the student.
That said, his main point is (though he makes others), which I’ll summarize as: SWR, when considering the entire available historical record varies with equity valuations (Shiller CAPE), and not substantially with bond yields. It is well supported by the complete analysis and data set he presents to prove it.
Sounds good. The option of spending down principal is always there, so is earning supplemental retirement income.
If one can’t debate in a respectful manner, I pay no attention. There must be some type of trauma he experienced or unhappiness he was pushed out and had to leave SF for him to be this way. It’s probably also frustrating how his site doesn’t get much traffic. Hope he can work out his issues and become a nicer person to others.
Great article Sam – I was listening to this postcast during lunch today. I’ve alway been curious if I have enought to break away from my Finance/Tech job at 1 New York Plaza in NYC. Since I have both Retirement and Real Estate portfolio, this makes the calculation a little challenging.
My desired Financial Freedom (FI) Number is $150k per year.
My rental Real Estate portfolio is $3.6 million (with $2m in Debt). If my FI number is $150,000 / 4%, my real estate portfolio is enough. However, the cashflow is not near enough to live off (my guess is around $60k per year).
My 401k portfolio is $800k with 80% in EQ and 20% in FI. I also have $150k in Cryto and another $400k cash for rainny day.
Even with this numbers, I don’t feel comfortable leaving my corporate job and pursue rental real estate full time. My goal is to leave this job and simulate what many REIT/private equity firms are doing.
Great article but I still lean toward the 20-25x annual expenses, especially with this audience. This audience are mostly savers and probably have little debt.
If I make 800k now and spend 200k, and save 200-300k a year, and have done so for many years, AND paid off all my debt, AND that 200k I’ve been spending including numerous luxuries such as travel trips, and hobbies, the idea that I will spend north of say 300k in retirement just doesn’t seem possible to me. I’ve done all the detail math on extra healthcare, etc. I have more than 4 mill in investible assets, but doubt I will even get through that. needed 16 million (off the 800k gross income) sounds ludicrously conservative approach.
Then again I am 60 years old, so don’t have as many years to cover as a 45 year old. Still, does a 45 year old really need 16 million in the bank to retire?
Is that part of your equation, 30+ years instead of 20+, that leans you to gross income?
Using your numbers, then my Minimum Investment Threshold formula will overstate how much investments you need to retire. Clearly, at 60 years old with $4 million and close to receiving Social Security, you can retire now if you want to.
So for you, I would use my formula as a wake up call to reassess what you want to do with your life right now. Time is super valuable to you and you must be OK with continuing to trade time for more money when you don’t need it.
Do you love doing your job more than anything else you would prefer?
Great article Sam. I’m age 47 and I was panning on retiring between age 52 and 55 but after reading this I might be able to walk out at 50. Thanks for the motivation!
Honestly, I stopped reading after “During a recession your ROE goes down..”. That’s one of the stupidest statements I’ve ever heard since your hard earned money is now buying more shares AND it’s better to work through a recession and retire into an upwards market (the 5% failures in FIREcalc are retiring into a significantly downward market where you have to start selling).
No worries Ryan. You are free to work harder when your net worth and income growth are slowing or going down. Especially if you are still far away on your financial independence journey.
Here’s the mathematical formula to show how your Return On Effort declines the harder you work.
Traditionally, ROE standards for Return On Equity. The formula is (Net Income / Shareholder’s Equity) X 100. A high ROE indicates that the company is effectively using shareholders’ equity to generate profits.
In my version, Shareholder’s Equity is equivalent to Effort. If you decrease the denominator you will increase your Return On Effort and vice versa.
It’s just math. When you want to maximize returns, you work hardest during good times.
Are you also retired? Because I haven’t met a person who is retired or financially independent before who disagrees with the math yet. How old are you and where are you on your financial journey?
Related post: https://www.financialsamurai.com/the-pointlessness-of-working-when-your-net-worth-is-declining/
As a manager, I love to hear this! I love it when my worker bees work harder for less money. This helps me actually me and my company make more money.
When the good times return, my company will make even more money thanks to worker bees who will feel grateful for not getting laid off during the downturn.
