In this episode I give you a behind the scenes look at my FIRE number calculation and my expected early retirement age. I’m covering all the variables and assumptions that you need to calculate your own path to FIRE. Early retirement isn’t just for the super rich. If I can plan for it, you can plan for it too. But it’s super important that your FIRE number calculation and early retirement age are realistic. Otherwise, you run the risk of falling short and running out of money. And what you hear on the internet about multiplying your expense by 25 or increasing your savings rate isn’t always the best advice. So, how do you do a FIRE number calculation properly?
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Hello, friends! And welcome back to Girl on FIRE, the financial independence podcast for independent women.
My name is Priya, I’m a Chartered Accountant, an analyst and the creator of Paper Money Co.
I’m also a fierce financial feminist and the host of this podcast. I believe that a woman who is in control of her money, is in control of her life.
Today, I wanted to talk a little bit about what my own FIRE calculations and planning looks like.
And I’ve talked a bit about what my personal investing strategy looks like and the types of things that I’m invested in.
But today, I want to go into the detail of how I’m planning to reach early retirement. This is going to be a quick episode, but as always it’ll be full of information.
We touched on this a little bit in episode 23 when we talked about the Trinity Study and the 4% rule. But I can’t emphasise enough how important it is that you always look for what assumptions anyone is making in any model or study.
If you’ve been listening to Girl on FIRE for a while then you know that I’m not interested in being the kind of financial expert that tells you what to do.
My goal with this show is to teach you what you need to know but also to help you figure things out for yourself.
It’s about learning how to think and make decisions for yourself instead of listening blindly to popular advice.
And one of the super important things you need to learn to do is to question the assumptions that are used in any model, in any study or calculation.
Because when you start to ask questions, you’ll uncover biases or holes in the model that you need to adjust for when applying it to your own situation.
For example, think about when you see some new beauty product at Sephora or Mecca Cosmetica. And it says that it improves the appearance of your skin by 89% in 10 days.
Number 1: look at the language a claim like that is using. It improves the appearance of your skin.
Just the appearance. It’s not claiming to heal your skin or improve the structure and functioning of your skin cells, it’s claiming to improve the way your skin looks.
And then there’s always that little asterisk next to that claim. And if you follow it, it says something like “based on a study of 300 women” or “based on a study of 300 Asian women” or “based on a study of 300 women aged 40+”.
Those are all assumptions that they made in that study. And those assumptions influenced the results that came out of that study.
And the same thing applies in any financial model. You saw me doing that in episode 23 when I looked at the assumptions the Trinity Study used to arrive at a safe withdrawal rate of 4%.
So, that’s what we’re doing here today. We’re taking a look at the assumptions that I use when planning for my wealth and retirement.
I was thinking I’d also record my screen showing you how it all looks in my FIRE calculator spreadsheet, but I’ll do that separately and send a link around.
It’s a plug and play tool, but it’s still a financial model and it can be complicated. And most importantly, I want you to know how it works.
I want you to understand how all the assumptions play off together and how the calculation actually works.
So, if you want to see that, you’ll have to be signed up to my newsletter which you can do on my website, papermoneyco.com/startinvesting.
My Investing Starter Guide will keep you company while I work on getting that video recorded and uploaded.
In this episode, however, I’m just going to talk you through it so that you can start to see the logic behind me saying I want to retire at 45.
So, keep doing whatever you’re doing, and listen in. I know that some of you Girls on FIRE like to listen to me while you’re cleaning.
That walkthrough tutorial will be in a separate video that you can watch in your own time as you work on your own FIRE calculator spreadsheet.
As always, Girl on FIRE is about learning, so whip out your favourite notebook or journal and get ready to take some notes.
If you’re not into writing things out by hand, you can always find the transcript on my website — papermoneyco.com/gof28.
Okay, let’s dive in!
FIRE Calculation Assumptions
Now, to be clear, in this episode I’m going to talk about my retirement account and my portfolio. So what’s the difference?
When I talk about my retirement account or retirement money I’m talking about my superannuation or 401(k).
It’s money that’s 100% mine but I can’t get access to it until I reach traditional retirement, except under extreme circumstances.
And my portfolio is my brokerage account. That’s my investments outside of my superannuation. I can get at that money anytime, I don’t have to wait.
