Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / The 25x Rule for Early Retirement
Transcript
- Lucas: So, Luna, I've been thinking about this classic rule of thumb that gets thrown around in the FIRE community: the idea that you need twenty-five times your annual expenses saved up before you can quit your job. Luna: Yeah, the twenty-five times rule. I feel like that's the first thing anyone learns when they start reading about financial independence. Lucas: Exactly. And there's a good reason it's so popular. It's simple, it's memorable, and it comes from a fairly well-known piece of research. But the more I dig into it, the more I think people treat it as a hard and fast number when it's really more of a starting point. Luna: Where does it actually come from? Is it just someone's gut feeling or is there real math behind it? Lucas: It's based on the Trinity Study from the nineties. A group of professors looked at historical market returns and figured out that a four percent withdrawal rate, adjusted for inflation, had a very high success rate over a thirty-year retirement. And four percent is the same as one divided by twenty-five, so that's where the twenty-five times comes from. Luna: Right, so if you spend fifty thousand dollars a year, you'd need one point two five million dollars in investments. Lucas: That's the math. But here's the thing: that study was designed for a traditional retirement that lasts thirty years, not for someone who retires at forty and might need that money to last fifty or sixty years. And it also assumes a very specific asset allocation and ignores a bunch of real-world variables. Luna: Like what? I mean, beyond the timeline issue, what else could trip someone up? Lucas: The biggest one is probably taxes. The Trinity Study looked at gross returns, but when you're actually living off investments, you're paying taxes on dividends, capital gains, maybe even ordinary income if you're tapping a retirement account before you're eligible. That can knock a full percentage point or more off your effective withdrawal rate. Luna: So your four percent becomes more like three percent after taxes. That's a big difference. Lucas: And then there are investment fees. Even a one percent expense ratio on a mutual fund eats into your returns year after year. Over a long retirement, that compounds into a significant shortfall. The original study assumed low-cost index funds, but a lot of people are sitting in funds that charge way more than that. Luna: I've heard people say that the four percent rule is outdated because bond yields are so much lower now. Does that affect the twenty-five times rule too? Lucas: It does, and it's a fair point. The Trinity Study used historical data that included periods with much higher bond yields. Today, with ten-year Treasuries sitting around four percent, a lot of people argue that a more conservative withdrawal rate, like three and a half percent, is more realistic. And that would push your multiple up to closer to thirty times your expenses. Luna: So should someone aiming for financial independence just ignore the twenty-five times rule entirely? Lucas: No, I don't think so. It's a great rough benchmark. It gives you a target to work toward, and for a lot of people, hitting twenty-five times their expenses is a massive achievement. But if you're planning to retire really early, you need to stress-test that number with your own assumptions. Luna: How would you actually do that? Like, if I have my expenses and my portfolio, how do I know if I'm on track? Lucas: The first step is to be brutally honest about your annual expenses. A lot of people underestimate what they'll actually spend in retirement, especially if they have plans to travel or take up expensive hobbies. The FIRE community calls it the 'one more year' syndrome because people keep adding to their budget to feel safe. Luna: So you're saying the rule might not be the problem, it's the inputs that people use. Lucas: Exactly. Garbage in, garbage out. If you think you spend fifty thousand but you're actually spending sixty, your twenty-five times number is off by two hundred and fifty thousand dollars. That's a huge gap. So the first thing is to track your spending meticulously for at least a year before you pull the trigger. Luna: And what about the investment side? Is there a way to make your portfolio more resilient so you don't need as large a cushion? Lucas: Sure. You can tilt toward assets that historically have held up well against inflation, things like real estate or Treasury Inflation-Protected Securities. You can also build in flexibility with a variable withdrawal strategy, so you spend less in down years and more in good ones. That reduces the risk of running out of money without needing to save extra. Luna: That makes sense. A rigid formula assumes you'll withdraw the same amount every year, but real life is more flexible. Lucas: Right. And on that note, there's also the idea of using a 'safe withdrawal rate' that's specific to your situation. Some people use a three percent rate to be extra safe, which means you need thirty-three times your expenses. Others feel comfortable with five percent if they have a pension or other guaranteed income. The key is to know your own risk tolerance. Luna: So, if someone is listening and they're trying to figure out their number, what's the first step you'd recommend? Lucas: I'd say start by calculating your current annual expenses, all of them, including irregular ones like car repairs or annual insurance premiums. Then multiply by twenty-five to get a baseline target. But don't stop there. Subtract any expected income like Social Security or a pension, and adjust for taxes and healthcare costs. Then add a margin of safety. Luna: So it's not just one formula, it's more like a process of refining your estimate. Lucas: Exactly. And honestly, that's what makes the difference between someone who quits their job and then panics during the next market downturn, and someone who can ride it out. The twenty-five times rule gives you a starting line, but your own planning gets you to the finish. Luna: I love that. It's so easy to get caught up in the magic number and forget that the real goal is to have a plan you can stick with for decades. Lucas: And that's exactly why I think this conversation is worth having. If you're on the fence about retiring early, the twenty-five times rule might tell you you're almost there. But having a deeper understanding of what it does and doesn't account for can give you the confidence to actually pull the trigger or the wisdom to wait a bit longer. Luna: It's about peace of mind, really. Not just hitting a number, but knowing that number is right for you. Lucas: And that peace of mind is something we love to help our listeners get to. If today's conversation gave you a new way to think about your own retirement number, the best way to keep these episodes coming is to support the show directly. You can buy me a coffee dot com slash fexingo, and it goes toward keeping this podcast free and ad-free for everyone. Luna: Yeah, it's a small way to say thanks and it really does make a difference for us. Lucas: So, back to the math. We've been talking about the twenty-five times rule as if it's one size fits all, but the truth is, your personal multiplier depends on a few key assumptions: your withdrawal rate, your time horizon, and your spending flexibility. If you can adjust any of those, your target number changes. Luna: Can you give us an example of how that works in practice? Lucas: Sure. Let's say you have sixty thousand dollars in annual expenses. At twenty-five times, you'd need one point five million. But if you decide to use a three point five percent withdrawal rate instead of four, you'd need about one point seven one million. That's an extra two hundred thousand dollars you'd need to save, just for a slightly more conservative rate. Luna: That's a significant difference. It really shows how small changes in assumptions can move the goalposts. Lucas: It does. And that's why I always recommend running a few different scenarios. Use a calculator that lets you adjust your withdrawal rate, your portfolio mix, and your expected inflation. See how your number changes and find the range you're comfortable with. Luna: And if you can cut your expenses by even a few thousand dollars a year, the multiplier works in your favor too, right? Lucas: Absolutely. Reducing your annual spending is one of the most powerful levers you have. Not only does it lower the amount you need to save, but it also makes your portfolio last longer because your withdrawal amount is smaller relative to your returns. Luna: It's like a double win: you need less to start, and you have more room to weather bad years. Lucas: Exactly. And that's the real takeaway here. The twenty-five times rule is a useful shorthand, but it's not a magic switch. The people who successfully retire early are the ones who understand the mechanics behind it and adapt it to their own lives. Luna: So, for our listeners, what's the one thing you'd want them to remember from today? Lucas: I'd say, use twenty-five times as your starting point, but don't stop there. Dig into your real numbers, stress-test your assumptions, and build in a margin of safety. That's what turns a rule of thumb into a solid plan you can actually live on. Luna: Well said. It's been a great conversation, Lucas. Thanks for breaking it all down. Lucas: Thanks, Luna. And to our listeners, keep questioning the rules and make them work for you. See you next time.