Achieving F.I.R.E. (Financial Independence Retire Early) is a new-ish movement, relatively speaking. The acronym, though talking about retiring early, actually focuses more on the purpose of putting someone into a financial position where they no longer have to trade their time for a paycheck. This does not mean that people who reach F.I.R.E no longer work, it simply means that once you reach your financial independence, you can choose how you want to the spend your time for the rest of your life. You could choose to keep working the same job, or you could go work at a non-profit, or start a new career. You could also fully retire, travel the world, home school your kids, or (my favorite) you could choose to work part-time at something that you love and spend the rest of the time doing other things you love (with who you love). In this post, we are talking about the traditional calculation of your “F.I.R.E Number”, which is the amount of investment assets you would need to become fully financially independent, based on safe, historical returns and you chosen withdrawal rates. In other posts, we will jump into what is called your “Barista F.I.R.E Number”, which is the amount of invested assets you need to only have to work part-time for the rest of your working years, before full retirement. This “Barista” retirement direction is much faster and easier to reach because you need far less investments saved up. And I’m sure many people would still find a way to be alright with no longer working their 40 to 50 hours a week and cut that down to 25 or 32 hours a week for their remaining working years (and spend the rest of their time living life).

For now, we are going back to the full “F.I.R.E Number” conversation. This conversation starts with calculating a realistic financial goal (referred to as your F.I.R.E. Number). This post provides a step-by-step guide to understanding this target, based on your annual expenses and projected withdrawal rates. With your F.I.R.E. number in hand, you will better understand how much you need to save, invest, and manage to be totally financially free.

For the answers to calculating your F.I.R.E Number, we need to switch over the conversation to what is called the “Trinity Study” which was included in the February 1998 issue of the Journal of the American Association of Individual Investors. The Trinity Study, and subsequent studies by many others, concluded their findings in a way that we can chart out the likelihood of someone running out of money during their retirement years, while factoring in risks such as depressions, recessions, market crashes, and so on. What they did in the study was simulate different types of portfolio designs (so, for example, having all stocks as investments compared to having 50% stocks and 50% bonds), and added in different ranges of withdrawal rates and taking the money out for income over different periods of time.

With their findings, we can take a more detailed understanding of the different levels of risk. Here is a chart below breaking down the information. In this study, what was found was that for the majority of Americans retiring at age 65, and needing 30 years of income, they could safely withdraw 4% of their investment balances for income each year. If they did so, they would have anywhere from a 94% to 100% likelihood that they would not run out of money during that 30 year period, even with market crashes, depressions, wars, etc. taking place during their retirement (30 years). This, in the general F.I.R.E conversations, is what is known as the “Safe Withdrawal Rate”, meaning people who withdraw 4% a year are almost guaranteed to not run out of money over a 30 year period (hence the “Safe”).

For a quick and super basic example, if you had a million dollar portfolio, withdrawing 4% of that portfolio would be $40,000. The balance would then drop to $960,000, but if that portfolio had a return that year of 5% for example, the balance would increase back up to $1,008,000. Each year will have different returns for your investments, but ultimately, withdrawing 4% of the balance will leave your account with funds remaining, even taking into account many years where the market drops significantly.

On the chart, I highlighted the 4% withdrawal rate over 30 years and also a 5% withdrawal rate over 30 years for you to see differences. The reason I highlighted the 5% withdrawal rate, as well, is that someone can choose to take a riskier approach with the amount they withdraw in order to get more income and save up less money. That is up to each individual, but you can see from the charts below, your likelihood of running out of money increases quite a bit by bumping up that withdrawal percentage.

As shown in the chart, the studies found that if you had a 50/50 stock and bond portfolio, and you withdrew 4% of the portfolio every year, you would have a 100% chance of not running out of money over a 30 year period of time. Pretty cool, aye? If you instead switched it to a 75/25 portfolio (which allows for more potential for higher returns) your likelihood of running out of money over that 30 year period of time drops to 98% due to the little higher risk.

But, if you look at the longer periods of time or the higher withdrawal percentages, you can see that the 50/50 portfolio eventually has a higher likelihood of running out of money, because of the likelihood of lower overall returns. You, therefore, need to decide what direction fits you best for you specific circumstances. If you will be withdrawing money for longer than 30 years, as an example, you likely should focus on having your portfolio have a little higher percentage of stocks to increase the opportunity for higher returning years.

Even a 70% chance of success is still pretty high, technically speaking. So you could feel moderately comfortable taking out higher percentages, or the 4% over longer periods of time. But that will be a comfort call by each person.

Ok, so moving the conversation back to your “F.I.R.E. Number”, or the number you would need in assets to comfortably be financially independent. What the F.I.R.E community traditionally agrees upon for their withdrawal rate number is the 4% “Safe Withdrawal Rate”. We will duplicate that here to coincide with traditional conversations. If we look at the 4% Safe Withdrawal Rate, you could (if you were nerdy like many in the community) notice that $1,000,000, divided by the $40,000 taken out in that example of 4% withdrawal, would equal 25. Or, said in another way, it would take 25 times the amount you withdraw from your portfolio, using the 4% Safe Withdrawal Rate, to reach the assets you would need to equal the income you need based on what the 4% withdrawal rate provides.

Why is this important? Well, that means that in order for you to be financially independent (while using the 4% Safe Withdrawal Rate), you need to cover 25 times what your annual expenses are. So, if you have annual expenses of $50,000 a year that you need to covered, you need to have (take $50,000 times 25) $1,250,000 in investment assets to be financially free and to do as you want (prior to age 65 range). This is your F.I.R.E number, in that scenario ($1,250,000). If your expenses that you need to cover were $40,000 a year, your F.I.R.E number would be $1,000,000. These examples, of course, do not include you receiving social security income or other guaranteed income. So, if you were going to wait until 62, 65, 67, or 70 to take social security and officially retire, some of your expenses will already be covered by social security, and your remaining expenses would allow you to save up much less in your investment accounts. For instance, if you needed $50,000 of expenses covered, but social security already covered $24,000, then your F.I.R.E number would be $650,000 (50k minus 24k, multiplied by 25). Though, in that scenario, you are not achieving a F.I.R.E number, in a literal sense, because you are not “Retire Early”. You are retiring at traditional retirement ages. So, your true “F.I.R.E Number” would be the number you would use if your goal was to retire before the 62+ ages in your life.

Hopefully this makes sense. You simply multiply your yearly expenses by 25 to find your full “F.I.R.E Number”.

There are many options to take into account with this information. If you do choose to “Barista F.I.R.E”, which means getting yourself to a point where you only need to work part-time because your investments are covering your remaining expenses, your number that you need to save up to is significantly less (see Barista F.I.R.E Number post). Or, if you are comfortable with taking a higher withdrawal rate (and you understand the risks) you can safe up a smaller amount as well. For instance, if you used a 4.5% withdrawal rate, you would multiply your expenses by 22.22 times. If you used a 5% withdrawal rate, you would multiply your expenses by 20 times. And so on.

You can also understand the importance of cutting down your yearly expenses. If you can focus heavily on dropping those expenses, you again can save up far less money. To understand how cutting expenses is so powerful, see the below post.

Regardless of your plan, the main thing is to understand the math and strive for the goal you want. You can make it to financial independence, just like millions have before you. Figure out your number and figure out how to optimize your finances (feel free to use other posts available to you on the Midwest Money mentor site) to get their as quickly as you can. I can pretty well promise that you won’t be bummed out when you reach your goal and can create a new life for yourself.