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Early retirement isn’t just what you dream about in boring business meetings. It’s a real quest for the community of people who make up the FIRE movement – which stands for Financial Independence, Retire Early. If you want to join the ranks of FIRE and say goodbye to professional life before your sixties, here are four steps to get there.
1. Reduce your living expenses
Reducing your living expenses is a strategy that comes straight from the FIRE manual. And if you think that means you need to cancel your cable, you are only slightly right.
FIRE supporters are pushing downsizing to the extreme. You could move out of your two-bedroom apartment and settle into a studio in a cheaper neighborhood, for example. Trade in your car for a bike and you’ll waive maintenance costs as well as gasoline and insurance costs. Replace your iPhone with a generic smartphone from a low cost supplier. And yes, cancel that cable. You could hold on to your Amazon Prime membership, but only because you can use it to access free movies, shows, music and books as well as shipping.
Image source: Getty Images.
Your goal would be to live on 50% of your income or less. This frees up the remaining 50% for savings. There is also another advantage. Resizing your lifestyle today forces you to rethink what is really needed. Learn to live comfortably on less now, and that naturally reduces your income needs in retirement.
2. Increase savings
It’s an obvious point, but funding early retirement usually requires a drastic level of savings. The retirement saver who has a more traditional schedule typically needs to set aside 15% of their income for a few decades to retire comfortably. This assumes that this traditional saver must remain solvent for around 30 years. In your case, you might not have a few decades to spare, and you will definitely need your money to last more than 30 years. So you have less time, but you need to save more.
Here’s a look at the numbers. Let’s say you are 30 years old and you earn $ 48,000 a year. If you save 15% of your income, including the employer’s consideration for the next 35 years, you will accumulate approximately $ 1 million. This assumes that your contributions increase by 7% per year on average. However, to reach that $ 1 million goal in 20 years, you will need to save and invest over $ 2,000 per month, which is about 50% of your salary.
3. Diversify your savings
You could pour $ 2,000 a month into your 401 (k), but you might not want to. The IRS normally prohibits 401 (k) distributions until you reach age 59 and a half. There is, however, an exception to this rule. If you quit your job after the year you turn 55, the usual 10% penalty is waived. This age increases to 50 if you are a public safety worker. You need to withdraw the 401 (k) money from your last job.
If your goal is to retire in your 50s, your 401 (k) may support it – assuming you have enough in your most recently active 401 (k) to survive for at least a few years until you were 59 and a half years old.
To retire in your 40s, however, you’ll want to save some extra money outside of your 401 (k). Two options are a Roth IRA or a taxable brokerage account. You can withdraw your Roth contributions, but not any earnings, at any time. Earnings must remain in the account until you are 59.5 years old and it has been at least five years since you made your first Roth contribution.
The taxable account has no withdrawal restrictions, but you have to pay taxes each year on interest, dividends, and realized gains – which your Roth account does not.
4. Improve your investing game
Since your retirement schedule is short, you don’t have much room for investment mistakes. You can’t be too aggressive because you can’t afford high volatility. But you can’t be too shy either. You will have a hard time meeting your savings goals unless you see at least market-level returns in your portfolio.
So this year, become an investment student. Learn about index funds, diversification and asset allocation. Study the best practices of buy and hold gurus like Warren Buffett and Benjamin Graham. And – this one is important – review the major stock market cycles in history. Learn about the slowdowns and recoveries that followed. You want to familiarize yourself with the idea that the market can be volatile in the short term and that you can overcome these cycles.
This could be your year
It probably takes a little planning to start saving 40% or 50% of your income, but there’s no better time than now to move in that direction. When your thoughts drift into carefree days with nothing on the calendar, focus on the steps you are taking to retire early. Describe your efforts to downsize and save more, think about your strategy to avoid IRS early withdrawal penalties, and plan your self-directed investment training. Make 2021 the year you take action so your dream can take shape in the real world.
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