Before I begin, let me issue a little warning about this post.  What follows is a stream of consciousness type account of some of the things I’ve been thinking about lately regarding calculations for early retirement. I hope that this post generates a discussion rather than provides any answers on its own merits.  I make many assumptions below, but I hope to focus on the method of thinking rather than the merits of those assumptions themselves.  Now that that’s out of the way, let’s proceed:

First, Some Background

A general rule of thumb is that you need 25X your yearly expenses saved/invested to be able to retire.  I’ve discussed this previously in my post, Deciding Early When to Retire.  That number comes from the fact that withdrawing 4% historically allows your investments to last indefinitely.  Assuming the 25X number is correct, you might still be miscalculating your retirement needs.  It’s in this area that my latest calculations come into play.

The two main factors of influence are my mortgage and the fact that retirement investment accounts can’t be accessed until much later in life then I hope to retire.

Assume a 32-1/2 year old with expenses of $6000 a month including a new 30 year mortgage that is $3500.  Using the 25X calculation, you’d say that $1.8 Million is necessary for retirement.   If the inflation-adjusted equivalent was finally achieved in a 401K by age 45, however, retirement still wouldn’t be possible, since that money couldn’t be touched without penalty for many more years.

The Solution

To solve this problem, I’ve been considering retirement in two stages: the first part is

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Many readers of Richer by the Day would be surprised to learn that I have an iPhone.  Isn’t the iPhone the gold standard example of exorbitant luxury spending totally at odds with someone who blogs about personal finance and frugality?  It turns out that my iPhone actually costs a lot less than you would think due to the many ways it saves me time, money, and even electricity.

Before we begin, note that I didn’t say the iPhone pays for itself, but that MY iPhone pays for itself.  Your use, lifestyle, and alternatives could make it even more cost effective for you or a horrible waste of money.  Here is the analysis for my situation.

Background and Assumptions

The smallest talk plan has almost always been sufficient for my cell phone needs.  In this analysis, I’m comparing the cost of my previous phone service to the iPhone.  My first assumption is that I need a cell phone.  My old Verizon plan came with a free phone and gave me 450 minutes plus 250 TXT messages for $40 + $5 + taxes and fees.  A 20% discount through my employer made my monthly bill $43.  The iPhone 450 minute plan, 200 TXT messages, and required Unlimited Data plan costs $40+$5+$30 + taxes and fees.  I again receive an employer discount (17%) so my total bill is $72 per month.  So the premium I pay for having an iPhone is $29 per month.  That’s the expense I’m trying to justify.

There are obviously some apps that save me money directly such as

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A reader recently asked how the interest is calculated on Lending Club loans and what her return in dollars might be.

Here’s my answer:

Loans through Lending Club are amortized over 36 months to keep payments fixed.  The quoted rate is the yearly rate, so 1/12 the rate is applied to the outstanding principal each month.  To determine your return, you’ll need to calculate the monthly payment, take out the 1% payment service fee and multiple by 36 months.  I believe that estimated monthly payments are shown when you consider a loan, but if not, you can use the following formula in Microsoft Excel, Google Spreadsheets, or a similar program: =PMT(rate/12,36,-loan) where rate is the quoted rate as a decimal (13% would be 0.13) and loan is the amount that you loan.  For example, 10% interest on a $3000 loan would be represented as =PMT(0.10/12,36,-3000), which returns a monthly payment of $96.80.  Multiplying by .99 is what you would get each month after the 1% service fee is taken out.  So you would get $95.83 each month.  After 36 months, you will have received $3450.01 for a profit of $450.01.  That amount would be subject to taxes as interest income, so your after tax profit would be

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In part 1 of this topic, I discussed different ways to apply historical default rates to small value P2P loan portfolios.  To make more sense out of how historical default rates might affect loan performance, I ran a monte carlo analysis on a select set of hypothetical loans.   Here are the simulation results.

