It seems that many people under the age of 50 are planning for (or at least dreaming of) early retirement. Making that happen, though, requires a concerted effort. You’ll need to save an outsized percentage of your income, and invest it consistently.
You’ll also have to cut your living expenses, and probably by a lot. If you do that, you increase your chances of actually achieving an early retirement. That’s not where the work stops, though. You’ll need to keep those expenses down to a reasonable level in order to ensure that you aren’t forced to come out of your retirement later down the road.
Learning to reduce your spending is the other side of the retirement planning coin — and it’s one aspect that you absolutely can’t ignore.
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Make Room in Your Budget for Saving A Lot of Money
Even if you are planning to retire at a traditional retirement age (like 65), it will be tough enough to accumulate a retirement portfolio capable of keeping you comfortable for the rest of your life. Many of us heard our parents talk about “a million to retire on,” but new studies suggest that number falls far short. Millennials are expected to need $1.8 million for retirement, on average, with their slightly-younger counterparts requiring $2.5 million plus. Start dreaming of a retirement age closer to 50, and your goals become much more difficult.
Retiring early means you won’t benefit from quite as many decades of saving and investing money. You also miss out on its accompanying compound interest. To compensate, you’ll either need a higher-than-normal rate of return on your investments or to save a higher amount of money. Since high rates of return are almost always accompanied by significantly higher risk, the emphasis will almost certainly need to be on the savings side.
If you plan to retire early, saving the usual recommended percentages of your income – 10%, 15%, or even 20% – won’t cut it. You’ll need to save a lot more.
Resource: Use our Financial Freedom Calculator to determine how much you should save
Let’s say that you are 30 years old, and you want to retire by the time you’re 50. That gives you a 20 year window to make it happen. If you decide that you will need a return from your investments of at least $40,000 per year, that will require saving about $1 million (applying the safe withdrawal rate of 4% to your investment portfolio).
By way of example, if you earn $75,000 per year, save 10% of your income (or $7,500 per year), and invest it at an average annual rate of return of 8%, you will have $368,142 by the time you’re 50. That clearly won’t get the job done.
In order to get to the magic $1 million mark, you have to save three times as much… or about 30% of your income. Investing $22,500 ($75,000 X 30%) per year for 20 years, at an average annual rate of return of 8%, will produce a portfolio of just over $1.1 million.
Related: How Much Do You Need To Retire?
It’s probably safe to say that most people could save 10% of their incomes with relatively little sacrifice. But saving 30% of your income is likely to be downright life-changing.
That isn’t just a matter of clipping coupons and cutting out cable TV, either. You’ll probably have to reduce or eliminate some serious expenses. You may have to commit to living in a less expensive residence, driving an older (paid off) car, or cutting out vacations. To pad your savings, you might need to trim back a number of luxuries that many people consider “necessary” to modern suburban living.
It’s part of the price you will have to pay for the reward that is early retirement. How badly do you want it?
Hold a Retirement Dress Rehearsal
This doesn’t get nearly as much attention as investment strategies. But it’s the all-important B-Side to retirement planning, and much more so when it comes to early retirement.
Saving and investing money for retirement is obviously mission-critical. But you will also help your own cause by learning to live on less. After all, the less money that you need to live on, the less income your investments will need to provide.
By cutting your living expenses now, you will be preparing yourself for the time when you retire. This is more important than it seems on the surface. Lifestyles are all about habits, and habits are behaviors that you are comfortable with. Unless you expect to be downright wealthy by the time you retire, cutting basic living expenses is an important secondary strategy.
Say you earn $75,000 per year and take home $50,000 (after income taxes, 401(k) contributions, etc.). If you get comfortable living on that income level, you may find it very difficult to manage the reduced income that early retirement will almost certainly require.
If you condition yourself to living on less money now, the transition won’t be a problem later. By saving a high percentage of your income, you also force yourself to live on less money. That will reduce at least some of the stress from saving money, and serves as an important dress rehearsal for your actual retirement.
Make Your Money Last the Rest of Your Life
People who retire at traditional retirement ages consider this to be a major concern. If you are retiring early, it will be an even bigger worry. Say you can reasonably expect to live to 85. If you retire at 65, your money needs to last for 20 years. But if you retire at 50, it will need to last for 35 years.
Part of that will be accomplished by intelligently and consistently investing your money during retirement. But perhaps an even bigger side will involve expense control. The less money that you need to live on, the longer you can make your investment portfolio last.
This will be especially important during years, or even cycles, when the investment markets are not performing well. By keeping your cost of living low, you may be able to reduce the amount of money you withdraw from your retirement portfolio for living expenses.
Have a contingency budget — something like a secondary budget that you will employ during stock market down cycles. This can be even more effective at making your money last for the rest of your life.
Master the Art of the Allocation
If you’re serious about retiring permanently, you’ll have to be fully capable of living on a fixed income. That will require the ability to balance and allocate scarce resources. It’s the kind of discipline that you develop from living beneath your means. If you embrace it now, you’ll be a pro at it by the time you retire.
For example: a dilemma that you are very likely to face with earlier retirement is health insurance. You’ll be too young to qualify for Medicare, but since you are no longer employed you will no longer have the benefit of employer-subsidized insurance. You’ll have to be able to figure out a way around the issue. That will almost certainly involve reducing costs elsewhere in your budget.
Make it a habit – or better, a lifestyle — of cutting expenses and living on less than you earn. Adjusting to expense challenges will be easier to manage in the future.
Health insurance is just one (major) example where early retirement will force you to allocate your now-limited resources. It’s an acquired talent, but once you do you’ll be much better able to deal with the financial challenges that will await you in early retirement.
No matter your ideal retirement age, it’s important to learn how to significantly cut your living expenses now. Save more, spend less, and figure out how much you actually need to live comfortably. If you can reduce your spending now, you’ll have a far better chance of accumulating the money that you will need to fund your early retirement. You’ll also have the discipline to adjust to a minimized cost of living, and deal with any financial hiccups that may occur.