Today we’re talking about
numbers – not in the dirham sense, rather a guide of sorts of specific numbers that I believe are important to know, and which will help you plan your financial independence.
25: This begets you the (huge) magic number that doesn't stop giving – money that is. It's the number you multiply your year's expenses by – expenses you would incur when you stop earning. This is the amount of money you need to save up to still afford the life you want after you stop earning.
The idea is that you invest this pot. Certain assumptions kick in that boil down to the pot earning at least 4 per cent a year. This means you can withdraw up to 4 per cent every year, without depleting the principal. This is why I call it the number that doesn't stop giving. I will now state the obvious – because so many people I talk this through with bring up the same sorts of issues: the number you multiply by 25 is not what you spend today, it is what you would spend in the future, when you don't go to work.
So for example, I would assume there would be no school fees to pay out, or commuting costs to work to include.
Most people are terrified, when they see the number that comes up once they multiply by 25. How much you need depends on how you live. Ski holidays twice a year vs living in a village in Asia. It's Your call. Now you know how to work out if you can afford it.
4: Refers to 4 per cent, aka the "safe withdrawal rate". The assumption is that taking out 4 per cent every year won't reduce the lump sum initially invested – ideally the lump sum is the magic amount that doesn't stop giving (above). There are calls for this figure to be revisited. There are people who think 3 per cent is more realistic, and others who state 7 per cent is more liveable on. You can read more if you look up the Trinity Study – well known for financial and retirement planning. The point is that 4 per cent is something to aim towards and gives us a benchmark.
72: The rule of 72 is a simplified way to work out how long it will take an investment to double, given a fixed annual rate of interest, and assuming both the principal and the return are left to compound over the years. It is a rough estimate and is not accurate to the day. Here are examples of what I mean:
You have money deposited in an account that pays 2 per cent interest every year. 72/2 = 36. The rule of 72 tells us that it’ll take about 36 years to double the investment – provided you don’t touch it, or the interest. In reality, it takes 35 years if you work out the compounding, so the rule of 72 is 1 year out in this case. But say you were lucky enough to get 9 per cent interest every year – then (72/9) your investment would double in 8 years – which is nearly spot-on in reality.
There you go. Three simple numbers: 25, four and 72. Use them and you will win at the game of life.
All this is insignificant if you don’t knuckle down to the most basic of numbers – ones that only you know:
How much money you have coming in.
How much stays in (savings).
How much you owe – the sum total of all debts.
Without knowing the above, the rest is irrelevant.
What about net worth you might ask. Yes, it’s nice to know net worth – but it’s meaningless if assets cannot be exchanged for cash – easily, quickly, whenever you want.
Numbers aren’t scary. Money isn’t interesting.
But understanding both is very, very important.
Nima Abu Wardeh is a broadcast journalist, columnist and blogger. Share her journey