There are all different ages that people want to retire at, and for many people, it’s as early as possible! According to the United States Social Security Administration, the typical age of retirement is 65. We use this age as our baseline for financial plans to run scenarios based on how early or late people want to retire. Many people want to retire early but do not know the steps to take in order to do so. If that’s you, here are some actions you should be taking.
Define Your Goals
Early retirement can have a different meaning depending on who you ask. Retirement gives you the flexibility and independence to live life on your terms. Maybe you want to leave your desk job for something more creative and less stressful. Or travel the world? Or do volunteer work? Each goal has its own price tag.
The first step of retirement is defining what that means to you and to build a financial plan to help you get there.
Invest for Growth
You are not going to be able to retire at 50 by investing in low interest-bearing assets. These types of assets include CDs, bonds, or your checking/savings account.
To invest for growth, you’ll need to own equities (stocks). The stock market has an annualized return of just above 10% going back to 1926. Be mindful when trading individual stocks, options, or speculative investments because for most retail traders this leads to long term underperformance. Owning a diversified ETF or mutual fund is often a more suitable strategy.
Make sure to invest based on your age and how long you have until retirement. As you approach retirement, you will want to reduce your exposure to risky assets.
Save Early
As a young investor, time is on your side. The sooner you invest your money, the more you’ll benefit from compound interest. This occurs when you earn interest on both the money you’ve saved and the interest you earn. It’s your money making more money.
For example, if you deposit $10,000 and receive a 5% return, you’d get $500 interest after a year. In year two, you would have $10,500. If you made 5% again you would now make $525 on interest payouts. As time passes, you’ll earn interest on even larger balances.
The chart below shows how investing early can make a significant impact on your savings. For more information on this topic, check out my post “5 Reasons to Start Investing Early”.
Save More
A common saving rate is 15% of your pre-tax income. This may be enough for you to retire at 65 and live a comfortable retirement depending on how you invest it. This is a relatively average retirement age and saving amount. Everyone has different financial goals and if this works for you that’s great!
But if you’re serious about retiring early, plan to save more than the average amount. That might mean saving 20% or more of your income.
Max Out Retirement Savings
One common trait you often see in early retirees is they maxed out their retirement accounts. Taxes can be underestimated for retirement planning. A great way to reduce your tax liability is to take advantage of tax-sheltered retirement accounts.
Which account you should be contributing toward depends on your situation. Some of the most common are your Roth IRA, 401(k), 403(b), HSA, etc. With these accounts you can benefit from tax free or tax deferred growth on your earnings.
The more earned income and investment income you can shelter from taxes, the better.
The negative is the restrictions on early withdrawals. You won’t be able to take money without a penalty from most retirement accounts until you’re 59 ½. However, you can dip into your Roth IRA and take out contributions tax-free at any time. Roth conversions and investing in taxable accounts may be worth looking into if you plan to retire before 59 ½.
Live Below Your Means
“People who live far below their means enjoy a freedom that busy people upgrading their lifestyles can’t fathom.” -Naval Ravikant
One financial habit you must get into is living below your means. Meaning you spend less than you make. For example, if you make $100,000 a year after tax, you’ll live on $70,000 and save the rest. People who are constantly upgrading their lifestyle end up living paycheck to paycheck.
Living below your means is not easy to do. But you need to remember to pay yourself first! A great way to do this is by automating your savings. Each month set aside a certain percent or dollar amount towards savings.
Stay Out of Debt
Credit card debt should be a last resort if you can’t pay your bills. Interest rates can be as high as 20%, meaning you’re paying a dollar for every five you’ve borrowed. This can hamstring your finances at any stage of your life.
Other debt such as student loans, mortgages, and car loans generally have more reasonable interest rates. But even though you’re able to have large amounts of debt, doesn’t mean it’s a good idea. When debt is interfering with achieving your financial goals, it’s too much.
A rule of thumb is to not let your total household debt exceed more than 36% of your gross monthly income (Debt to income ratio). If you want to retire early, you will want to reduce this number and avoid taking unnecessary debt.
Bottom Line
Money can’t buy happiness or health, but it can give you independence. The ability to do what you want when you want. For many that could mean retiring early, and for others it could mean flexibility in their careers. If you follow the steps above, you will be a step closer to financial independence.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimers and Sources:
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy ensures success or protects against loss. This information is not intended to be a substitute for specific individualized tax advice. The Standard & Poor’s Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Investments in real estate may be subject to a higher degree of marker risk because of concentration in a specific industry, sector, or geographical sector. Other risks can include, but are not limited to, declines in the value of real estate, potential illiquidity, risks related to general and economic conditions, stage of development, and defaults by borrower. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Treasury Inflation-Protected Securities, or TIPS, are subject to market risk and significant interest rate risk as their longer duration makes them more sensitive to price declines associated with higher interest rates.
