25x your annual expenses

Why is the title “25x your annual expenses”? Well, because of the 4% rule (of thumb) of course.

In the FIRE community, we often refer to the 4% rule which is a rule of thumb that helps you either (1) calculate how much you can sustainably withdraw from an investment pot each year or (2) calculate how much you need to invest to sustainably withdraw a certain amount of money each year.

The relationship is as follows:

• Annual amount you are able to sustainably withdraw = investment pot amount x 4%

For example, if you have an investment pot which amounts to £500,000, then you will be able to withdraw £20,000 sustainably (£500,000 x 4%).

The formula can also be re-arranged to calculate the investment pot required to sustainably withdraw a certain amount annually. In this case, dividing the amount (say £20,000) by 4%. This is effectively the same as multiplying by 25.

For example:

• £20,000 divided by 4% or multiplied by 25 = £500,000

Anyway, what is the purpose of this post I hear you ask? Surely it is more interesting than this. And you would be right. So let’s get into it.

Based on the above, we should always keep in our mind that the following is always true:

• Every £1,000 you add to your annual expenses increases your required investment pot by £25,000

• Every £1,000 you remove to your annual expenses reduces your required investment pot by £25,000

Let’s have a play with some real numbers!

I have been tracking my expenses since January 2022 (see last post on spending here). What I have done is taken the average amount spent (for the 7 months so far) and extrapolated to estimate a full year of spending.

I hope to be able to reduce our spending next year (for example we moved house last year so we have been spending quite a bit on the house this year) but these numbers should help give context.

So what you can see below is the spending breakdown (totalling to £35,655 for us as a couple) and the required investment pot to sustain each of the categories (yearly amount x 25). I find this really helps me realise how much money I would actually need invested and highlights what is expected to cost me most money (based on current spending).

Annual spending breakdown and required investment pot for each category

As expected, mortgage costs are highest and would require around £233,000 invested (on top of the equity already invested in the house). But you can see even other items such as eating/ drinking out still require a significant amount of money invested to sustain (around £97,000 in this case).

The required investment pot for each spending category is also shown in the bar chart below.

Required amount invested to sustain each annual expense category

Breaking down each category like this really helps you see which spending items are inflating your required investment pot so much.

For example, if I was to downsize my property and completely pay off my mortgage (e.g. moving from house 4 bedroom house to a 2 bedroom), I would reduce my required investment pot to around £658,000 (instead of the approx. £891,000 required based on current spending). Downsizing my property would also likely reduce spending such as home bills and home spending which I think would have the potential to reduce the required investing pot to around the £580,000 mark (based on some rough estimates).

So as you can see, optimising your spending can make a significant difference and pull forward your financial independence date by years. It all depends on what you want to prioritise. In this scenario, with a few lifestyle changes and optimisations, I have been able to reduce my required investment pot by around 35% without even touching my variable costs (particularly my excessive eating/ drinking out consumption).

Let me know in the comments section if you have done a similar exercise and what findings you had. Also let me know if you found this post useful.