I can’t think of a better way to motivate a post than this:
Without giving too much away, in the movie Matt Damon’s character is stranded on Mars and has to figure out how to survive. Our problem in defining the basic math of CoastFI is actually pretty similar – how much in “supplies” do we need to stock up to last us until some date in the future?
Table of Contents
Coast FI – Necessary Definitions and Concepts
Before we get too far into things it’s helpful to define some things.
FI Milestones
- Financial independence (FI) is the point at which your assets generate enough money to cover your expenses for the rest of your life. Once you reach this point, often called your FI number, you theoretically should never have to earn another dollar. A rule of thumb often used to quantify this is 25 times your annual expenses (more on this below).
- Financial Independence Retire Early(FIRE) is the choice many make to retire from their career early once they’ve reached FI. While some live a leisurely life of retirement, others use the opportunity to start new careers doing something they enjoy more without the burden of having to earn a particular amount to cover their living expenses.
- Coast FI is the point at which you could stop saving and, factoring in the expected growth of your assets with no withdrawals, you would be FI by the time you reach retirement age. In other words, at this point you can “coast through life.”
Coast FI Math Assumptions
- Withdrawal rate – Once you start living off your assets you’ll by definition need to start withdrawing from them. If that withdrawal rate is too high then you’ll run out of money too early. However the lower the withdrawal rate, the higher your FI number will be. The 25x rule of thumb I mentioned above comes from the Trinity Study and is based off of a 4% withdrawal rate (1/0.04 = 100/4 = 25).
- Rate of return – We also need to make an assumption about how much return we can expect to get on your investments. If you need x dollars by the time you’re 60 and you’re 30 today, then your rate of return will determine how much you should already have today in order to reach your goal. If you assume a higher number your Coast FI number will be lower, and vice versa.
Inflation
I’m going to use terms like “after inflation” and “in today’s dollars.” That’s because, due to inflation, in 30 years $1,000,000 won’t buy as much as it will today. How much inflation will we have? I don’t know. But as long as my investments grow at a higher rate than inflation, my purchasing power will continue to grow. And as long as I always calculate things in “today’s dollars” then I can compare across time.
A Toy Coast FI Example
In the simplest case we could just save up enough for retirement and stash it somewhere. This “somewhere” is a place where the value keeps up exactly with inflation. First I’ll estimate my retirement expenses to be $40,000 in today’s dollars. I assume that I’ll retire at a typical retirement age of something more than 60. Now it gets a little tricky because I don’t want to run out of money. While chances are I’ll live <30 years beyond retirement age, I’d want to save more than that just in case. How much more isn’t clear, but let’s say I want at least 40 years of expenses to make sure it lasts. In order for my money to last throughout those 40 years, I’d need $40,000 * 40 = $1,600,000.
This is really similar to the math in The Martian. He knew how long he needed to survive. Based on that amount of time, he could calculate the amount of food he would need to sustain himself. Once he had accumulated that much food, he’d be able to make it.
If you’re like me, you’re looking at $1,600,000 and thinking that’s a lot of money that I’d need to save! Sure, if I were able to save that much today then I’d have my retirement taken care of. I could put it away and safely focus on just getting myself to retirement, knowing I’ve got my stash waiting for me.
Fortunately we don’t have to save that much. So far I’ve assumed that I’m going to save everything today and it’s only going to keep up with inflation. In reality I can invest my money today and let it make more money for me. In other words, I don’t need to save that entire $1,600,000 now. I can save some and then let it grow. This means I’d be increasing my rate of return, which so far I’ve implicitly assumed to be 0%.
A Better Coast FI Example
Let’s assume instead that I think I can earn a 5% rate of return, after inflation, on my investments. We’ll assume I’m still going to retire in my 60’s and that I’ll still need $1,600,000 for retirement. For fun let’s say I’m 30 today. That gives me 30 years for my money to grow. I can use an online calculator like this one to figure out (through trial and error) that I’d need to invest right around $359,000 today in order to reach my goal.
That’s quite a bit better! Thanks to the magic of compound interest and the fact that I’ve got decades before retirement, I only need to save $359,000 / $1,600,000 = 22.44% of what I’ll need for retirement. Beautiful! That’s a much more manageable amount to save up today. It’s roughly equivalent to buying a house with cash, depending on where you live, of course.
But wait a minute! We can do even better! In this example we only let our money earn more money before retirement. In reality, we’ll have a whole bunch of money saved up at retirement that can continue to make money for us during our 40 year retirement. This is where our withdrawal rate comes in.
My withdrawal rate in both examples so far was implicitly assumed based on the 40 years that I needed the money to last: $40,000 / $1,600,000 = 1 / 40 = 2.5%. But if our money is going to continue making more money for us during retirement, we’ll actually need less than $1,600,000. This would raise our withdrawal rate. But how much less would we need? We have to make an assumption about our withdrawal rate.
Calculating Coast FI – Putting It All Together
A number that often gets used for a withdrawal rate is 4%. There’s lots to say about where this comes from and how reliable it is. If you want to learn more now you can read the Safe Withdrawal Rate Series at Early Retirement Now. For now let’s use it as a counterpoint to the 2.5% that we’ve assumed so far. I’ll also remind you that these are assumptions, meaning that a) you can change them to get different results and b) what’s appropriate for a given person can depend on a lot of different things, some knowable and some not.
If we assume a 4% withdrawal rate, that means I would only need $40,000 / 0.04 = $1,000,000 in today’s dollars rather than the $1,600,000 I assumed before. Punching that into our calculator instead we get $224,000.
That’s less than 2/3’s of the $359,000 we needed before! It’s only 14% of $1,600,000, the amount we were originally thinking about saving. And it’s only 22.4% of the $1,000,000 that we now think we’ll need. Thanks to the power of compound interest, we can save fractions of what we need for retirement and still be ok.
Getting Started to Coast FI
The only reason this works so well is because time is on our side. With less than 30 years to grow, these numbers would look a lot different. Albert Einstein is purported to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
It’s ok if you’re not motivated to retire early. I’d still argue that there’s a ton of security to be gained from the financial independence piece of FIRE. If you’ve reached Coast FI but aren’t fully FI today, knowing that you’ve already saved enough for retirement just so long as you don’t touch it provides its own level of comfort.
Now that you know the CoastFI math basics you know that the earlier you start saving, the more you can accumulate, and the faster you can reach whatever milestone you’re aiming for.
Cover photo by Danielle MacInnes on Unsplash
