# How quickly can you retire? Part 2: The advanced calculation

Posted by Dan Montgomery on 18 September 2018 in General Early Retirement

Recently I outlined the 10 second calculation to understand how much you need to retire. Basically, we need to save 25x our annual expenses.

That’s a great rule of thumb. But if you’re like me, you still had a bunch of questions like “how long will it take me to save that much?” and “how much of my income should I be saving?”.

I hear you! In this post we walk through the Ordinary Dollar Early Retirement calculator — a simple to use (but very powerful) tool that helps calculate different retirement scenarios.

Once we’re done you’ll have a much more detailed understanding of how much you need for retirement, how long it will take you to get there, and how much money you can spend once you’ve retired.

Congratulations! You’re about to take a big step towards early retirement.

## The early retirement calculation

### The Ordinary Dollar Early Retirement Calculator

When I first found the early retirement community I dove straight into the mathematics. What can I say? I’m a nerd.

But it was quite tricky to learn how to calculate when I could retire. The calculations had to account for my income, current expenses, post-retirement expenses, investment return, and more.

So I built myself a simple calculator. The calculator allowed my to adjust different factors (e.g. my savings rate) to see how I could achieve early retirement faster.

I adapted that calculator and turned it into the Ordinary Dollar Early Retirement Calculator. And it’s free to download!

This tutorial will walk you through how to use the Early Retirement Calculator to calculate (1) how much you need to retire, and (2) how long it will take you to get there. You can download the free calculator here.

### 1. Calculate your savings rate

According to Mr Money Mustache (a legend of early retirement), your savings rate is the most important factor that determines how quickly you can reach early retirement .

Your savings rate is simply:

Savings Rate = How much you save / Your total income

Why is your savings rate so important? Well think about it this way:

- If you save 100% of your income, then you can retire right now because you obviously don’t need any income to cover your expenses
- If you save 0% of your income, then you will never retire because you will have no savings to pay your expenses once you quit your job

**So your one goal for early retirement should be to maximise how much you save.**

Before you get too excited, sell your house, and start living in your car to save money, stop think carefully about this!

**Any reduction in your expenses needs to be sustainable for a long time**. Most people think it’s a brilliant idea to sell their expensive car and start taking public transport — but once you’ve sold it and it becomes an absolute hassle to get anywhere, you’ll probably just end up buying another one. Don’t do that. It’s stupid and expensive.

Personally, I have a few things that I’m not willing to sacrifice for early retirement. Eating out occasionally is very important to my partner and she is important to me, so I want to spend money on this. I also like to buy books and really enjoy travelling. These are things that I consciously choose to spend money on.

We all have these things. So before you transform yourself into the ultimate frugal minimalist,** take some time to think about what you’re willing to stop spending money on, and what you will continue to spend money on.**

The goal here is to have a decent estimate of how much money you need to spend per week and how much money you can save per week. Don’t agonise over calculating the exact number, just get to a fairly confident guess.

Once you’ve done that, plug your age and current investments, along with your weekly income and weekly expenses into the Early Retirement Calculator. The calculator will automatically calculate your savings rate.

### 2. Determine your investment return

The reason that we just talked about increasing our savings rate is because we invest our savings to help the money grow faster. The more money we save, the more money we invest, the more money we make, and the earlier we can retire.

**The second important factor that determines how fast we can retire is our investment return. **The higher the investment return, the faster we retire. But remember high returns carry high risk.

For people who already have some investments, you might want to use your historical return on those investments to estimate your future returns (yes, past performance does not guarantee future performance but we’re just estimating here!). Most funds will give you an annual statement that outlines your investment return for the year. It’s a little trickier with property and other investments but have a go at estimating your return anyway.

If you have no existing investments to use, then you may consider using recent historical performance of share and bond funds. For example here is some data from Vanguard:

- The Vanguard Australian Shares Index ETF (VAS) returned 8.77% in the 5 years ending in August 2018.
- The Vanguard Australian Fixed Interest Index Fund ETF (VAF) returned 4.31% in the 5 years ending in August 2018.
- The Vanguard MSCI Index International Shares ETF (VGS) returned 11.27% in the 3 years ending in August 2018.

