Early retirement is not just the subject you dream about during boring work meetings. It is a true search for the community of people who make up the FIRE movement – which means Financial Independence, Early Retirement. If you want to join FIRE and say goodbye to professional life before age 60, here are four steps to make it happen.
1. Reduce your cost of living
Reducing your cost of living is a strategy that came straight from the FIRE manual. And if you’re thinking it means you need to cancel the cable, you’re just a little bit right.
FIRE proponents take downsizing to the extreme. You can move from your two-bedroom apartment to a studio in a cheaper neighborhood, for example. Exchange your car for a bicycle and you are exempt from maintenance, gas and insurance costs. Exchange your iPhone for a generic smartphone with a low-cost provider. And yes, cancel that cable. You can hold on to your Amazon Primary subscription, but only because you can use it to access free movies, programs, music and books, as well as for shipping.
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Your goal would be to live on 50% of your income or less. This frees up the other 50% for savings. There is another benefit as well. Reducing your lifestyle today forces you to rethink what is really needed. Learn to live comfortably on less now, and this will naturally reduce your retirement income needs.
2. Increase the economy
This is an obvious point, but financing an early retirement usually requires a radical level of savings. The retirement saver who follows a more traditional schedule generally needs to set aside 15% of income for a few decades to retire in comfort. This assumes that this traditional protector needs to remain solvent for about 30 years. In your case, you may not have a few decades to save, and you will certainly 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’re 30 and make $ 48,000 a year. If you saved 15% of your income including the employer’s salary for the next 35 years, you would accumulate about $ 1 million. This assumes that your contributions are growing at an average of 7% per year. To achieve the goal of $ 1 million in 20 years, however, you would have to save and invest more than $ 2,000 a month – which is about 50% of your salary.
3. Diversify your economy
You could dump $ 2,000 monthly into your 401 (k), but you may not want to. The IRS normally prohibits 401 (k) distributions until you reach the age of 59 and a half. However, there is an exception to this rule. If you leave your job after turning 55, the usual 10% fine will be waived. That age decreases to 50 if you are a public security worker. You have to take the 401 (k) money from your most recent job.
If your goal is to retire at 50, your 401 (k) can handle it – assuming you have enough in your 401 (k) most recently to survive for at least a few years until you reach 59 and a half.
To retire at age 40, however, you will want to save additional funds outside of 401 (k). Two options are a Roth IRA or a taxable brokerage account. You can withdraw your Roth contributions, but not your earnings, at any time. Earnings must remain in the account until you are 59 and a half years old and it has been at least five years since you made a Roth contribution the first time.
The taxable account has no withdrawal restrictions, but you have to pay taxes annually on interest, dividends and realized earnings – which is not the case in your Roth account.
4. Step up your investment 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 too much volatility. But you also can’t be shy. You will have a hard time achieving your savings goals unless you are seeing 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 purchasing and maintenance gurus like Warren Buffett and Benjamin Graham. And – this is important – analyze the main stock market cycles in history. Read about decelerations and the recoveries that followed. You want to be comfortable 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 some planning to start saving 40% or 50% of your income, but there is no better time than now to move in that direction. When your thoughts stray to carefree days with nothing on the calendar, shift your focus to the steps you are taking to retire early. Describe your efforts to reduce and save more, think of your strategy to avoid early IRS withdrawal penalties, and plan your self-directed investment education. Make 2021 the year you act to make your dream come true in the real world.