Financial Independence, Retire Early (FIRE) is a movement that aims to help individuals achieve financial freedom and retire at a younger age. One of the important steps in pursuing FIRE is determining your FIRE number. Your FIRE number represents the amount of money you need to accumulate to sustain your desired lifestyle without having to work anymore. Here’s how you can calculate your FIRE number.
1. Determine Your Annual Expenses
To calculate your FIRE number, you first need to determine your annual expenses. Take some time to track your spending and create a comprehensive budget. Include all your essential expenses such as housing, transportation, food, insurance, and healthcare. Also, consider discretionary expenses like entertainment, travel, and hobbies. Add up all these expenses to get your total annual expenses.
2. Calculate Your Safe Withdrawal Rate
The safe withdrawal rate (SWR) is the percentage of your investment portfolio that you can withdraw each year while still maintaining the principal. It is a crucial factor in determining your FIRE number. The generally accepted SWR is around 4%.
To calculate your safe withdrawal rate, divide your total annual expenses by your SWR. For example, if your annual expenses are $40,000, your FIRE number would be $40,000 / 0.04 = $1,000,000.
3. Adjust for Inflation
When calculating your FIRE number, it’s important to consider inflation. Over time, the cost of living increases, and you’ll need more money to sustain your desired lifestyle. To adjust for inflation, multiply your annual expenses by the expected inflation rate and add the result to your total annual expenses.
For instance, if your annual expenses are $40,000 and the expected inflation rate is 2%, your adjusted annual expenses would be $40,000 + ($40,000 * 0.02) = $40,800. Recalculate your FIRE number using this adjusted annual expenses figure.
4. Factor in Other Income Streams
Consider any potential income streams that you’ll have during retirement apart from your investment portfolio. This can include rental income, pension payments, or part-time work. Subtract these income streams from your total annual expenses to determine the actual amount you need to achieve FIRE.
5. Time to Reach Your FIRE Number
The time it takes to reach your FIRE number depends on several factors, including your current savings, annual income, and how much you can save each year. Use a FIRE calculator to estimate the number of years it will take to accumulate your desired amount based on your saving rate, investment returns, and other variables.
Conclusion
In conclusion, calculating your FIRE number is an essential step in planning for financial independence and early retirement. By determining your annual expenses, safe withdrawal rate, factoring in inflation, considering other income streams, and estimating the time needed to reach your goal, you can devise a personalized plan to achieve FIRE. Remember, the key is to save diligently, invest wisely, and stay committed to your financial goals.
Disclaimer: I am not a financial advisor and this should not be used as financial advice