Does 25 times annual spending estimate work?

M. asks: Did you use 25 times your annual spending to estimate your "magic number" for retirement savings?

She is referring to the post about my "magic number" challenge, which is $3,000,000.

When I was estimating my number, I did not use the popular among FIRE community members 25 times annual spending calculation. it seemed to be an underestimation to me. 

I went another way and calculated my annual expenses, added comfort margin and ran it trough inflation calculator.

I also made some optimistic assumptions about the life expectancy (at least 102 years, see why in the Challenge 102 post).
And I made some pessimistic assumptions about the investment growth which included absence of social security income and low returns).

I also didn't assume that I will retire early, and my estimated retirement age was 65.

 
Per official government actuary table I as a female of 44 years of age have life expectancy of 38.65 years more to live and my estimated expiration date provided by the government is in 2056 at age of 82.65.

If I just take 25x my annual expenses, first thing that bothers me is that 25 is less than estimated 38.65 and the second is that the expenses in this calculation don't appear to be adjusted for inflation.

I will make some example calculation with the following data:
Female 44 years old, official life expectancy 38.65 years (age 82,65 years)
Retirement savings: 25 x annual spending = $1,250,000
Retirement date - now at 44 years of age (FIRE)
Yearly returns - 7%
Estimated annual inflation - 3%
Calculations done on www.mycalculators.com, you can use your variables for your own calculation.

You can see that at 7% annual growth rate on the investments the yearly withdrawal is around $62,000 per year. For the first few years that will work.
 
It looks like in this calculation the annual inflation rate is only applied to the growth. The withdrawal amount is the same each year and is not adjusted to inflation (you can see it on the withdrawal schedule which is provided by the www.mycalculators.com.  

But how much are the $62,000 in today's dollars are worth in 38 years?

I calculated it on www.smartasset.com. The $62,000 will be equivalent of approximately $190,637 in 2018 dollars.
It doesn't look like it will be enough.

That supported my suspicions that FIRE is not for me.

Next, I used the Retirement Income Calculator from www.bankrate.com
It gave me the monthly income at age 45 (the same for the next 38 years).

 

 

 



I decided to check the only 3% yearly return which is what you can reach with government bonds. The monthly income decreased appropriately.

 

 

 

 

 

With the inflation, the necessary withdrawal amount will have to increase. The monthly withdrawal amount income should change with estimated inflation of 3% from $4,217 to $12,966 in 2056.

 

 

 

 

 

 

The inflation increases the amounts substantially. That was my main reason not to use the 25x yearly expenses estimate. The number $1,250,000 seems to be too low.

 

My estimates gave me the number of $3,000,000 as a comfortable minimum.  

If I don't retire early and keep working as planned until 65, this number should be reachable for me.

 

If I figure out how to stay alive until 102, this amount should be enough.

 

For calculation, that will be 37 additional years from age of 65 to 102.

According to the inflation calculator the $50,000 of yearly expenses will be approximately $93,000 in 2039 (retirement year).

At that time I will be able to withdraw about $152,000 (according to the calculator below) every rear for 37 years until age of 102 (year 2076).

 

 

 

The inflation calculator from www.smartasset.com doesn't go until year 2076, it only goes until 2068 and the value adjusted for 3% inflation for that year is $219,000. If I use less in the beginning and more later, it seems to be enough.

 

I am finding it very funny to plan until 102 years of age. That is probably a serious overestimate. I am really curious about how it will turn out.  

How to manage lifestyle inflation?

Lifestyle inflation - is it a problem of control?


Since I started working as an attending my expenses increased compared to the expenses during my residency.


Things that have changed since the new job:


1. I drive a more expensive car. The reason to buy a more expensive one was: I need a reliable car because I am expected to be at work as scheduled. Calling in because of a broken unreliable car is not professional. This expense makes sense and is justified. My old car was not reliable at all and when I traded it in for the new one a light smoke was coming out from under the hood. They still took it.


2. I buy more business/official looking cloths and shoes. This is also justified. I don't wear scrubs or a white coat and as a laboratory director I have to look accordingly to project competency and authority to both sides, personnel and administration. Old or non-professional looking cloths won't cut it.