As a society, we need more worker bees to grind it out to make the owners money.
Yeah, usually the fear of getting laid off is enough to drive people to work hard during the downturn. But I’m addressing people who have worked for decades, and saved enough to have optionality to take things down.
If we can get these experienced people to continue to work for money, when they don’t have to, then this could bring in a greater competitive advantage, and more profits to the company, which is great if you are an owner.
Maybe the key to getting rich is to implant fear in peoples hearts that they will never have enough.
FS, when I first saw the ITF in your newsletter I thought “Looks good, but overstates need.” My thinking – cover current expenses, maybe averaged over 5 years – but not my income. Doing so, means I would still sock a large part away in savings, and I have no need for that once I retire.
After reading article I am somewhere in between. One example, under your formula someone earning $150,000/yr. with 8% return needs at least $1.875 million to retire. Certainly covers ALL the bases (unforeseen insurance costs, etc.) But if that same person is saving $75,000/yr. it’s a completely different ballgame. They would only need half that (1/.08* $75K)= $937,500 since they no longer need to save.
Arguably, returns fluctuate, there are unforeseen costs, etc. But taxes will almost definitely go down, lifestyle creep is almost completely removed (Don’t need new work clothes, don’t need to drive to work, etc.) that are offsetting. Also, some folks have a pension and eventually SS will play a role. Do we want people to die with money in the bank unless they want to die with money in the bank? I like your formula as an upper threshold and mine (ok yours, just modified) as the lower. People can then make choices where they want to land. And isn’t that the biggest part of FIRE? Independence? Really it should be fIre.
One last item – the point about real estate is highly valid. Not sure if QBI deduction remains past 2024 but combined with depreciation, taxes, insurance and mortgage and a person can reap paper losses all day while having a somewhat steady income stream from rentals.
I definitely like this framework, I’ve seen too many people try to do BaristaFI or CoastFI and fall flat depending on excess compounded returns whilst this framework provides a roughly 10X gross income measure. I do agree with your metric that 20 X gross income is the ultimate obtainment goal. I’ve reached 10 X + my gross income and am starting to take the foot off the gas pedal a little but realize there is a little more ways to go. Have a great day!
IMO it’s 15x without kids. Someone making 200k will be happy 3 mil in the bank and a paid off one bedroom condo. Private school and saving for college pushes it to 20x income
Sure, those multiples could work. And I would say that’s based off good for you and individual circumstances.
But my minimum investment threshold formula uses historical returns, data, and one’s current gross income to come up with a concrete investment amount based on whatever investment you prefer to own for retirement.
The beauty of the formula is that it is pertinent to every single worker on the planet. I can’t believe I didn’t come up with this simple, yet powerful framework earlier.
Subconsciously, I have been testing this formula in real time since I left work in 2012. So maybe it just took that long to figure it out.
How do you count for the breakdown between taxable and tax afford accounts using this? For example, I make $200,000 a year and have just more than enough money in my accounts in total for 60/40 portfolio under this guidance. However, about 63% of it is in a pretax 401(k) and a Roth IRA and I’m only 43. I presume the guidance would be that using Roth conversion strategies or possibly a 72T is OK within this framework?
That’s a great question since most of us will have tax advantaged and taxable Investments as well as various tax-advanced investments like the Roth IRA and 401k.
The answer is, as you said. First focus on the total amount to accumulate. Then, you would access the amount, if needed, where there are no tax penalties or where you need to pay taxes, and then the tax advantage amounts after the age when there are no longer penalties.
You will unlikely ever need the full amount of your investments at once. So you would logically just draw from the investments with the least amount of penalties and taxes.
The reality is, if you decide to retire early, before the age of 50, you will most likely find ways to NOT drawn down principal and work at a more enjoyable job that helps pay the bills.
When using your 20x formula, do we include the income we save? For example, if we make $500,000 but save $200,000, do we multiply 20 times $300,000 or the $500,000. Great post. Thanks.