Okay, the first thing we need to address here is why I need to make assumptions for my FIRE calculation.
I’ve mentioned this before, but all financial models will require you to make some assumptions about either the data you’re using or the calculation you’re building.
And that’s something I deal with every day in my career as an analyst as well. We just can’t account for every single possible scenario under the sun.
There are too many variables that we can’t control and too many unknowns.
So, we have to make assumptions about how certain things will respond or behave and what characteristics certain things have.
It’s also helpful to think of these assumptions like variables that you can change and adjust. How will the result change if I adjust my assumptions, if I change my variables?
What happens if I invest an extra $200 per month? Or what happens if inflation increases to 3%?
With the right model, you’re able to test out what happens under different scenarios and different situations.
So, let’s talk about the assumptions I have in my calculation.
Assumptions based on age
First up, I have age or date assumptions. I make assumptions of my life expectancy.
I need to make an assumption of how long I’m going to live, because I need to make sure that I don’t run out of money.
Now the assumption I make on my life expectancy is a conservative one. I’m assuming that I’ll live for as long as possible.
I don’t want to do all this planning and hard work based on the assumption that I live until 85.
And then I somehow get lucky enough to live until 90. I’ll spend those last 5 years of my life in poverty with nothing else to rely on but the government pension.
And I’ve said this a million times but I need to say it again. The government will not help you. The pension will never be enough. So, you need to look after yourself.
The other assumption I make based on age or dates is when I’m able to retire according to the government.
So, I’m talking about the traditional retirement age here. Now, in Australia, we have two retirement dates.
There’s the preservation age which is the age when you can touch your superannuation, which is like your 401(k) for my listeners in the US.
Thats the age when you can access your retirement account.
And then there’s the qualifying age which is when you’re eligible to receive the government age pension.
And those ages are based on when you’re born. So, for me, I can access my retirement funds at age 60. But I don’t qualify for the age pension until I’m 67.
That’s a difference of 7 years and it makes a big impact on your retirement fund.
During those 7 years, a lot of people start transitioning towards retirement. They might start working part time, and pulling out some of their retirement funds.
Now, if I get my way, I’ll be retired long before that. But I still can’t touch my retirement money until I’m 60.
And if I want to supplement my income from my portfolio a bit with the age pension, I have to wait until I’m 67.
So I need to factor those dates into my FIRE calculation because my non-retirement investment portfolio needs to last me from early retirement at 45 until 60 or 67.
If I start accessing my retirement funds at 60, then my non-retirement portfolio can be smaller but I need more money in my retirement fund.
But if I start accessing my retirement funds at 67, I need less in my retirement fund because the money doesn’t need to last as long.
I’m closer to the end of my life. It feels so morbid to say that, but it’s true.
And if I wait until I’m 67 to access my retirement funds, that also means my non-retirement investment portfolio needs to be larger.
And all these factors impact when I’m able to retire and how much money I’ll have when I do.
Annual expenses in retirement
Now, that brings me to my next key assumption: how much money I need to retire.
We talked about this in episode 23 when we talked about the 4% rule and whether it’s good enough.
And in that episode, I also specifically drew attention to the fact that the 4% rule doesn’t work all over the world.
It’s not as ironclad in Australia as it is in the US. Not only that, but by using the 4% rule, I’d be taking on a whole lot of assumptions that I’m just not comfortable with.
The main one being that my money will last for 30 years. If I do get to retire at 45 as planned, the means I’d be planning for my money to last me until I’m 75.
And then what do I do? I don’t want to die at 75. I’m not comfortable with taking on that assumption for my retirement planning.
So, I personally don’t use the 4% rule to determine how much I need to retire. Instead I make an assumption of how much my lifestyle will cost in retirement.
I’m considering all living expenses and fun expenses that I currently have, so that my living standard doesn’t change. But I’m also planning for international travel.
And that means my expenses in retirement are higher than they are now. My current assumption is that my annual expenses in retirement are $70,000.
And that’s for both me and my husband. I do the financial planning for myself individually and for us as a couple.
We like to say that I’m the CFO of the family and he’s the COO. I know it’s not very common for women to manage the money, especially for investing and retirement. But welcome to the 21st Century.
