Calculating your goal

What is your number?

The answer in the movie “Wall Street: Money Never Sleeps” was more; however, the goal “more” only works when you have enough. Here we estimate how much investment capital is needed and never have to work again.

The standard financial advice follows the 4% rule. This rule states that one can annually withdraw 4% of the investment principal and the money will last 30+ years. For example, if one has total balance B = $600k of invested equity, one can annually withdraw E = 0.04·$600k=$24k for expenses E. This 4% is adjusted annually for inflation. For example, with annual inflation of 3%, the next years withdrawal can be 1.03·$24k = $24.7k.

The inverse relation between expenses E and investment balance B is B = E/0.04 = 25·E. Thus, if we know our annual expenses, we need to multiply this number by 25 to reach the goal of financial independence. This should be your savings goal. After you reach this number, you can always try to get “more” if you so choose ;) The 4% rule is summarized in Equation (1) below:

Savings target based on 4% rule

Alternatively, we can calculate the number using monthly expenses

Calculation of investment goal based on monthly expenses using the 4% rule

In summary, the steps for finding your number are:

1. Find out your monthly expenses Emonth.

2. Calculate the needed balance B of invested equity using Equation (2).

Table 1 shows a couple of examples to illustrate this process.

Table1: Calculation of financial goal

A link for an editable spreadsheet for the above analysis is below:


The critical part of the process is accurate assessment of monthly expenses. One way to approach this is to take your current expenses as the starting point – something you should know although surprisingly many are ignorant of! Next, deduct any expenses are that will be lowered (for example, mortgage paid in full). Finally, deduct any additional income such as social security (if you believe it will be around when you are eligible!). This is income that your investments should generate.

Finally, we note that the 4% rule corresponds to the historical inflation adjusted total return for the stock market. As such, there is not much margin for error in using this rule especially if the investments need to last over 30 years. Given that the dividend yield is historically low and the corresponding total future return is likely lower than the historical average, it may be prudent to use a smaller withdrawal rate such as 3% which results in a higher savings goal of 400 times the monthly expenses.