Hi JC, you would multiply your annual household gross income by 20X to come up with the net worth target to be considered financially independent. Once you hit 10X your annual gross income, you’re going to start feeling financially free. But based on my experience and other people’s experiences, while also running the numbers, 20X gross household income is the magical number.
How are you accounting for inflation or are you assuming it will return to 2 percent? The 100,000 you used as an example buys an awful lot less today than pre-covid, especially with respect to travel costs in the US.
I still remember the early 1980s when a I took a car loan at 14% simply because my money market was paying 18%.
It’s all baked in based on your income, because companies have to pay a competitive wage and employees will be on willing to work for less than what they think they are worth.
You simply calculate the formula every single year. And your investments will likely return greater than the rate of inflation.
Don’t forget the investment part. And yes, I believe inflation will return to his long on average between 2% – 2.5%. We’re almost there again after a couple of years.
You need to use the real rate of return to do this calculation, otherwise the real value of your assets will decline over time if you stop working. Even this is not good enough because of the variability of returns, which is why we have the 4% rule and variants that used simulations to work out what the safe withdrawal rate is.
As you wish. Feel free to share the formula that you would use instead. One thing to think about is that you can use my minimum investment threshold formula every single year to calculate what you need. Because, presumably, your income will change over time as well, and income is indexed towards inflation.
When creating these guidelines, you also have to be careful not to make it overly complicated. Otherwise, the average person might fade out.
You don’t. Income and investment returns, two of the formulas, are correlated with inflation.
Nice post and formula. Thank you.
I’m weighted heavily in real estate. I value real estate for the cash flow it provides and forget about appreciation. Maybe I’m being overly conservative and thus working too long? My other issue is that a meaningful amount of my net worth is inaccessible – in a 401k that I can’t access for some time and equity in real estate that I don’t want to refinance because the rate is sub-3%. If all the real estate equity and 401k were in a brokerage account, I could retire now using your formula. In the meantime, I’m investing all net rental and excess work income in a brokerage account to try to rebalance and prepare for early retirement.
How is your cash flow from your real estate compared to your expenses?
Yes, if you want to retire earlier than normal, you need to build up a large enough taxable portfolio. https://www.financialsamurai.com/after-tax-investment-amounts-by-age-to-retire-early/
The thing is, you don’t need your ideal net worth target to retire early, especially if you retire younger. B/c you’ll naturally find something you enjoy doing that also pays to supplement your retirement.
It’s not all or nothing.
My cash flow from real estate covers 70% of my regular expenses but doesn’t account for lumpy expenses like new cars or a broken collarbone. I am focused on my taxable portfolio now. Perhaps I should have been more focused on it earlier, but I prioritized 401k, 529 plans, and reinvesting real estate earnings into the real estate in capital improvements and mortgage paydowns, so now I’m paying for it in a sense.
70% is great. If you’ve still got the energy to work, then having healthy 401(k) and 529 plan balances is great. How old are you and how much longer do you want to work?
It sounds like you can take things easier if you want.
Early 40s. I’ve already slowed down with work, and I would consider being done if there were any other work that I’d enjoy more to bridge the gap, but part of what keeps me going is that I don’t want to work at all if I’m not well compensated. 401k is adequately funded, though as long as I’m still working, I continue to contribute and get the tax deduction. 529 plans are in a good spot, too, but I’m still contributing as long as I’m working, as I like the tax benefits. Perhaps I am letting the tax tale wage the dog.
Sam,
How do you factor the 30% chance of investments going down in any given year into your formula specifically?
30% is not a small number and could happen in consecutive years.
Seems like you would have a precise way of accommodating for this in your formula.
Thanks!
Hence, why this is the minimum investment threshold amount.
If you want to feel more confident, then to account for a potential 30% decline, you can aim to keep working, saving, and investing until you reach 142% of the threshold amount. This way, you have a 30% buffer. And if you think there will be multiple years of 30% declines (extremely unlikely), then you can accumulate 204% of the minimum threshold amount.
Wow I love how your brain works. It took me some thinking to fully grasp the math at first, but after reviewing the examples, I understand it now. I like how it’s customizable to the individual based on salary and average historical return based on one’s own investment make-up. Very smart logic, thanks!