3. I go on more expensive vacations. That is just for fun and I know that I am not overspending. I decided that spending $10,000 per year on vacation is fine.


Things that didn't change:


1. We still live in the same house we bought during residency. At the time of the house buying I read that most people buy a smaller "starter" house first and later move to a larger one. We decided not to do that and bought a right sized house from the start. 


2. We go out to eat about as frequent as during residency. The expenses didn't change much but the feeling has changed. Now I don't look at the prizes when I order. So the costs may have gone up a bit, but not significantly.


3. Nothing else changed really. Mostly we spend money on the same things as before, just the feeling is different, it just goes with ease and without any guilt feelings.


Some would say that I have a good self-control or will power. I would disagree. My will power is weak. But I have a trick.

I have worked out a decision process to use when spending money on something and that process became a habit.

Once you make a habit out of something, the will power is not necessary anymore.


How does this process work?


1. I have my major savings goal in mind and I update the status on how close I am to my goal once a month.

My major goal is to reach my savings magic number.  I update the balance monthly and I know where I stand. I know how fast or slow my progress is. I also know approximately how long I still need until I reach my goal. That gives me an idea on how strict I have to be with spending money.

2. I ask myself only one question before spending money on something.


Questions NOT to ask:

Do I need it? - is a wrong question. Your brain will always fool you into the need. The function of your brain is to keep you safe and to prepare you for any possible adverse situation.

Do I like it? - is also a wrong question to ask. I noticed that I like a lot of things.

Do I want to have it? - the same, most of the times you would want to have it.

The question to ask is this: 
How sad will it make me if I will die before doing that?


Here how the connection between savings goal and this one question plays its role: 
I know that I am not there yet and I still need a few years to complete the savings goal. I know that the job safety is not guaranteed and the way to the goal might get longer. But I also know that I will not live forever, that at some point I will die. That might happen before I reach my savings goal. 
All this information is balanced in the background. It is processed partially subconsciously and at the end I have my simple answer.  

The degree of sadness will tell you everything: if you should do it immediately or if you should wait and if wait then for how long.


I always dreamed about a romantic morning at the Ritz hotel somewhere in Europe with strawberries and Champagne for breakfast. 
After asking myself, how sad will it make me to know that I will die before I will get a chance to have my Champagne with strawberries for breakfast at a fancy hotel, the answer came immediately.
It would make me very sad. I didn't even want to wait for the hotel. Next day I went and bought fresh strawberries and Moscato vine (which I like more than Champagne).  I had my special breakfast every Saturday and Sunday for 2 months in a row.

Sometimes I think of going on vacation to Ireland. I spent 6 moth in Ireland and I like this country very much. When I ask myself how sad it would make me if I die before I go to Ireland, it makes me just a little bit sad, like 10 out of 100. So it is not an urgent item and I don't spend much time thinking about it at this time.

Another example:
My friend went to China. When I ask myself how sad will it  make me if I don't get to go to China before I die, the answer is surpizing: it will make me said if I do go there before I die. I don't know why. With a feeling like that I don't plan to go there.


Using this method makes the question about the lifestyle inflation mute and replaces it with a true personal value of things tailored exclusively for you.
But you have to be honest and only listen to you own feelings. It might not work for those who try to keep up with the Joneses. They have to work on their self worth and psychological self-sufficiency first.

                                             

Update on how much do I need to stop worrying

While I was working on organizing my non-probatable assets, I read few personal finance blogs.

All say about the same:
Trinity study is obviously the best or the most popular study to determine your withdrawal rate to make sure the money will last trough the retirement time. And that is 4% withdrawal rate on $3,000,000 saved.

Some people, especially in the comments section, were concerned about market downturns which no one can ever predict.

That made me think about the market downturns.
I went to the stock charts and checked how deep did the market go while recent market "crushes".

The drawdown was about 50% for indexes. It was more variable for stocks. 

Here are some of my thoughts on how to combat that:

Option 1: The downturns are temporary. I can sit them out.
Especially if I accumulated for many years and the average price will not be the top price. The 50% decrease will be  from the top price (and not from the average price) and that will not be as critical after years of accumulating. 
   
