Financial Samurai is one of the personal finance blogs that I enjoy reading the most. I like that Sam, the blogger, makes me think hard and provides valuable knowledge that helps solidify our investment strategy. I have nothing but praise for Sam’s work, but a recent particular recommendation–that I disagree with–motivated me to comment and ultimately write this post.
On the post, Achieving The Two Spouse Early Retirement Household, Financial Samurai provides great insightful advice for spouses to achieve early retirement and this is the part of the recommendation that I’m in disagreement with:
“Finally, instead of an income target, you guys can also consider a net worth target to achieve before both of you leave the workforce. My recommended net worth target is 20X gross household income.”
For full disclosure, I’m not a financial advisor, so this is based on my own experience and is for discussion purposes. Please, do not misconstrue this information as financial advice. 🙂
Financial Samurai recommends a net worth target based on household income instead of an income target. Before we get to that, let me tell you that I have a strong dislike for retirement recommendations based on actual income. The financial industry’s recommendation to “shoot to replace 70 to 80 percent of your pre-retirement income” doesn’t bode well for retirement income needs because it’s missing the most important piece of information from a future retiree:
their spending habits.
Basing retirement needs on income does nothing to anyone that is saving above the average personal savings rate, which hovers around 5.7% in the U.S.
Net worth target based on household income
I feel that Financial Samurai’s recommendation of having a net worth of 20X gross annual household income would discourage many people from retiring early. I know Sam plays more on the cautious side of personal finance, but I think it’s a number too high to shoot for, and probably unnecessary for someone that has a high savings rate. It goes back to the saying that “it’s not how much you make, it’s how much you keep”.
Net worth target based on annual spending
I love retirement recommendations based on annual spending. When I first came across the FIRE concept, it seemed simple to comprehend. To withdraw 4% from your portfolio, save 25X your annual spending, and you’re done saving for retirement. To increase the chances of your portfolio lasting a lifetime, you can save more and withdraw a smaller percentage.
4% annual withdrawal rate = safe withdrawal rate
3% annual withdrawal rate = perpetual withdrawal rate
What determines how fast you get to retirement?
The different ways to calculate retirement needs lead to various outcomes
Let’s illustrate how a couple, with a savings rate above average, can come to very different conclusions on the wealth they need to achieve to retire, depending on the calculation they use.
Scenario 1: replace 80% of income
Juan and Mary work in office jobs and have an annual household gross income of $175,000. They heard the conventional wisdom that they need to plan to replace 80% of that income in retirement. So, they’ll need to shoot for a retirement income target of $140,000 ($175,000 x 80%) based on this method.
Scenario 2: Accumulate 20X their annual household gross income
Financial Samurai would recommend that this couple shoot for a net worth target of 20X their annual household gross income which amounts to $3.5 million, before they leave the workforce. ($175,000 x 20)
They’d feel discouraged and confused on why they’ll need so much money because they only live on $55,000 a year. See the disconnect?
Scenario 3: save 25X annual spending for retirement income needed
If we use the FIRE community-preferred method of saving 25 times annual spending and plan to withdraw 4% a year from the portfolio, then they’d only need approximately $1.4 million ($55,000 of annual living expenses x 25), in income-producing assets. Even if you add in an extra sum of $500,000 to buy a house to live in, you’re still far from the $3.5 million recommendation.
If you want to retire and never have to touch your principal, then you can save some more and aim for the perpetual withdrawal rate of 3%. (Linking Financial Samurai here again, 🙂 I told you that I enjoy his stuff. ) This couple would then need approximately $1.8 million to be able to withdraw 3% annually from their portfolio. ($55,000 of annual living expenses x 33.3). Telling them to accumulate $3.5 million in net worth is like telling them to stay stuck in their jobs past 65. That’s not early retirement.
As you can see, there’s a big difference in each of the calculations! Even with a 3% withdrawal rate, they won’t need to accumulate $3.5 million to retire. A 3% withdrawal rate is bulletproof. That portfolio would last forever. I’m sure that Financial Samurai readers have high savings rates because these people love to save money and invest, moi included. You just can’t have one without the other. So they’re definitely in the Juan and Mary’s camp.