Some people never want to retire. In fact, some research shows that the happiest seniors are those who continue to work, at least part-time, as long as they can. Nevertheless, others cannot wait to retire and are focused on achieving financial independence as soon as possible. Few things give you a greater sense of freedom than knowing you do not need to work anymore, even if you choose to. This type of financial freedom is possible prior to Social Security age for young families willing to make some sacrifices.
The simple truth is the higher your savings rate, the sooner you can retire. Pretty simple, eh? You must spend less and/or earn more if you want to move up your retirement date. Spending less seems to be more practical and achievable for most families. The biggest categories (by far) to make a real dent in spending are housing and transportation (e.g., cars). Those two categories represent around 63% of the typical household budget, whereas entertainment is only 5.5%, clothing 3.5%, and food 13%. So if you want to retire early, you most likely will need to live in a modest home and drive used cars until the wheels fall off. The good news is smaller houses and older cars are unlikely to reduce your happiness level significantly. A growing body of research shows that we get the greatest happiness (per dollars spent) by spending our money on experiences, not material things.
Conventional wisdom is you need to save 10-15% of your income to retire by age 65 at a similar lifestyle to what you enjoyed while working, assuming you will not have a pension, inheritance, or any plans to downsize your residence. You will likely need a 25-30% savings rate throughout your career in order to retire in your early to mid-50s.
The average American has not demonstrated a willingness to save nearly this much. The average savings rate in the U.S. is only around 5%, which includes contributions to company retirement plans, such as 401ks. Here is an idea: If your savings rate is too low and the idea of budget cuts is too painful, simply commit to saving 50% of all future raises and bonuses. One big benefit of this strategy is keeping a lid on lifestyle creep, in which your expenses grow proportionally with your income. Lifestyle creep just increases the amount you will need to maintain your lifestyle in retirement.
Here are a few other early retirement tips:
- Start investing as young as possible. Savings is a habit that should start with a person’s first paycheck. You can save just over $998,000 by age 60 if you invest $5,000 a year starting at age 20 and average 7% investment returns. However, if you waited until 30 to start saving, your nest egg would only be $472,000 by age 60.
- Invest aggressively, assuming a time horizon of 10 years or more. The chances of retiring early are very slim if you keep your money in the bank or in very conservative investments. That most likely means investing in stocks, which have averaged about 10% per year over the past 90 years. Most investment analysts expect more modest returns in the future, so dial back those expectations a bit (e.g. 7-9%).
- If you are planning on Relocating in Retirement, consider a state with lower state income taxes and a lower cost of living. Check out: 23 Cheap Places Where You Will Want To Retire.
- When you consider the Cost Benefits of Downsizing make sure you are not simply trading maintenance costs for steep association fees.
- Avoid debt. Never borrow money for anything that is going to depreciate (e.g., car). Plan to have your home paid off by your planned retirement date.
Here is a cool (yet simplistic) When Can I Retire Calculator. This calculator assumes 5% investment returns after inflation and a 4% withdrawal rate once you retire.
Have a great week.
P.S. If you are already retired, pass on these tips to your kids.