“I'm never going to be able to retire.”
Have you ever mumbled this to yourself?
If you have, you're not alone.
Over 1/3 of all Americans don't believe they'll have enough money to live off of in.
With all the pessimistic view on, then how in the blue blazes are there outliers that are able to buck the trend and retire in their 30's?
While they may be on the extreme side of retiring early there's a lot to be learned from them.
So yes, even if you are one of pessimistic souls that believes that you can't retire early, here are 7 simple early retirement strategies you can implement today.
1. Know Your “Numbers”
Your “numbers” are the amount of money that you will need live on in retirement. There are two of them,
- The annual amount of income you will need to live on in retirement, and
- The size of the retirement portfolio that will be needed to generate that income.You have to start with the income number, since that will determine how large your investment portfolio needs to be.
Calculating your needed retirement income
The conventional wisdom is that you should plan to be able to retire on an income that is 80% of your pre-retirement income. That’s not bad since it will keep it simple, but you may want use that as a starting point only.
Depending on what your plans are for your life in retirement, the actual number could be higher or lower. For example, if you expect that health insurance will be more expensive than it is now, you’ll have to make an upward adjustment. If you expect that your housing will be lower, due to either downsizing to a less expensive home or paying off your mortgage, you can make a downward adjustment.
Once you have your income number figured, you can then calculate the size of the investment portfolio that will be necessary to produce that income.
Calculating your needed retirement portfolio amount
This is where another convention comes in handy. It’s called the safe withdrawal rate, and it’s loosely based on the idea that if you withdraw 4% of your investment portfolio each year as income, your portfolio will never run out.
This connection is probably based on the expectation that the portfolio will produce an annual rate of return of somewhere between 6% and 10%. That means that not only will there be enough income to cover your withdrawals, but enough return that your portfolio will keep growing.
Using the 4% safe withdrawal rate, we can calculate that whatever your necessary annual income number is, you can multiply it by 25 to determine how large your portfolio will need to be. 4% is 1/25 of your portfolio, so if you create a portfolio that is 25 times larger than the annual income requirement, you’ll arrive at your investment portfolio number.
So let’s say that you will need $40,000 in investment income to retire. In order to calculate how large your portfolio will need to be to produce that income within the scope of the safe withdrawal rate, you can simply multiply it by 25. In this case, $40,000 X 25 = $1 million.
But we’re not done yet.
Calculating inflation into the mix
You’ll also need to factor inflation into your plans. If you’re 30 years old, you want to retire at age 50, you’ll have to calculate – approximately – what inflation will do to your needed $1 million investment portfolio over the next 20 years.
There’s no way to know what inflation will be in the future, but you can estimate it based on past history. You can do that by going to the Bureau of Labor Statistics inflation calculator, and tracking what inflation has done over the past 20 years.
Using the inflation calculator, we can see that $1 million in 1995 will require $1.54 million to maintain equivalent purchasing power in 2015. We can project that number forward 20 years to 2035, and use $1.54 million – or roughly $1.5 million – as the target number for your investment portfolio.
And not to make matters even more complicated, but you may also need to plan for contingencies in your income number too. If you plan to purchase a boat or an RV, that will have to be reflected in the size of your retirement portfolio.
2. Lower Your Basic Cost of Living
Simply put, the less money you need to live on, the more you’ll be able to save, and the sooner you’ll be able to retire.
Keeping your basic cost of living to a minimum will provide you with the extra cash that you will need to save for retirement.
But at the same time, it will also condition you to living on less money, which will certainly help once you reach retirement itself.
This may mean driving older, less expensive cars, avoiding restaurant meals and costly entertainment, and keeping vacations close to home, or not taking them at all.
Todd Tresidder at FinancialMentor.com wrote about an unconventional yet powerful idea to lower cost of living:
Consider moving from a high cost of living area like San Francisco, New York, or any other major city or coastal area to a low cost alternative such as the South, Midwest, or even a foreign country. The cost differential can be as dramatic as night and day so don’t dismiss this possibility lightly.
Several things to consider before moving include proximity to family, friends, and important medical providers. Are there other retirees to connect with, and how does the lifestyle fit your retirement interests?
Consider visiting the area first and renting for awhile so that you can try before you buy. There are many low cost alternatives for retirement living including moving abroad so try visiting and renting at several until the fit feels just right.
