What's Going on With Your Money: How to Determine Your Financial Independence Number
A common myth pertaining to retirement is that retirement is an age when in fact retirement is a dollar amount. You’re probably thinking, “what is she talking about?”. Well, if you were 50 years old with enough retirement savings to provide an income for 35 to 40 years, would you consider retiring to enjoy the rest of your life? If your answer is ‘yes’ to that question, then you have the same mindset as most people.
When it comes to your money and saving for retirement, control what you can control. What you can control is how much you save and where you save it. But you should also know how it all comes together.
In my blog, you’ll learn how to calculate your financial independence number (FIN) for retirement, rule of 72 and reverse rule of 72, and the 3 variables that will affect your retirement if you don’t anticipate and plan for them now.
Step 1 – Calculating your financial need in retirement
To calculate how much you’ll need for retirement, follow the example below. I recommend taking into consideration the cost of living at retirement (I’ll discuss further in the next section of my blog, 3 Key Variables that will Affect Your Retirement).
Example: $100,000 (desired annual income) x 20 years (age 65 to 85) = $2,000,000 (FIN)
Step 2 – Rule of 72 and Reverse Rule of 72
Rule of 72
Rule of 72 is a mathematical formula that solves for compound interest. Sadly, many financial professionals do not explain what this means for the individual client as they accumulate their wealth. The rule of 72 states that if you take the annual percentage (annual yield) a financial institution is crediting your account and divide it into 72, you’ll know when your money will double. In the example below, I use 6%.
Example: 72 / 6 = 12 (years)
Why is this important to know? Because no one can truly save their way to retirement. Your money must grow and compound over time. It’s also the only way to determine if you’re on track toward reaching your retirement goal.
Reverse Rule of 72
Now that you know how to calculate compound interest and when your money will double (every 12 years), it’s time to use the reverse rule of 72 to establish your checkpoints as you reach toward your desired retirement age. To do this, you’ll need to have a starting point and an end point. For this example, I’m starting at age 29-30 (for math reasons) and ending at age 65 (when most people say they want to retire). Since we’re using the reverse rule of 72, we’re going to work from age 65 back to age 29. When we calculated the FIN above, we came up with $2M, that’s the end point you see below. If you subtract 12 years (rule of 72 calculation), you’ll need to have $1M by age 53 with an average rate of return of 6% per year. Following the same process, you’ll see that at age 41, you would need to have $500k and at age 29 $250k. If this is confusing, watch my latest video for a live tutorial.
Example
3 Key Variables That Will Affect Your Retirement
It’s important to anticipate and prepare for life to happen as you get older. With that said, there are 3 factors to consider when you’re planning for your future.
- Inflation – the cost of living will double 1.5x before you retire. Which means that the cost of goods and services will be more than double in retirement. This is why I used $100k for income in my example. If you don’t account for it, you’re almost certain to run out of money in retirement or you’ll be required to live off of less.
- Taxes – a very dangerous myth is that taxes will be less for a retiree. That is not always the case and since most retirement plans are contributed with pre-tax dollars, you’re simply prolonging the inevitable. You’re also forgetting that many of your tax deductions are no longer applicable which translates to a higher adjusted gross income…..not less like most assume.
- Losses (Health changes and Stock Market) – We all know that your health could wipe out your wealth. Preparing for long term care needs when you’re young is a wise preventive measure to combat bankruptcy in retirement. Additionally, protecting your wealth from stock market losses as you approach your working end date is extremely important. It’s what many baby boomers neglected to do a decade ago which has them living in tough financial times now.
Knowing your number is a vital piece of information toward reaching your destination. It’s like having a GPS or map (for the old school folks) to your financial destination. It’s almost impossible to arrive successfully without it.
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