Don’t worry, this is more of an art than a science. The best thing to do is to think about where you will invest your money in the future and find data that reflects those types of investments (e.g. if you’re going to invest in a Vanguard Australian Shares ETF, then use that fund’s historical data).

Let’s input our estimated investment return in the calculator. Just be careful and check whether our investment returns include or exclude inflation and input accordingly.

### 3. Decide how much money you need after you retire

In our 10 second calculation for early retirement, we assumed our living expenses when we retire will be the same as our expenses now because it simplified the culaculation

However, that’s not always the case. For example, you may want to retire to a lower cost of living area (I’m dreaming of a tropical island somewhere…) or you may want to start travelling more.

Fortunately, the Early Retirement calculator allows us to take into account a different post-retirement salary. **All you need to do is estimate your yearly ‘post-retirement salary’. Don’t agonise over the specific number; close enough is good enough.**

It helps to think about your expenses now and then adjust up or down accordingly. Personally, I expect to travel more when I am retired, so that means my expenses should be higher than my current expenses.

Once you’ve landed on a number, plug it straight into the calculator.

### 4. Consider any tax implications

Nobody like taxes, especially me. But to accurately calculate when we can retire, we need to take in to account any tax that we need to pay on our investments.

I’ll talk broadly about the tax implications for Australians. Remember, the following is general advice and doesn’t take into account your personal circumstances. You should always speak to a finance professional.

**If you follow our philosophy and decide to invest in index funds, then any money that you make when you withdraw money is considered capital gains. And further, if you have had those investments for over a year, you’ll be eligible for the capital gains discount.**

Imagine that you decide you have enough money to retire, tell your boss to shove it, quit your job, then live off your investments on a beach somewhere.

In this case your salary income drops to zero. But your index fund income replaces your salary and you’ll be taxed just like your salary was taxed. For example, if you withdraw $50,000 from your index funds then you’ll sit in the normal 32.5c tax bracket.

However, if you’ve held the index fund for over a year, you are eligible for the 50% capital gains discount, so you’re taxable income drops to $25,000 and you sit in the 19c tax bracket. Nice!

The retirement calculator asks us to input our tax payable as a percentage, so here is how you can calculate it. Note that we are going to assume we have no other income after we have retired.

Start with this calculator. In the Salary box, input how much money you expect to live off when you’re retired. It will spit out a number of different fields. Just input the corresponding values into this formula:

Tax Payable = (Total Taxes / Taxable Income ) * 50%

For example, if I expect to live off $50,000 when I retire, I plug that into the calculator. It tells me that my Taxable Income is $50,000 and my Total Taxes is $8,017. Then calculating $8,017 ÷ $50,000 gives me 16%. Applying the 50% capital gains discount means my tax payable drops to 8%.

Boom! Simply input the 8% into the early retirement calculator (ignore the data in the image below, it’s just an example).

## Case Study: My own calculation

To help illustrate how the calculator can be used, I’m going to run my own numbers and see what pops out. I’ll also test two scenarios to see how small changes in the short term can really help my retirement in the long term.

For those who haven’t read the article on how my mindset shifted to chasing early retirement, I said this:

I’m now 30 years old. Today I start my journey to financial independence in earnest and my aim is to ‘retire’ at the age of 45.

Let’s see if I can achieve that goal…

### Scenario 1: Using achievable numbers

The first scenario is going to use some reasonably aggressive but still achievable savings numbers to see when I can retire. I have a good idea of what I am able to save, as I break down my monthly expenses in detail in my Net Worth Reports.

