After the popularity of the 34 year old Millionaire article, I started to think a little more about early retirement, and how much someone would have to save to achieve financial independence at an early age. With that, I updated an article that I originally wrote in 2009 about the relationship between after tax savings rate and financial independence.
What exactly would be required to walk away from the day job and live completely off a portfolio? Am I saving enough money to realize my goal of becoming financially independent and how long will it take?
With those questions, I broke open a spreadsheet and evaluated the percentage of savings required to build a portfolio that would cover my expenses in the shortest period of time possible. I kept it simple and used after tax (or take home) salary, percentage saved, and a long term market return of 5% after inflation.
- Combined Household After Tax (or take home) Salary: $85,000 (assume grows with inflation)
- Annual Stock Market Returns: 5% (after inflation)
- Withdrawal Rate: 4% (assume only dividends are withdrawn from a dividend portfolio, thus highly efficient taxation ~0%)
- Assume invested in a non-reg portfolio with no capital gains tax.
I created a simple spreadsheet to go through the various scenarios at increasing savings rates. Instead of displaying all the numbers, here is the savings rate spreadsheet so that you can do similar calculations of your own. Within the spreadsheet, you can edit your “savings %”, your “annual after tax income”, and “market returns”.
After running through the scenarios, I came to the following conclusions on the years to financial independence (fi) based on after tax/take home savings rates.
|Savings Rate||Years to Fi|
Based on my assumptions, it’s apparent how guys like QCash were able to retire so early (in his 30’s). QCash has indicated that during their working years, they saved approximately 50% of their income. It’s also really interesting to note that if you can manage to save 65% of your household after tax income, then you can potentially be considered financially free in 10 years (providing that the market cooperates).
If you have a two income household, with roughly equivalent salaries, then perhaps a strategy that you can try is to live on one income. As you can see from the table, saving 50% of your household income puts you on the fast track to financial independence.
There are some weaknesses of the spreadsheet though. First it assumes a steady income and does not account for raises or reduced income. Second, as mentioned above, the shorter time frames to financial independence will result in greater market risk. While the stock market has never lost money over any 20 or 30 year period, the market has lost money over 10 and 15 year periods. Third, it assumes tax efficient Canadian dividend income with very little or no taxation. You may need to rework the spreadsheet a little if you have other sources of taxable income.
It’s pretty obvious that the higher percentage of income that you save, the closer financial independence becomes. However, what this article demonstrates is how powerful aggressive saving can be.
If you only save a small portion of your income, don’t be discouraged by the large number of years before financial independence. My calculations did not account for Canada Pension Plan or Old Age Security. Both of which could provide a family with up to $36,000/year providing both spouses qualify for maximum benefits (at age 65).
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