You've probably listened to a conversation or read an article online about people who have retired early and are now living their best lives. They've moved their permanent residence abroad, are traveling the world, or are pursuing passion projects.
These early retirement stories have probably intrigued you.
In fact, it may have made you curious as to how you can achieve this for yourself. Right? Well before you dismiss early retirement because you think it's out of reach, consider this; It might actually be something that you too can achieve.
While it won't be easy and will take hard work and discipline, the returns from your effort could mean that you can retire well in advance of when you might think!
So, let's get into exactly what you need to do to achieve early retirement too!
What does early retirement really mean?
Over the past number of decades, early retirement has meant different things to different people.
By the government’s standards, and in particular, the Social Security Administration (SSA), 67 years old is the official retirement age for everyone born in 1960 or later. If you retire early by the SSA’s standards, it means that you’ve decided to stop working and that you’ve chosen to take your Social Security benefits before 67.
On the other hand, among millennials and Gen Z, early retirement has taken on a whole new definition. Instead of linking retirement prospects to when you can stop working forever and start collecting Social Security benefits, younger generations are more focused on how soon they can stop working for money.
And that makes a huge difference.
We’re now seeing folks retiring as early as 28 and many people in their 30's and 40's pursuing this path as well. While they may no longer be working a traditional 9 to 5, they are pursuing their passion projects and some are making a good income in their retirement.
So, how much do I need to retire early?
In a nutshell, multiply your yearly expenses by 25 to 30 times.
How exactly is this estimate derived?
It is based on a concept that is known as your withdrawal rate. You see, your retirement funds are likely invested in the stock market and are earning a return. Your withdrawal rate is a percentage of the percentage growth of your investments.
For early retirement, a withdrawal rate of 4% adjusted for inflation is pretty standard for early retirees. This is called the 4% rule.
According to Investopedia, the 4% rule is a rule of thumb used to determine how much a retiree should withdraw from a retirement account each year. This rule seeks to provide a steady income stream to the retiree while also maintaining an account balance that keeps income flowing through retirement.
So if your investments are growing at 12% per year, your withdrawal rate would be 4% of the 12% growth.
For exact steps to figure out how much you need to retire early, here are 3 key steps:
1. Calculate your annual retirement spending
To really start building a clear picture of how much you will need in retirement, you will need to have a firm handle on your spending. You’ll need to know and understand what your monthly expenses are and you’ll need to be sure that you won’t make dramatic upgrades to your lifestyle that could steal away from your future income.
If you’re unsure of how much you spend per month, track your expenses. This is the easiest way to come up with firm estimates on what your spending will be.
Key items you may want to track include: Rent/mortgage, food, utilities, transportation, health insurance, clothing, entertainment, and any donations. You may have additional categories to keep in mind.
Say you do the math and determine that you will need $40,000 to live comfortably per year, you will need to have $40,000 x 25 or $40,000 x 30 to retire. Don't forget to factor in that this would be after taxes. (Numbers will significantly vary based on your lifestyle choices).
2. Determine your current net worth
Before you make a major commitment to early retirement, it is wise to know what your current financial status is i.e. know your net worth. We often associate net worth numbers with celebrities but knowing your personal net worth will help you understand where you are with your finances.
To go through this exercise, you can simply do it with pen and paper.
What you’re looking to determine is your assets (minus) your liabilities.
This metric is good to know especially if you have a negative net worth. A negative net worth could be an indicator of student debt or commercial debt that you may be carrying. Whatever the case, the more positive your net worth, the better position you’ll be in to retire early.
Keep in mind that as you earn more over your working years and with good money management, your net worth will go up.
3. Create a budget and strategy based on what you know
The key to successful early retirement is the ability to live within your budget. If you’ve budgeted $4,000 a month in spending but then start spending $6,000 instead, you’ll potentially derail your retirement strategy.
As you go through your budget creation process, be sure to make realistic assumptions based on your spending habits as mentioned earlier. If you know you like eating take-out, include that in your budget as opposed to budgeting based on lifestyle choices you hope you will make in the future!
7 Key steps to early retirement
Step 1: Create focused goals for your retirement
The word “retirement” often draws images of someone lounging away at the beach all day doing nothing.
While that is true for some folks, it masks the hard work and dedication it took to get there. Specifically, to retire early, you will need to create and stick to savings and investment goals.
