How to retire early
Retiring early isn't easy to do. If it were, you'd see more people doing it.
However, it's possible if you have solid strategies and patience. Early retirement doesn't have to be wishful thinking. Here are five steps to take to prepare for an early retirement:
1) Make some adjustments to your current budget
No matter how you want to slice it, retiring early means making some changes to how, you earn and spend money. For most people, that means cutting their budget to the bare minimum, which may be uncomfortable until you adjust. Many people with early retirement ambitions aim to live on 50% of their income (or less). The rest gets funneled into savings. It's also wise to find ways to bring in some extra income that can go directly into your early retirement.
2) Calculate your annual retirement spending
Add your final monthly expense estimates up, multiply by 12, and you have the magic number: your annual retirement needs. To make it truly magical, we'd recommend increasing it by 10% to 20%, so you have some wiggle room. You never know when you'll want to splurge on a haircut. Two things that are frequently overlooked during this tally, both of which could put an early end to your early retirement: taxes and health care. Health care is a real hitch in many plans, especially for those who get their health insurance through work pre-retirement. Leaving that job means leaving your policy behind.
3) Estimate your total savings needs
The work you did to nail down spending already has you halfway through this one, thanks to a couple of rules of thumb widely used by early retirees.
The first is the rule of 25: You should have 25 times your planned annual spending saved before you retire. That means that if you plan to spend $30,000 during your first year in retirement, you should have $750,000 invested when you walk away from your desk. $50,000? You need $1,250,000. Incidentally, this is good motivation to get that budget in check. The rule assumes that your retirement nest egg is invested, so it continues to grow — after all, thanks to inflation, your spending will increase at least slightly each year, and your investments need to keep up with that. Which brings us to the second rule: the 4% rule, which indicates you can withdraw 4% of your invested savings during your first year of retirement. Each year after, you draw that amount adjusted for inflation.
4) Invest for growth
At the risk of stating the obvious, retiring early means (1) you have a shorter period during which you can save, and (2) you have a longer period during which the money you've saved needs to support your spending.
Both of those mean investment returns are going to be your best friend. It's important to remember that the time you spend in retirement should be included in that horizon — you might be retired for 50 or 60 years; you need your money to continue to grow during that time.
5) Keep your expenses in check
You've done a fair amount of work, estimating how much you'll spend in retirement. The harder job will be actually sticking to that estimate.
It starts small: You throw yourself a retirement party. Then you find yourself with some extra time on your hands — you're retired, don't forget — so you plan a vacation, mindlessly browse stores, take up gourmet cooking, or adopt a dog. Suddenly that 4% has a one in front of it.
Don't do that. Not to state the obvious, but the 4% rule only works if you stick to the rule. It's designed to allow your spending to increase with inflation, but not to withstand significant spending increases beyond that. Each spending increase — particularly recurring expenses, like a new debt payment — increases your likelihood of running out of money.
For most people, running out of money means running back to work. So in order to prevent that, you'll have to have self-discipline.
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