How much I need in retirement
So, now I’ve made assumptions about how long I’m going to live, when I can reasonably expect to retire and how much I want to spend each year in retirement.
But how do I figure out how much money I need in total to fund my retirement. What’s my FIRE number? How much do I need to be able to retire?
For that, I need to add a few more assumptions. I need to make an assumption about how much return I’ll earn from my money.
What’s the return on the market that I’m invested in? It’s super important to remember that you need to use the return of your investment.
Don’t use average long term stock market returns if you’re only invested in real estate. That doesn’t reflect your money.
I assume an 8% average annual return for my investments. Because that’s the average long term return on the Australian stock market which is where most of my money is invested.
I’m also invested in the US and international markets but I’m being conservative by only using an 8% annual return.
The long term return on the US market is about 10%. So, my long term average is probably more like 9% but I would much rather be over prepared than fall short.
So, I take a conservative approach when making assumptions about the return my investments will make.
I also need to include an assumption for inflation. It’s absolutely critical that you include inflation here. Because inflation eats into your returns and reduces the purchasing power of your money.
$50,000 of annual expenses today isn’t going to be $50,000 of expense in 30 years. You’ll need more money to buy the same amount of stuff.
Think of inflation as the economy-wide jacking up of prices over time. That’s how it turns a mountain of money into a molehill.
For my calculation, I’m going to be conservative again and I make an assumption of 2% annual inflation.
In reality the average inflation rate in Australia over the last 5 years has been somewhere between 1.3% and 1.9% per annum, but like I said earlier, I want to be conservative.
That means that after inflation, my net returns are only 6%.
The last thing I want is to be a year or two away from the finish line only to realise that I’ve still got 100 miles left to go.
It’s not the finish line, some idiot just put tape in the middle of the road. I’m not planning my future based on that.
Now, with all that information, I’m able to calculate how much money I need to retire so that my money will last me for the rest of my life.
The next set of key assumptions I need to consider is how my portfolio is going to grow.
My goal is to grow my portfolio to match my FIRE number. My “how much do I need to retire” number.
And by tracking how my portfolio will grow, I can see when I’m realistically able to retire. I might want to retire at 45 but is it possible?
When will I reach that FIRE number goal? So, what kinds of assumptions do I need to make here?
Rate of return
First, I make an assumption regarding the return I’m expecting to earn on my investments.
I assume 8% annual return for my investments, which is the same return I used for calculating how much money I need to retire.
And that’s based on the long term average rate of return on the ASX, on the Australian stock market. It also assumes that I’m reinvesting my dividends.
I’m not taking my dividends as cash, I’m reinvesting them either through a DRIP which we talked about in episode 25 or by having my dividends paid back into my brokerage account.
I also include the inflation rate that’s going to eat into that return. Again, I assume 2% for inflation, which is within what the reserve bank tries to target.
And I make sure to adjust my market returns for inflation. Because that inflation will eat into my money a little bit.
Current net worth
Then, I also have how much money is currently in my portfolio. This isn’t really an assumption, it’s just the current market value of my portfolio.
But this is only the value of my stock portfolio. I don’t include any other assets here like savings or vehicles because those assets aren’t out in the market making me money.
They’re chilling at home.
I just log into my accounts and get the amount from there. So, I’m not making any assumptions there, that’s just fact.
But I do make an assumption for how much money I’m able to keep investing every month.
And it’s super important to remember that I’m not just talking about a savings rate here. We talked about this in episode 19.
Your savings in sinking funds and emergency funds don’t count here because you’re not investing that money.
That’s why I ignore that and only look at how much I’m investing. Now, again, I try to be conservative.
I look at the lowest monthly contribution I’ve made over the last few months, and I assume that that’s what I’ll contribute each month in the future.
Of all the assumptions I make, this is the one that changes the most because I’m always trying to invest more and more each month.
When I can retire
Now, with all that information, I’m able to calculate how my portfolio will grow over time.
And based on that I can see how many years I need to keep working so that I can keep growing that portfolio.
So, all of this information, all the assumptions we’ve talked about so far, are part of my financial model and they tell me when I can retire.
And based on the information and assumptions I have now, my model is telling me that I can retire at 43.
