There’s so much press devoted to the idea of early retirement, but is it even really possible for the average person? The answer to that is almost certainly yes, but it’s all in the numbers. As in, you have to get the numbers right in order to have any hope of it working out.
Saving more than the usual amount
If you want to retire early, the most important effort on your part will be to save as much money as you can. This will go well beyond the usual recommendations of saving 10% or 15% your pay. You have to think in much bigger terms.
How much you’ll have to save will depend upon how far out into the future you want to retire. The more years than you have, the lower the percentage of your income that you need to save. Less years will mean that you’ll have to save a higher percentage.
For our purposes however, if you want to retire in a reasonable timeframe – let’s say 20 years – you will have to be saving something on the order of 25% of your gross.
There are at least two reasons for doing this…
The double-edged advantage of lowering your living expenses
By saving such a dramatically large percentage of your income you accomplish two purposes, both of which advance the case of early retirement dramatically:
- You create the funding necessary to seriously enable you to rapidly build your retirement portfolio, and
- You lower the amount of money that you need to live on – which means you’ll need less money in retirement.
The first point is self-explanatory, but let’s spend a little bit of time on the second – it’s often overlooked.
People often try to define their retirement goals based on their current living standards. Unless you’re already wealthy, saving up enough money to be able to retire without lowering your cost of living from where it is now will probably require something close to 50 years. That’s not early retirement, and that’s why we have to discount plans that include savings rates that are considered “more manageable” by conventional standards (like 10% of your income).
Early retirement is a privilege that is exclusive to either the already wealthy, or to those willing to make deep and even painful sacrifices in the present to provide for a more leisurely future. 10% to 15% just won’t get you there, not if you want to retire early.
Finding more money in your budget for savings and investing
You’re probably scratching your head wondering how you can possibly live on only 75% of your gross income. It’s a reasonable concern, but doing so is hardly out of bounds. I can say that because there are people doing it right now, though it’s not always for the purpose of saving for early retirement.
Will it be easy? Not unless you’re already doing it. If you aren’t, here are some suggestions for ways that you can make it happen.
- Cut your housing costs – Most people pay way too much for housing, without realizing that most other expenses are tied to housing. This is your biggest expense, and the richest source of savings.
- Stay out of debt – The less money that has to go into debt payments, the more you’ll have for savings and investment.
- Stop buying new cars – This is one of the best ways to stay out of debt, and it keeps insurance and ad valorem taxes low too.
- Keep entertainment expenses to a minimum – Rent videos, cook your meals at home, learn to enjoy family and friends (more than paid activities) and stay out of bars!
- Buy secondhand where ever possible – You can buy clothing, appliances, furniture, car parts and nearly everything you can think of on the cheap by buying them secondhand.
This is just a small sampling of the ways you can cut your living expenses. There are literally dozens of ways to do this without seriously affecting your lifestyle in a big way.
Making sure your money never runs out
One of the biggest challenges to the would-be early retiree is the very real prospect of running out of money after retiring. After all, since early retirement will mean that you will spend a greater portion of your life retired, the likelihood of outliving your money is far greater.
You can work around this by keeping your portfolio withdrawals limited to what is known as the safe withdrawal rate. This is probably a theory than anything else, but it is actually quite logical. The safe withdrawal rate holds that if you limit your portfolio withdrawals to not more than 4% per year, your portfolio will never run out.
For example, if you earn an average rate of return of 8% on your portfolio over the very long term, 4% withdrawals will leave 4% in your portfolio to protect it from inflation and to keep growing at least a little.
The theory isn’t perfect – if the rate of inflation exceeds 4%, the safe withdrawal rate you won’t be so safe. And if the rate of return on your portfolio is below 8%, or goes negative, for a substantial amount of time – that’s another complication. The key to the theory is that it statistically works over a period of many decades. The flaw is that you could experience a decade where it doesn’t work at all.
An early retirement example
Let’s try working an example to see how this will play out. Start with a good investment calculator to make number-crunching easy.
Next, let’s go with the following assumptions:
- You want to retire in 20 years (your age doesn’t matter for this example)
- Your total household income is $100,000 – I realize this is about twice the US national average, but we want to use round numbers
- Your after tax income is $75,000, and you plan to live on $50,000 and save the other $25,000 (25% of your gross income)
- The expected long-term rate of return is 8% per year
- You expect to make withdrawals at the “safe withdrawal rate” of 4% per year at the end of 20 years
- Your plan will never run out of money
If you invest $25,000 per year in each of the next 20 years, with an average annual rate of return on your portfolio of 8%, you will have $1,235,573 in your portfolio at the end. If you withdraw 4% per year, that will give you $49,423 for living expenses, or just about the $50,000 per year that you’ll be living on between now and then.
Meanwhile the 4% in earnings that you retain in your portfolio will keep it growing to account for inflation, so that you’ll never run out of money. Once again, it's all in the numbers.
Timing is everything
Age can be a factor when it comes to planning for early retirement. Let’s say you’re 45 years old, and planning to retire at 65; that can work especially well since that's about the age when Social Security and Medicare will be available to you. They will either reduce the amount of money that you need to have in your investment portfolio, or they can provide you with extra budgetary breathing room once you retire.
On the flipside, let’s say that you are 25 and planning to retire at 45 – it may not be quite as simple. If you are single and childless, it may be very doable. If you have a family – or plan to have one during that time – there will be some obvious complications.
First, you’ll almost certainly need to commit a greater percent of your income for the support of your family over the next 20 years. Second, at the end of that 20 years, you may find yourself still owing a mortgage on your home, and needing to provide a college education for your children.
The other hand, if your children will be grown – and their education behind is behind you – by the time you reach your targeted early retirement date, it may work out as planned. It just may require a little more creativity along the way.
Use the investment calculator in the post, and see what you can come up with for an early retirement date. Plan on saving as much money as you need between now and then to make it happen.
Does your early retirement planning look anything like this?