How do you determine your financial independence (FI) number?

The 4% Rule

If you’re interested in FIRE, one of the first things you’ll likely do is try to determine what your target FI number is. The short answer to this question is to follow the 4% rule. The 4% rule was created in the 90s by financial advisor William Bengen. He looked at historical market returns and determined that, if you withdraw just 4% per year, there was no historical case where this would last less than 33 years. The percentage you can safely withdraw each year is often called your safe withdrawal rate (SWR).

Following this approach, the way to get this number is to take your annual expenses (including taxes, of course) and multiply it by 25. So if you need $50,000 per year, your FI number would be $1.25 million.

Other Opinions

Within the FIRE community, you’ll see some debate around this. Some people think a 4% SWR is too high, believing that the stock market won’t do as well over the next several decades as it has historically. Other people think the 25x expenses target is too conservative, because it ignores the fact that many (if not most) early retirees will continue to earn at least some income during some of the years. It also ignores the fact that, for most people, following the 4% rule will mean ending up with more money than you started with. Sometimes you’ll see people argue that, because of your potential to both reduce spending and earn future income, you can safely “retire” when you hit a certain percentage (say 75%) of your FI number.

I don’t have a particularly strong opinion about any of this positions. Determining your FI number (much like your asset allocation) is a combination of art and science. The science part is basic math, but no one can claim to know exactly what that number should be. And the art part is your comfort with risk. If you’re comfortable with risk, and confident in your ability to either adjust your spending and / or earn more money, retiring with a higher SWR seems totally reasonable. If, on the other hand, you’re risk averse, you may be more comfortable targeting a lower rate.

If you have guaranteed income sources (like social security, CPP or OAS), you can subtract these from your expenses to lower your FI number. Personally, I don’t do this, though. Ignoring these future likely but not guaranteed sources of income is a way to build a bit of a safety net into my plan.

Another area where you’ll find some disagreement is around exactly what you’re taking 4% of. Some people, for example, include the equity in their house. Personally, I don’t do this. When I’m looking at my FI number (or even my net worth, honestly) I ignore home equity. Again, this adds a bit of a cushion to things if it turns out my expenses in retirement were higher than expected, or if market returns were lower than historical averages.

One final note — a 4% SWR is predicated on a certain asset allocation (typically 50% stocks, 50% bonds). If your asset allocation is more conservative (meaning more bonds) you’d have to adjust your withdrawal rate accordingly. Personally, I have always had an aggressive asset allocation (90% stocks / 10% bonds) and I plan to continue leaning in this direction in retirement.

Uncertainty

The important thing to bear in mind with the 4% rule (or whatever metric you use to determine your FI number) is that it is a rough estimate. This is not written in stone. There is a fundamental uncertainty that undergirds all planning, financial and otherwise. And that uncertainty grows the longer term the planning is. So if I’m trying to determine a dollar amount that is “enough” for several decades, it is impossible to avoid a significant amount of uncertainty. For this reason, I wouldn’t worry too much about getting your FI number exactly right. And, from my POV, the 4% rule seems like as good a way as any to get that initial estimate.

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