Option 2: I can increase my magic number from $3,000,000 to $5-6,000,000. That number appears to be difficult to reach, because I don't know if I even reach the $3,000,000. And I will have to call it the "super-magic number".

But if the downturn is about 50% only from the top price and it might be only about 30% from the average, I might need only approximately 30% increase in the magic number and that will be approximately $4,000,000. This is still very far out but looks more doable.

Option 3: I could create an additional source of income. Dividends would be one option. Dividends, in most cases, are paid during marked downturns and can help to bridge that time. I can't think of any other realistic options working full time.

Challenge "Magic number"

There are many nice blogs by physicians who set as their goal to retire early from their medical carriers.  

I do have a family history of "early" retirements: my mother retired with 55 and father with 60. When they retired they found some new things to do for themselves. My father started a new business and my mother got a lot of chickens, turkeys and geese to keep herself busy. 
I don't have any particular plans yet. 


I am not in a hurry to retire and to retire early is not my goal. I like my work. After I moved to the place where I live now from a very very cold place, the weather here makes me feel like I am on vacation almost every day. When I go on vacation, it is like I am taking vacation from my vacation. 


My main motivation to reach that magic number of $3,000,000 is just to finally feel safe, because I grew up very poor and that "post-traumatic stress syndrome" of growing up very poor still doesn't let me go.  


In savings, like in other things I like to underpromice and to overachieve.
Of course I will try to overachieve here in this challenge. 

I don't know when I reach the magic number of $3,000,000 or even if I ever reach it. But I every month I will make small steps toward my goal.











    

Rules of 72, 114 and 144

Conservative estimates of 1% per year for returns of my investments are really very conservative. I am sure they are not realistic, in a good way.

After maxing out all tax advantaged options I will have to start taxed investment accounts.


It is interesting to make some estimates for different rates of return, which are more realistic than 1%.

I found some "rules"  for quick estimates of approximate calculations.

Rule of 72

1) Estimate of time to double your money based on growth rate.
Example:
Expected growth rate: 10% per year
Time to double your money: 72/10=7.2 years.

2) Estimate of needed growth rate for purpose of doubling your money
Example:
Targeted time for doubling money: 5 years
Needed yearly growth rate: 72/5=14.4%


Rule of 114  

1) Estimate of time to triple your money based on growth rate.
Example:
Expected growth rate: 10% per year
Time to triple your money: 114/10=11.4 years.

2) Estimate of needed growth rate for purpose of tripling your money
Example:
Targeted time for tripling money: 5 years
Needed yearly growth rate: 114/5=22.8%


Rule of 144  

1) Estimate of time to quadruple your money based on growth rate.
Example:
Expected growth rate: 10% per year
Time to quadruple your money: 144/10=14.4 years.

2) Estimate of needed growth rate for purpose of quadrupling your money.
Example:
Targeted time for quadrupling money: 5 years
Needed yearly growth rate: 144/5=28.8%


Using those rules I see that with my very conservative estimates of 1% growth I will not go far.

My own conservative example:
Growth rate 1%
Time to double the money: 72/1=72 years, very long time.
If I can get at least 5% yearly growth in my "challenge" account that will double the money in 14.4 years. 





 

How long is the list of tax advantaged retirement savings options?

The tax advantaged options are very few: 401k (and similar plans like 403(b), 457 and SEP), IRAs and HSA.

HSA is a special case: it is a health savings account but after age of 65 it can be used as an IRA.
401k and IRAs have 2 varieties: Roth and Traditional which means the contributions are post-tax or pre-tax. 

Here is this short list including contribution limits:

1. 401k (or Roth 401k) How to decide between regular 401k and Roth 401k 
    2018 limits: $18,500, catch up with 50 - additional $6,000


2. IRA (Traditional or Roth) How to use backdoor Roth IRA
    2018 limits: $5,500, at 50 - additional $1,000
      

3. HSA Why is it on this list
    2018 limits: 
    Individual $3,450, family: $6,900, 
    at age 55 - additional $1,000 (per person of age 55)


I am not counting the 529 college savings plan. Even if this account is in your name and theoretically it can be used as savings back up but the penalties are very high.



