My wife and I have been talking about retirement recently. While neither of us are in our 60s, we can see a path forward to retiring before we hit the traditional age of 65. Here are some steps you can take if you too hope to retire early.
Watch your spending today
This might seem counterintuitive. I’m looking for ways to accumulate enough to retire on, what does it matter what I’m spending? The first reason is pretty obvious – if you’re spending every dollar (or are in debt and spending more than you have), you won’t have any money to invest. But the second reason your spending matters is something a lot of people don’t grasp. If you are used to spending less throughout your accumulation phase, you should be okay with spending less when you retire.
Basically, this is managing lifestyle creep. Instead of buying a bigger house or more expensive car, can you be happy with the house you’re in and a used Accord? Because if you’re spending $5,000 per month now and are happy, you would probably be happy spending about the same in retirement. Yet if you get used to a rich lifestyle, living on half that amount in retirement will make you feel poor.
The key here is that if you’re saving for a smaller goal, chances are you can reach it quicker. Let’s say you’re hoping to replace $5,000 while your friend wants to spend $8,000 per month in retirement. Assume you both are using the 4% withdrawal strategy. You would need to save $1.5M for retirement. Your friend? $2.4M. You could be sipping drinks on the beach while he’s still working to save up the extra $900,000.
Estimate your retirement budget
A retirement budget is slightly different than your working budget. For instance, we have two kids, one still in college. When they were in middle and high school, we paid for braces, soccer, dance, school supplies, etc. I’m guessing I won’t need braces in retirement. Similarly, we have covered the cost of their college expenses, car insurance, and health insurance. Some expenses will go away when it’s just the two of us.
Yet when we retire, the biggie we’ll be adding to our expense ledger is health care. In fact, that has caused us to reevaluate the date when we’d be comfortable retiring. We also plan to travel more and will probably be eating out more often than we are now. Try to estimate your retirement budget as closely as possible.
At what age will you retire?
If you read about FIRE adherents you will find some that were able to retire at 40 or even younger. This could result in them living more than half their life in retirement. Other people choose to work well into their 70s, perhaps spending a decade or less retired. Obviously, the amount of time you will live on your savings will determine how much of a nest egg you need.
Estimate the big number
This is where it gets mind-boggling: where you estimate the numbers of years you’ll be retired and the amount of money you’ll need, mix in a few variables, and come up with a big number. There are all kinds of estimates out there, including some that provide a multiplier for your expenses (I saw one that said multiply your expenses by 33) and others that use your income as a basis. If I were you, I would utilize online calculators, including using a Monte Carlo simulation to determine how much money you would need and if that amount would hold up for the number of years you want to be retired.
Is it doable?
Now the question becomes matching the retirement goal (the big number above) with how much you can save in the intervening years. Again, online calculators can help. They will ask you to enter how much you’ve saved, how much you can save in the future, and the number of years (along with an estimated rate of return). Hopefully your inputs will result in a savings amount that is higher than you need; unfortunately, it’s often the other scenario where your savings won’t add up to the amount you need given the time constraints.
If this happens to you, you will need to change the inputs. Are you willing to delay retirement, thereby adding in more years of savings and giving your savings more years to grow? Are you willing to reduce your expenses in retirement? Can you make more now? You can play around with the numbers to best figure out how to achieve your goals.
Use retirement accounts to their fullest…
If you’re hoping for an early retirement, utilize every retirement account available to you. Over the past few years, I’ve been able to make a catch-up contribution to my Roth IRA since I’m over 50. Additionally, we have maxed out on our normal retirement plan through work. Depending on your particular situation, you may want to invest in Roth accounts, traditional retirement accounts, or a mix. If a Health Savings Account is offered through your job, consider taking advantage of it too.
…and consider after tax accounts or other investments
If you really are pushing an early retirement – like the people who retire in their 40s – you will probably need to do more than just invest in the company 401k and an IRA. Many people who have retired early have invested in real estate to provide income. Others have used after-tax accounts, often investing in low-cost exchange traded funds.
Invest wisely
To maximize your returns, you may need to invest in riskier assets. Stocks have long achieved the largest return, averaging more than 10% over long periods of time. Yet as we know, stocks also may drop 20% for seemingly no reason and can go down 40% to 50% occasionally. This is where the wise part of investing comes in. Can you handle seeing half your money evaporate, or will you sell at a loss and turn conservative? Take an honest look at yourself and decide how much risk will let you sleep at night.
Achieving an early retirement can open up a world of possibilities for you, whether you choose to relax and read or even start another career. If you watch your spending and invest wisely, you too may find yourself considering your life after work before the normal retirement age arrives.
Photo by Kindel Media