Would you be willing to relocate to keep costs down? It just might be the very thing that makes or breaks your retirement.
Retiring at the rip old age at 30, Pete who runs the wildly popular blog Mr. Money Mustache knows a few things about reducing your spending. He says,
Our giant culture-wide misconception that reducing our spending will lead to a less happy life. In practice, the reverse is almost always true: voluntarily scaling back luxuries, increasing the level of challenge in your life, and banking the enormous surplus of money that results is probably the fastest way to gain control, satisfaction, and happiness.
So the answer to early retirement is much easier than most people think: really understand and streamline your spending, and use the savings to invest heavily in a low-cost index fund like Vanguard's LifeStrategy or Betterment. Once you have 25-30 times your annual spending invested in this account, you can quit working forever.
If you save 50% of your take-home pay and live on the remainder, your entire mandatory working career only needs to be 17 years. After that, you're financially free and can do whatever you want – continue work, all play, or a healthy mixture of the two.
Mr. Money Mustache also explained the difference between conventional advice and his radical, but effective advice:
For almost two years, I’ve been preaching a different brand of financial advice from what you see in the newspapers and magazines. The standard line is that life is hard and expensive, so you should keep your nose to the grindstone, clip coupons, save hard for your kids’ college educations, and save any tiny slice of your salary that remains into a 401(k) plan. And pray that nothing goes wrong in the 40 years of career work that it will take to get yourself enough savings to enjoy a brief retirement.
More from GFC, Below
Mr. Money Mustache’s advice? Almost all of that is nonsense: Your current middle-class life is an Exploding Volcano of Wastefulness, and by learning to see the truth in this statement, you will easily be able to cut your expenses in half – leaving you saving half of your income. Or two thirds, or more.
He also explains how to practically cut expenses:
Here’s how to cut your life costs in half. Start by getting rid of your Debt Emergency if you have one.
Live close to work. Move to another city if you enjoy adventure. Don’t borrow money for cars, and don’t buy stupid ones. Ride a bike wherever you can. Cancel your TV service. Stop wasting money on groceries.
His list goes on and on. It's definitely worth a look!
If you’re serious about early retirement, you’ll need to embrace all the steps that will be needed in order to make it happen. I put together a list of 15 Reasons Why You Won’t Be Able to Retire Early to outline habits and mindsets that will sabotage efforts to retire early. Not coincidentally, how you spend your money is a big part of those habits and mindsets.
3. Stay Out of Debt
Debt is another one of those bad habits that will sabotage your early retirementefforts, and a big one of that. Debt reduces your cash flow, and that will cut into the amount of money that you’ll have available to save for retirement.
There’s also a toxic mindset associated with debt when it comes to retirement. If you get too comfortable with debt, there’s a very good chance that you’ll carry some, or even a lot, into retirement. That will only raise your cost of living, and make early retirement far less certain.
Todd Tresidder at FinancialMentor.com highlights the importance of eliminating all consumer debt in preparation for retirement:
Credit card debt is wasteful and expensive. Pay off your highest interest balances first and use the money freed up as each card gets paid off to accelerate the payoff of the remaining cards. Never spend more in a month than you can afford so that no new debt is accumulated.
Never settle for making just minimum payments on credit cards because it is financial suicide on the installment plan: it makes compound interest work against you instead of for you. The sooner you stop overspending and pay down existing debt, the sooner that money can be redirected to investments so that you’re financing your retirement as a wealth builder instead of the bank executive’s retirement as a debtor.
Todd brings up an excellent point: it's a good idea to ensure compound interest is working for you, not the financial institutions.
Not only do you need to get out of debt, you need to stay out of debt and put the savings toward your retirement plan.
4. Don’t Buy a House That Will Own You
Have you ever heard of the term house poor? That describes the condition of living in a beautiful house, but one that costs so much that it leaves you very little money to do anything else. Being house poor is not a positive state of existence when you’re planning for early retirement.
Not only is your house a long-term expense that will have a major impact on your cash flow, but it is also the kind of purchase that can set the spending tone in your life. For example, a higher end home will require more costly maintenance, more expensive furniture, typically higher utilities, and higher maintenance costs, particularly in regard to landscaping.