You’ll have to dig deep to understand what works best for you. Are you a completely digital budgeter? Do you track everything in Excel? Do you keep a notebook? Whatever the case is for you, clear goals focused on helping you hit your retirement targets are the best way to guarantee you’ll hit them.
Step 2: Monitor expenses and cut back on your biggest costs
If you’re looking for the fastest ways to cut back on your costs it’s to simply revisit your big-ticket spending items each month. For almost everyone, this would include rent or a mortgage and transportation.
Are you living in an apartment that is way above your means? Common wisdom says to spend no more than 30% of your income on rent. If you’re way above this guidance, you may want to consider moving somewhere cheaper. For instance, moving from a $1,600 apartment to a $1,100 apartment automatically saves you $500 a month. This quickly adds up! You also consider roommates or renting out a room in your home.
The same thing applies to transportation. If you live in a big city and don’t need a car, don’t get one. If you do need one, go with a used car. You’ll achieve the same purpose of getting from point A to point B at a fraction of the cost.
Step 3: Take advantage of employer-sponsored plans
Many employers offer really amazing perks to their employees such as a health care plan or 401(k) plans. Many times with a company match; You don’t want to miss out on this! If you have access, sign up and be sure to understand the full potential of the benefits so you don’t miss out on potential 401(k) matches that could boost your retirement savings.
Step 4: Automate & diversify your investments
You never know what direction life will take tomorrow. Tech could be the hottest thing today but tomorrow it could be real estate. Putting all your eggs in one basket is unwise because you can bet your bottom dollar that things will indeed change!
Diversification is always wise. If you’re unsure how to set up your investment strategy, check out our course on investing so you can get started today!
Step 5: Create multiple streams to increase your income
Diversification is not just key for your investments, but also for your income. Instead of waiting for just your paycheck from your 9 to 5 at the end of the month, you can easily make additional dollars by thinking outside the box. Establishing multiple streams of income not only increases your income but serves as a buffer in the event of a job loss. For instance, side hustles, investments, etc.
You'll want to be careful though. If you’re looking to retire early, make sure this extra income goes towards your goal of early retirement.
Step 6: Start a side hustle
The most obvious way to get started with additional income streams is by starting a side hustle (or multiple side hustles). The internet is full of opportunities to do so. You can sign up on sites such as TaskRabbit, you can babysit or house sit or you can create content online through YouTube and blogging to help you earn additional income.
Step 7: Ask for a raise
Have you been doing a great job at work? If so, you should definitely ask for a raise. Many people leave money on the table by not asking for a raise based on their stellar performance. It’s an easy way to earn additional income on the work you are already doing!
How to maintain your early retirement
Retiring early is one thing, but maintaining it also takes a little bit of discipline and planning. Here are a few tips to guarantee that you stay on track with your goals!
- Use the 4% rule investment strategy
As mentioned earlier, if you’re looking for a good estimate of how much you can safely withdraw on your investments, you can assume a withdrawal rate of 4% based on the 4% rule described above. This is a percentage of your investment growth, so the healthier the growth on your retirement account, the better income you’ll see when you make a withdrawal.
- Live within your means
Depending on your spending habits, this one could be hard or easy. The key is to remember to live within your means – always. A little splurge here and there is completely within reason but living beyond what your nest egg can afford you is a recipe for re-joining the workforce halfway through retirement.
There are various tricks and tips you can use to regulate your spending some of which include automating all your spending, sticking to a budget, and redesigning your lifestyle choices. Instead of splurging on foreign vacations to expensive locations, why not explore local destinations or travel hack your way through international travel? Your wallet will thank you for it.
- Continue to generate income doing what you love on your own terms
The way that we work has fundamentally changed. Back in our parents' day, people would do work to put food on the table. Nowadays, people look for work they find rewarding. The beauty of early retirement is that you can truly continue to generate income doing what you love on your own terms. Are you an avid photographer? Photograph weddings and other big life events in your spare time. Do you love cooking? Start a food blog. The opportunities to earn income from what you love are endless!
- Maintain a budget in retirement
You can have all the tricks in the trade but the key to building a successful retirement strategy is to maintain a solid budget. This will help you constantly check the temperature on your spending and ensure that you’re working within reasonable limits.
Early retirement is not a far-fetched idea regardless of your income and age. However, in order to achieve it, it's important to first set the intention and adjust your mindset for the journey ahead towards achieving your dream. The key is to start making sound financial decisions and to get started today!