To get a better handle on the effect of historical default rates on P2P loan portfolios, I performed a monte carlo simulation on portfolios lending $100, $500, $1000, $2000, and $5000.  Since I assumed that the money was spread across investments of $25 each, those dollar amounts correlate to 4, 20, 40, 80, and 200 loans respectively.  For each test case, I simulated investing in all A1, C1, E1, or G1 loans (using Lending Club grading terminology) as well as an equal mix of those 4 grades, which I called Div for diversified.  I used the following historical yearly default and corresponding loan interest rates (again from Lending Club’s site):

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I recently discussed how your savings rate can determine when you’ll be able to retire.  To go along with the table in that post, I developed the Saving Retirement Calculator below.  You can enter specifics for your situation to see when you might be able to retire.  Once you have an answer, you can copy the badge code and paste it into your webpage or blog to get a badge that looks like this:

Note that changing income will have no effect on the answer, unless you currently have a non-zero amount saved.  That is due to the fact that calculations are all made on a relative basis, i.e. if you are saving 10% (and thus living on 90%) 90% x 25 is the amount you’ll need to save, which does not need absolute current income to be  calculated.

Here’s the calculator:

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I finished reading The Long Tail over the weekend. The name of the book comes from the increasing importance of the sum of products and services that sell in small numbers. It makes the case that because there are so many of them, adding up these little sales actually makes them more valuable then the small number of products that sell in huge numbers, i.e. the biggest hit is the sum of the non-hits.

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One thing you notice when you watch a lot of golf on tv is that the same commercials are repeated over and over ad nauseum. This past week was no exception. I must have seen the ING Your Number commercial at least 10 times. Clearly their marketing tactic worked, because I did indeed go to their website.

The premise of the commercial is that everyone has a number that correlates to the amount they’ll need to have saved to retire when and how they want. In the ad, people are carrying around a physical number. By going to the website, you can calculate your number and then find a new financial professional in your area or email it to your existing one.

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Everyone loves a good rule of thumb. Knowing that the number of cricket chirps in 15 seconds plus 37 is the approximate temperature _[1] is great . I usually do the old 100 plus my age comparison when I get my blood pressure checked as well. These ballpark estimates are easy to remember and give a close enough approximation for many things in life. Unfortunately, there are often way too many variables for a rule of thumb to be of any real value for personal finances.

There are some financial rules that are valuable, but they tend to be the ones that are math based. An example would be “Double your hourly rate and add three zeros to get approximate yearly salary.” Of course, even such a rule makes the assumption that you work 40 hours per week. These “rules of thumb” are what I generally file under Quick Calculations. They are more mathematical approximations

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The Rule of 72 is well known: Divide 72 by a rate of return to get the number of years for your money to double. Example: at 4.5% return it will take 72/4.5= 16 years to double your money

Here are a few more quick calculations:

Cost Before Taxes
Multiply an item’s cost by 1.4 to figure out what you need to earn before taxes to afford it
Example: A $250 Nintendo Wii will require 250*1.4= $350 in pre-tax earnings

Hourly Rate to Yearly Salary
Double your hourly rate and add three zeros to get approximate yearly salary
Example: at $20/hour, you make about 20*2 = 40 –> $40,000 per year

Yearly Salary to Hourly Rate
Opposite of above: Remove three zeros from your yearly salary and cut in half to get an approximate hourly rate
Example: at $60,000 per year you make about 60,000 –> 60/2 = $30/hour

Current Spending Versus Nest Egg Worth
Add a zero to the cost
Example: Using $2,000 for a new computer today would have been worth 2,000 –> $20,000 in a retirement account 30 years from now.

Calculations assume a 40 hour work week, 8% investment return, and 28% tax bracket.

This post will be used to list favorite calculators, etc

Quick Calculations
Karl’s Mortgage Calculator
Baby’s First Year Cost Calculator
I Volatility Options Calculator
What Your Time is Worth Calculator
Price Comparisons Over the Phone