That’s fantastic news for me. I’m aiming for 45 but I’m not saying no to 2 extra years of freedom.
Not only that, but this gives me a 2 year buffer. I’m sure that when I get to 43, the idea of retiring and relying on my portfolio to feed myself and my husband will give me all sorts of panic attacks.
So, who knows, I might wait those extra 2 years and grow my portfolio even more so that I feel more secure.
And it feels really empowering to say that I’ll be able to give myself that choice.
And the great thing about modelling my finances and my future like this is that I don’t have to wait until I’m 45 to see if this will all work out.
Yes, anything can happen along the way. But I update this spreadsheet at least once a month when I calculate my net worth.
Next month when I update it, it might all of a sudden say that I can’t retire until I’m 50.
And I’ll know now that I have to adjust my plan and my forecast. I’ll know that at 29 not at 45 when I’m hoping to retire.
I’ll have time to right the ship.
Now, there are some other assumptions that I have to make in order to build a financial model like this.
First up, I assume that my income doesn’t change. All the planning and calculating I do is based on the income I’m earning now. It’s all based on my last paycheck.
It doesn’t take into account any raises or promotions I may get in the future. And I’m okay with that, because I’m also assuming that even when I change jobs, I’m not accepting a pay cut.
I’m making the assumption that as long as I’m working, I’m always going to be earning at least what I’m earning now.
And I’m also working on the assumption that any increase in my salary will be invested. I’m not planning for lifestyle inflation.
In the last few years, my husband has also faced redundancy and he lost his job in COVID. So, because I like to be conservative, I only make assumptions on my income.
We’ve been a single income household for a long time, and I assume that that’s going to continue. All my planning is based on that.
I’d rather be safe than sorry. And, yes, I’d rather be too safe than even a little sorry. I’m not taking chances with my freedom.
I also don’t include any assumptions about taxes in my model. Because taxes are really complicated and they can change based on how your situation changes.
This is something I might try building into my model in the future, but it’s a bit complex.
Also, the mandatory superannuation contribution may be increasing. That means that a higher percentage of my salary will be paid directly into my retirement account and not my bank account.
I haven’t allowed for that in my model, though, because it may or may not happen.
Politicians have no problem playing with our money or our futures. So, who knows what that’ll look like in the future.
FIRE & investment calculator spreadsheet video
So, this was just a really quick overview of how I build assumptions into my model and what those assumptions look like.
As I said, I’m planning on doing a screen recording walking you through all these things on my FIRE & Investment calculator spreadsheet.
I’ll send you a link to that video when it’s ready but it’ll only be sent to you if you’re on my email list.
If you’ve been listening to me for a while you know that I’m a really private person. It’s easy to talk about personal things when I’m talking to my laptop and you’re listening to me a week later.
But I know that the internet can be a cruel place. I’ve been judged on everything from how much money I make to how chubby my fingers are and even the way my wedding ring fits on my finger.
And even though it terrifies me a little bit, I’m going to show you my real calculation with all my real numbers.
So, I don’t want to just make a tutorial video and leave it on YouTube for the world.
I want to keep it only for people who truly want to be in this community with me. For my Girls on FIRE who tune in to listen to this show every week.
So, you can get on the list by heading to my website — papermoneyco.com/startinvesting to download your free copy of my Investing Starter guide.
The Investing Starter Guide will keep you occupied while I get that video ready.
It walks you through the step-by-step process to get your finances ready to start investing.
It’s actually a simplified version of what I teach in Financial Mess to Money Success which is my online program that walks you through step-by-step how to build that solid financial foundation that I keep banging on about every week.
So, get on the list if you want that video. That link again is papermoneyco.com/startinvesting.
Next weeks’ episode
And that’s all I have for you Girls on FIRE today!
My challenge for you this week is to think about those assumptions we talked about today.
How might they look in your life? What kinds of assumptions would you have to make about your life and your finances when planning for retirement?
On next weeks’ episode I’m not sure what’s coming up just yet. I said I would have a guest this week, but that episode is still in the pipeline, so next week is going to be like Christmas.
It’s going to be a surprise episode.
But as always, it’s going to be worth the wait so you’re definitely not going to want to miss it.