When it comes to housing and early retirement plans, you’ve got to be guided by the less is more doctrine, as in less house result in more savings.
5. Save More Than You Thought You Ever Could
If you plan to retire in 40 years, you can probably get away with saving 10% or 15% of your income every year. But if you plan to retire in 15 or 20 years, you have to up your game. 30%, 40% or even 50% will be more likely.
You shouldn’t allow yourself to be limited by employer plan contribution limits either. Contribute to a traditional or Roth IRA if you can qualify. Save money outside of your retirement plans.
If you’re self-employed, consider setting up your own 401(k) plan, also known as a Solo 401(k) plan. The contribution limits on these plans is incredibly generous. In fact you can even set up one of these plans for a side business, and really accelerate your retirement savings.
One big advantage of a solo 401(k) plan is that under IRS regulations, 100% of the first $18,000 ($24,000 if you‘re 50 or older) of your income can be contributed to the plan for 2015. And since you’re also the employer, you can contribute an additional 25% of your total income.
For example, if you earn $60,000 from your business, you can contribute $15,000 ($60,000 X 25%) to the plan as employer, plus up to $18,000 as an employee. This will give you a total contribution of $33,000, on an income of $60,000. Do you think that might get you to early retirement faster?
6. You May Need to Increase Your Income
If you don’t believe that you will be able to achieve your retirement portfolio number by the time you will to retire, you may need to increase your income. But if you do so, make sure that 100% of the extra income actually goes and retirement savings.
There are several possibilities here. You can work to get a better paying position, or you can take on a part-time job. You can also set a side business (where you can set up that Solo 401(k) plan), or simply take side work based on any special skills that you have.
You don’t have be locked into one method either. You can work a part-time job for a while, run a side business for a time, then do side jobs.
7. Make “Balance” Your Investment Guiding Principle
Be reasonable in your projection of your anticipated rate of return on your investments. An unrealistic rate of return (ROR) on your investments could cause you to save too little under the misguided assumption that you’ll make it up in returns. As well, if you set the ROR bar too high, you may find yourself speculating to make those returns a reality.
Warning: Speculating is not investing. Whether you want to invest $100 or how to invest $20000, you need to begin. You could end up losing money, and that will put an end to your early retirement plans.
What’s reasonable when it comes to ROR?
The average annual rate of return on the S&P 500 Index has been in the ball park of 10% since 1928. Investing in index funds based on the S&P 500 should get you that kind of return over the coming decades.
If you assume a 10% average annual rate of return on your stock holdings, you can expect an overall rate of return on a portfolio comprised of 80% stocks and 20% fixed income securities to be in the neighborhood of 8% (since fixed income investments currently pay close to zero in interest!). So use 8% as your anticipated rate of return on your investments for planning purposes. It’s reasonable.
Calculating Your Strategy to Hit Your Retirement Portfolio Number
Bankrate has an excellent 401(k) savings calculator that will allow you to determine exactly how much money you‘ll need to save each year in order to make early retirement a reality.
We’ll use it to calculate how much you will need to save each year in your 401(k) to enable you to hit your retirement portfolio number.
Let’s assume that you’re 30 years old, earning $60,000 per year, you want to retire at age 50, and you currently have $100,000 invested in your 401(k) plan.
As discussed in Strategy #1 above, you will need $40,000 a year in income, which will require an inflation-adjusted portfolio of $1.5 million. Using the Bankrate 401(k) savings calculator, how much will you need to contribute to your 401(k) plan each year?
- Percent to contribute: 30% ($18,000)
- Annual salary: $60,000
- Annual salary increase: 2%
- Current age: 30
- Age of retirement: 50
- Current 401(k) balance: $100,000
- Annual rate of return: 8%
- Employer match: 6%
- Employer match ends: 50%
Saving 30% of your income in your 401(k), or $18,000 per year (the 2015 401(k) plan contribution maximum), your 401(k) plan will grow to $1.424 million by the time you reach age 50. That’s a little bit shy of the mark of $1.5 million that you will need, so you will have to plan on saving money outside of your retirement plan in order to reach the goal.
It’s certainly a tall order, but it is doable. By using all seven of these strategies, you’ll make it happen.
This post originally appeared in Forbes.