In the tables below are the maximum yearly contributions based on 2017 contribution limits. 
The first table is for a family with two working adults showing two 401k and IRA accounts and a family HSA.

You can see the added "catch-up" contributions at age 50 (401k and IRA) and at age 55 (HSA). 

The second table shows yearly contributions for a single person showing one 401k, IRA and single HSA.

The list is short and the contribution amounts are small. 
A high income professional will use up those options fairly soon. 
The rest of the savings will have to go into a taxable account. 

How much money do I need to stop worrying?

I remember days when my family didn't have enough money for buying bread. I was about 7 years old and I was scared. 

In school I had to smear the black shoe polish on my shoes every day, because they were so worn out, they were gray. The soles were glued back several times.

I was not allowed to touch eggs in the fridge if we had any. I liked to go to my friend for whom eating scrambled eggs every day was normal. She was nice to share with me sometimes. 

The winters were cold and I remember how I was dreading getting out from under the blanket in the morning because the house was so cold. 


Now I have my own house. It is never cold in my house. I eat eggs everyday, unless I am traveling. 

I promised myself that I will do everything I can to never be cold again. I keep my house at 72 F degrees in the winter even if my friends try to persuade me that I could save money by heating less and that it is healthier to sleep in a colder room. 


By now I have earned more money then both my parents in their entire lives combined. But I still feel unsafe. When will that feeling stop?

Financial uncertainty

Everyone is different. And the safety threshold to feel financially safe is different for everyone, dependent on their previous experiences.

When I researched about financial safety, I found a (quite esoteric) exercise which should produce your minimum number at which you will feel good/safe/comfortable. I tried it. 

Here how it goes:
You should say the dollar amount starting from small moving up and watch how you feel. At certain amount you will feel comfort. If you are under or over your comfort amount, that will make you feel uncomfortable, feeling "not enough" or "too much". 
My comfort amount was 2 million dollars. Per month! 


Obviously that exercise was useless, but it made me to find a more realistic method. I ended up with something what is generally recommended: calculating and estimating expenses versus savings.



What can I estimate? 


It is useful to make some estimates and projections. Nothing is certain so all the estimates and projections are very approximate.

As life goes on, there are 3 main development scenarios:

1. Something non-catastrophic happens, like loss of job.
2. Something catastrophic happens, like disability or death. 
3. Nothing will change. 


A windfall also can happen but it is not one of the main scenarios. It is rare, I don't expect it but I will handle it well. 


There are some things one can prepare in advance for the three main scenarios.  


1. A non-catastrophic event. 
It is good to be prepared for a non-catastrophic event like a job loss. 
The emergency fund is the best preparation here. The fund should cover expenses until you can find another job. 

The amount in the emergency fund will depend on the ease finding another job in your field and the estimated fixed expenses. 
For example, if you are a highly qualified specialist, such jobs are rare, and your fixed expenses are high, the emergency fund should be of appropriate size. 
Check. I've got that. 


2. A catastrophic event.
Life does not give any guarantees. For something catastrophic like disability, loss of partner or your own death some preparations could be done. 

Your own death will be the easiest. It will make all your worries (including financial) stop immediately. 

But if you want your family to betaken care of, a term life insurance would be a good choice. A term life insurance is cheaper because it will have no value at expiration. 
The point here is the replacement of lost income in case of death of income provider. 
Especially in families with young children it can be very important to have this kind of insurance.
Check. I've got that. 

A disability insurance should cover the case of disability. They are more expensive than term life insurances and are supposed to replace lost income. They don't cover disability related medical costs.
Check. I've got that. 

  
3. No events. 
Nothing will change. Expenses and savings will stay the same.
The usually recommended estimates of expenses versus savings will cover that.
No check. I have never estimated anything like that. I will work at that right now. 


To make those estimates for expenses versus savings I need 2 variables: years left to live and money amount to live on. 

Life uncertainty

Certainly there is an uncertainty about how long I will live but it doesn't bother me much if I die before my money runs out. If (when) I die, my financial worries will stop automatically. 
But to make the projections I need approximate expected length of life.

