Do you want to know how much money you need for (early) retirement? The rule of 25 is going to help you exactly how much you need to retire comfortably.
When you are striving for financial independence and/or retire early, it is important to know how much money you need to retire.
There are many things to consider when you’re planning for retirement. To make things easier let’s look at one widely used rule of thumb: the rule of 25. Here’s what the rule of 25 is, how it works, and how you know how much you need to retire.
What Is FIRE?
FIRE stands for Financially Independence and/or retire early. Many people strive for financial independence and some of them want to enjoy retirement early. Getting out ahead financially is mostly done by making extra money and living below your means.
Most people who want to reach financial independence do so by building passive income, saving money, and investing in the stock market.
While there are many reasons why people want to retire early, the most prominent reason for many is freedom. Do what they want to do, when they want to. For example, here’s what I plan to do when I am financially independent.
What Is The Rule Of 25?
The rule of 25 is a way to calculate how much money you need for (early) retirement. That amount is 25 times your expected expenses in retirement.
The multiply by 25 rule is a great way to know exactly how much money you need for early retirement or financial independence.
When you want to calculate your financial independence number, it is important that you know approximately how much you want to spend in retirement. You won’t know exactly, but having a rough estimation will help when you’re working toward building that liquid net worth.
[Related read: what’s the average net worth in the Netherlands?]
How Does The Rule Of 25 Work?
Let’s put the rule of 25 in practice. If you want to spend $3,000 per month in retirement, that is $36,000 per year. $36,000 multiplied by 25 is $900,000. That means you would need $900,000 to retire comfortably and spend $3,000 a month.
This number does not take into account any other sources of income, like rental properties, side hustles, or social security.
While $900,000 is a lot of money, it’s often less than people expect. When I started my own financial independence journey, I expected to need millions to comfortably retire. Given the fact that I can live on minimal expenses per month, I personally aim for $300,000.
The less money you can live on per month, the earlier you will be able to retire. Here are some tips to save money:
- How I live on half my income – and you can too
- 25+ money saving tips to try today
- Frugal living tips to make frugal life enjoyable and fun
- Find frugal and minimalist hobbies that you enjoy
How do we know you can safely withdraw $3,000 per month from a $900,000 portfolio and not run out of money? That’s thanks to the 4% safe withdrawal rate!
Linking The Rule Of 25 to The 4% Rule
Another rule of thumb in personal finance is the 4% rule. The 4% rule states that if you withdrawal 4% of your portfolio annually, you can live on that portfolio for an indefinite amount of time. The probability of your portfolio running out of money is there, but it’s low. Over 98% of portfolios haven’t run out of money after 30 years.
The rule of 25 determines how much money you need to save in order to retire. The 4% rule determines how much money you can take from your portfolio annually, to prevent running out of money.
To actually prevent yourself from running out of money in retirement, it’s important that your money is invested. The average annual stock market return is 7%, which is corrected for inflation. If you withdraw 4% annually, there is enough money left in your portfolio to live off of for a long time.
Does The Rule Of 25 Work?
While the rule of 25 is a great rule of thumb to aim at, it is not the end all be all. It mostly gives you a starting retirement number to work toward
There are dozens of things that can change between the time you decide to retire and the time you start to plan for it. A couple of important things to ask yourself are:
- Where do I plan to live?
- What do I plan to do?
- What are my healthcare costs?
- Do I plan to have kids or pets?
Add all these plans up and you will end up with a very rough estimation of what you will spend in retirement. Multiply that number by 25, and you get the amount that you need to retire.
Improve your Chance Of Successful Retirement
When you’re working toward 25x times your yearly expenses, be aware of the fact that you have two options:
- You never want to work again. In that case, it may be best to add a little safety margin to your financial freedom number.
- You are flexible. If you are flexible, saving 25x your annual expenses is great. You don’t work as long, but you know there’s an opportunity that you need to pick up some gigs at times. Here are some tips if you need money now.
Whether you’re flexible in retirement or you never want to work again, there are some things you can do to improve your chance of a successful retirement:
- Pay attention to the first 10 years. The early years of retirement are important, if things aren’t going well early on it has an impact on the rest of your retirement. When you notice things aren’t going as planned, you can decide what decision fits you best at this moment.
- Extra income. If you get just a little bit of active income from work, this goes a long way in retirement. Every dollar that you get in extra income will help you down the line.
- Reduce your costs. If you notice that your retirement isn’t going as planned, you can decide to reduce your costs for a while. You can do that by cutting back on certain expenses or move to a cheaper country.
- Keep track of your finances. If your retirement plants are coming close, it is important to keep track of your finances. Know how your expenses have increased, what your buffer is, and how much you can spend per month in retirement.
We All Have To Start Somewhere
If your current situation is very far from where you want to be, know that here you are now is the perfect starting place. We all have to start somewhere. It’s important to not compare your chapter 1 with someone else’s chapter 20.
Start from where you are now and start working on building that investment account. You can do so by start investing, I recommend you check out:
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|Investing Your Change||Learn More|
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|Investing With Advisor||Learn More|
Conclusion – The Rule Of 25
Do you want to know how much money you need in retirement? Check out the rule of 25. You will learn exactly how much you need to have to live comfortably when you’re older.
If you start by investing a couple of dollars a month, that’s perfectly fine. Work your way up from there and you’ll be surprised where you end up.