In a recent visit from a friend of mine, over the course of a few late nights and few more beers, we got to chatting about what I called "The Number".
The Number is a notional amount of money sufficient to retire on and when I say retire I actually mean stop working full time for someone else...stop being the wage-slave if you like.
My friend said to me - 'But how do I know what my number is?' Oh but that's easy I said, just work out your net assets and take 4% of it - if the 4% figure covers your current living expenses then you have done it!
I kind of picked the 4% figure intuitively based on the way I tend to spend my days looking at property and other types of long-term investing but I did not have a lot of science or reference points behind it, apart from it being similar to an annuity rate and the Government’s permitted pension income drawdown percentage that is.
I even started my own mini-calculator to answer the question, then, this article from Mr Money Moustache came to me and so did another from Moneystepper and so I feel better able to share the concept that has occupied my thoughts long after my friend returned home and the hangover subsided.
I intend to elaborate further on this concept and relate it back more directly to property investment but in the meantime, here is the concept in outline to work out The Number:
(A) - First, do an assets and liabilities statement to work out your current ‘net worth’ (or net assets). Make sure you only include saleable or income producing assets (like savings, investments, property and your current pension pot value but not the TV, designer clothes or music collection realistically) and liabilities (like loans, credit cards, mortgages, etc.). If the result is negative then focus on paying down debt first I suggest.
(B) – Next, calculate how much money you think you can save between now and retirement
(C) - Next, work out what your state pension will be at retirement.
(D) - Next, work out your annual expenses. There is a difference between housing costs if you are paying off a mortgage at some time in the future. To keep it simple, make an assumption about this but essentially add up all of your annual expenses at today’s prices (like rent/mortgage, food/groceries, utilities and other bills, clothing, holidays, entertainment and everything else you can think of for that matter…birthdays, Christmas, haircuts…you get the picture)
The calculation of whether your Number will be big enough at normal retirement is:
IF ((A + B) * 4%) + C >= D THEN you have enough money to retire on already or ELSE you still need to invest/save more or plan to live on less in retirement
The calculation of whether your Number will be big enough to stop being a wage slave is a little more complex and involves another step – having enough money to live on between the early retirement date and the normal retirement date. Varied as follows, changing B to be how much you can save between now and the new early retirement date:
IF ((A + B) * 4% >= D AND if the original calculation as shown above for normal retirement is also true THEN you have enough money to early retire on already or ELSE you still need to invest/save more or plan to live on less in (early) retirement.
That is it – the simplest way of trying to work out if The Number is big enough to retire on or not as far as I know at least.
However, a word of caution here…OK so, it is far too simplistic of course it is. Firstly, it ignores investment performance and inflation pretty much. Plus, if you are lucky enough to live to say 130, or we have super-inflation, or interest rates rise / fall wildly, or average historical returns turn into those of Japan over the last 15 years rather than of the US & UK over the last 150, and, and, and…it just won’t work…hence why I suggest you should do two things:
1 – Do not rely on this calculation or indeed my advice in anyway but use it only as a rough guide
2 – Do aim higher, instead shoot for the sun and should you miss, you will still be among the stars as they say
Later, I shall elaborate but in the meantime:
What is Your Number then?
[…] on those 13 properties may not be precise enough. One suggestion is to calculate what I call ‘The Number’, which put simply would be 25 x your annual lifestyle costs for a comfortable passive income […]