The Social Security Administration has actuarial life tables with estimates of the life expectancy.  They are for year 2014 and for that degree of uncertainty about life using them in 2017 will be fine. 

I am 43 now. Per table my life expectancy is 39 years. First thing I see is that I have less years left than I already lived. It is a little sad.

43+39=82. 


Maybe it is not so sad. I might have some genetic modifiers. My grandparents died at 85, 95, 56 (heavy smoker) and 68. 

Because of optimism (I would prefer to live longer) and because of pessimism (I would not like to run out of money) I will use the maximum: 95 (that means 52 years left for me). 

Actually even that might not be enough because I have a granduncle who is currently 102 years old (he was married several times, because his wifes kept dying before him). Maybe my extreme maximum should be 102 or even more.

Anyway, now with my life expectancy numbers I can start planning the financial part. 

Financial planning

Since the esoteric method gave me unrealistic results I will use information I found on most websites which calculate retirement planning related needs. 

According to most, the magic number is $3,000,000. That number makes you money never run out at 4% yearly withdrawal rate if you withdraw $100,000 per year. 

But will $100,000 be enough for me?


Calculating current fixed expenses 

I calculated fixed yearly expenses.

I didn't calculate the bare bone minimum. Bare bone minimum is too scary. I want to have enough room not to worry about my heating costs and other things that add to daily comfort. 
This is not a frugal estimate, this is a comfortable estimate. 

The expenses as of 2017 are about $55,000. 




 Estimating fixed expenses in retirement

After retirement some expense items will disappear, for example term life insurances and disability insurance. 

I estimated that the expenses are a little lower, about $42,500.
But they are not inflation adjusted yet.  

Now I will add 3% of inflation to every item, using inflation calculator (I used one on www.calculator.net).

At age 65 with yearly 3% inflation the $42,500  will become $81,270. 

Due to continuing inflation the number will continue to change. By my age of 85 (in 42 years) it will be $146,790. 
Of course those are only the estimates, inflation may be lower or higher... 

Calculating necessary amount of savings

As mentioned before, the magic number for the amount of necessary retirement savings should be $3,000,000. 

That number should make you money never run out at 4% yearly withdrawal rate if you withdraw $100,000 per year. 


But it looks like I might need $146,790 at age 85 (if I live that long). 


To better see what happens, I made two tables, using various calculators on www.bankrate.com.
The first table includes estimated Social Security benefits. 

The maximum Social Security benefit for 2017 is $2,687 ($32,244 yearly). 
Because Social Security is under stress and the benefits might not keep up with inflation, I will use only 1% inflation for the adjustments of Social Security benefits.

The second table doesn't have Social Security benefits.

For the savings growth rate I will use very low 1% growth rate. Markets will go up and down. Historical results don't predict the future. We all know that.

I am probably underestimating growth and overestimating spending, but I am not calculating the best case scenario. In general, I like to under-promise and over-deliver and it definitely shows here. 

In the table below the projected savings at age 65 (in 22 years for me) are $3,000,000. 
Is it a realistic number? That is a completely different question (for a different post). 

Back to the table. 
With the chosen settings of 1% returns and estimated expenses rising with 3% inflation it is clear that this $3,000,000 number will decrease with time. 

Difference to cover is the amount to be covered from savings after the Social Security benefits. 

The last line in the table is the age when the money will run out.

Looks like this estimate makes the money to run out at my age of 108. 

The second table is without Social Security benefits. 
Here the money runs out at my age of 95.  

Of course all numbers are very approximate. 

Taxes and not calculated. 

The taxes are estimated lower in retirement because they are mostly based on earned income. Other presumed factors also may be different.

But now I have something to work with and when I will approach my retirement age, it will be easy to recalculate and see where I stand. 
I probably will recalculate it more than once.

Summary

It looks like a $3,000,000 nest egg will be enough if getting Social Security benefits. 

I need at least $3,000,000  with or without Social Security.

Without Social Security benefits the money will run out at my age of 95. 

I really don't want to feel the pressure to die at age of 95.

What I need is to get busy with how to make sure the returns above 1% so I don't have the pressure to die at 95 or at 108. I want to beat my granduncle.  



10/12/2017:
I just posted an update with additional information and some recalculations.