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Author: SoftSimp Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 5069  
Subject: Estimating future needs Date: 8/7/2003 10:03 PM
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A lot of people are having trouble coming up with a figure that says what they'll need to be financially independent. It just so happens that I cleaned off my desk today, and buried under a pile of mail was a newsletter that has an article on estimating your retirement income.

First, set up a little table that shows your current expenses. Then, try to predict how those expenses will change when you FIRE. After that, you'll use a multiplier (which I'll get to in a bit) to figure the inflation adjusted annual income you'll need.

Current Projected Annual
Annual Annual x multi- = Income
Areas Expense Expense plier Needed
----- --------- --------- ------ --------
Housing $xxxxx $xxxxx
Food $xxxxx $xxxxx
Clothing $xxxxx $xxxxx
-----
Healthcare $xxxxx $xxxxx
Taxes $xxxxx $xxxxx
Insurance $xxxxx $xxxxx
-----
Transportation $xxxxx $xxxxx
Vacation/Travel $xxxxx $xxxxx
Charitable Cont. $xxxxx $xxxxx
Other $xxxxx $xxxxx
----- ---------
TOTAL PROJECTED ANNUAL EXPENSE: $XXXXXX x x.x% = $XXXXXX

You can make your table much more complex than I did, but this should cover the basics. Certain costs may increase or decrease when you stop working - for instance, your housing costs may go down because your mortgage is paid off, or your healthcare costs may go up because you're no longer covered under an employer's plan. Take these changes into account when coming up with your "Projected Annual Expense" (in today's dollars).

Next, you'll need to figure a "inflation factor multiplier." Conveniently, the newsletter has done this for us:

Years Anticipated Inflation Rate
to FIRE 3% 4% 5% 6%
------- ----- ----- ----- -----
5 years 1.2 1.2 1.3 1.3
10 1.3 1.5 1.6 1.8
20 1.8 2.2 2.6 3.2
30 2.6 3.2 4.3 5.7

The tough part here is picking which inflation factor to use, because inflation rates aren't steady and aren't necessarily easy to predict. So just pick one. :)

Then, take your "Total Projected Annual Expense" from the first table, multiply it by the "Inflation Factor" you picked from the second table, and you will have your "Estimated FIRE Annual Income."

Total Projected Inflation Estimated FIRE
Annual Expense x Factor = Annual Income Needed

Where is this income going to come from? Any number of places, many of which we've already been discussing. The following is a list of some, but by no means all, possibilities:

* Asset Income (dividends, interest, rents)
* Pensions and Retirement Plans
* Earnings (Wages)
* Social Security
* Other (Residuals, Licenses, Other Types of Benefits)

So the next difficult task is to figure out what percentage of your "Total Projected Annual Expense" each type of income will provide. This figure will probably vary over time as well. For instance, if you retire early, it'll be some time before retirement benefits like Social Security kick in, so maybe during those years you'll still want a small wage coming in - perhaps from a hobby.

I'll leave it to you to figure out the rest. Hopefully I've gotten those of you who have no direction headed the right way.

SS
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