These are the numbers I put into the calculator:

**Current age:**I’m still 30 years old — so that’s what I put into the calculator (obviously).**Current liquid assets:**Right now I have $28,500 invested in a mix of Vanguard stock and bonds index funds, so that’s my starting balance.**Net income per week:**I earn $140,000 per year before tax, which translates into roughly $100,000 after tax. I also earn about $1,250 per month from rental income. Therefore, my weekly income is about $2,350.**Average saved per week:**According to my most recent Net Worth Report, I spend approximately $5,500 per month. So I’ve assumed I spend about $1,385 per week. This puts my saving rate at 41%.**Investment returns and inflation:**My investments are 80% stocks and 20% bonds, so I’ve assumed I’ll achieve about an 8.5% return per year. This is just a guess but seems consistent with what other experts say and the Vanguard data I outlined earlier in this article.**Post-retirement income:**I’d really like to have about $70,000 income per year when I retire. Mainly because I love travelling and want to continue to do that.**Tax on investment income:**This is always difficult to estimate but according to the pay calculator I will need to pay 22% tax on my $70,000 income. I’ll assume I get the 50% CGT rebate and pay 11% tax on my income.

Here goes! So when can I retire…?

**According to the calculator, I can retire at 47 years old on a salary of $70,000 per year. **Hmm… I don’t reach my target retirement age of 45 but I’m still pretty happy. It just means that I’ll have to either increase my income or reduce my expenses over time.

Remember, this calculation won’t be perfectly accurate but it gives us a broad understanding of how much we need to save in order to retire.

### Scenario 2: Assuming that my spending increases

Running through my retirement calculation got me thinking about how the savings rate affects retirement age.

I started to wonder what would happen to my retirement age if I started getting lazy about saving and spending more money. Maybe I start eating out a little more or buying more toys for myself.

So I plugged the numbers into the calculator. I kept all the numbers the same, except that I changed my savings per week from $965 to $600.

**I found that increasing my weekly spending by $365 pushed my retirement age by 6 years!**

6 more years of work! No dinner or new computer game is worth that. Next time I feel like buying something silly, I’ll try to keep this perspective.

## Go ahead and calculate your retirement age

You should have a fairly good idea of how the retirement calculator works. So go and play around with it!

I’d recommend using Scenario 1 with your current spending and saving habits. And then using Scenario 2 to see what happens to your retirement age if you save more or less than that.

And remember this: every time you choose to spend money on short term pleasures, you’re making a choice to push back your retirement age.

That’s fine. Sometimes you need those short term pleasures. But just consider what you’re giving up by doing so.

Happy calculating! If you have any questions, please just drop me an email 🙂

All the best,

## Steve

December 30, 2018 at 10:17 am

Sorry, but I don’t get your tax calculation…. If you are invested in dividend-paying shares you won’t get a 50% discount on the dividend income…

## Dan Montgomery

January 2, 2019 at 9:52 am

Hi Steve, thanks for the comment! You’re right, any dividend income won’t be eligible for the CGT discount. In my scenario, I would be automatically reinvesting dividends and selling equities for my income, thus the CGT discount applies. If you’re living off dividend income, then don’t discount your tax payable by 50%. Hope that clears things up!

## Chris

January 8, 2019 at 11:30 am

Hey Dan, What about the tax on the dividends?

## Champion Mumch

January 13, 2019 at 4:48 am

Hey Dan, love the blog and early retirement calculator looks handy. Chris makes a good point – if you are using a dividend reinvestment plan, you still have to declare that as income in your tax return. If you want to do what you are suggesting, you would need to invest in assets that provide you with capital growth only and no dividends.

Another point – be wary of using historical performance from only the past 5 years. The aus (and us) sharemarkets have performed very well over the past decade. If there is a Stockmarket crash in the next few years, those % will drop significantly.

If you are investing mostly in shares that track the index then 7% is a reasonable number to use (as mentioned elsewhere in the article)

## Dan Montgomery

January 14, 2019 at 9:27 am

Thanks Chris and Champion Mumch. I didn’t quite realise that! I’m in the process of improving the calculator, so I’ll make sure I’ve accounted for the DRP tax implications. Thanks again guys 🙂

## Lochlin

February 13, 2019 at 12:34 pm

Hey mate,

The link to the calculator is broken.

Cheers,

Lochlin

## Dan Montgomery

February 14, 2019 at 9:33 am

Thanks for the heads up Lochlin. I’ve just added a note to the top of the post because it’s now out of date. You can download an updated calculator from the home page 🙂