Early retirement is the dream for many people. So how do you know when you can afford to retire? Most people assume they'll have to wait until they're retirement age. But that needn't be the case.
We take a look at 3 factors to help you figure out how long it might be until you can afford to retire in comfort.
1. Net assets
In order to retire you will need to generate enough income from your assets to be able to support your lifestyle. So the first step to figuring out when you can retire is to take stock of your assets. This includes things like property, shares, ETFs, and superannuation. Keep in mind you may not be able to access your superannuation if you retire early.
A lot of people prefer to retire debt free so that retirement income is not spent on interest payments. If this applies to you then work out your debts. Add up how much you owe on any credit cards, mortgages, personal loans etc. Subtract your debts from your assets to work out your net assets. This represents the amount you'll have to retire on, debt free.
2. The 25x rule
The 25x rule gives an indication of how much you should have in your investment portfolio in order to retire. According to the 25x rule, you will need an amount equal to the annual income required in retirement multiplied by 25. So if you will need $40,000 from your portfolio to live on each year, you will need $40,000 x 25 = $1 million in order to retire.
The 25x rule assumes you will be able to generate real returns (i.e. returns net of inflation) on your portfolio of at least 4% per year. Interest rates are currently much lower so ASX shares with reasonable yields have become more attractive to income seeking investors.
3. The 4% rule
The 4% rule gives an indication of how much money you can withdraw annually without cutting into your investment principal. According to the 4% rule, in your first year of retirement you can withdraw 4% of your total portfolio value. So if you retire with $1 million, you can withdraw $40,000. The next year you should withdraw the same amount, but adjusted for inflation. So if inflation was 3% you could withdraw $40,000 x 1.03 = $41,200. Each year after that you continue to adjust your initial withdrawal for inflation to calculate how much you have to spend.
Foolish takeaway
Working out when you can afford to retire doesn't have to be complex. These 3 factors will help you calculate what you need to retire and how close retirement could be for you.
