The typical way of thinking for most professionals is to work over a 40-year career, invest consistently into their retirement accounts, then retire once they’ve hit retirement age using the savings they’ve amassed over their careers. However, who says you can’t retire early? You may think that you need to really hit it big at an early age to achieve financial independence, but that is not necessarily true. In order to figure out how to achieve financial independence, we need to first think about the variables and factors that will allow us to retire. Once we’ve figured that out, we can think of strategies to get to that point. It is simpler than you think.
When I first discovered the early retirement and financially independent community online, I was fascinated and blown away. I never thought there were so many people out there who aimed to retire early. I never even thought it was possible. The truth was, people were doing it with dividend stocks, blogs, real estate, and other assets. I needed to learn as much as possible from these people since I realized that if I could pull off what they did, I would have so much more time to pursue personal projects, build other businesses, spend time with family, and travel for fun.
Think About Your Living Expenses
First, you need to understand how much money you’ll need to live. Some people may want to live an extravagant lifestyle, and therefore will need more money. However, other people may not want fancy cars, large houses, and extravagant vacations. The key is to figure out approximately how much cash flow you’ll need for retirement. Will your house be paid off? Will you be living in a lower cost of living area? How much should you set aside for healthcare for the rest of your life? Can you take on a part-time job to supplement your retirement income? What tax bracket will you be in? These are all factors to consider. Once you’ve arrived at a realistic annual number, you can come up with a strategy to generate that much annual income.
The Saving and Investing Strategy
Your living expenses, take home pay, and rate of return will determine the number of years it will take for you to retire with this strategy. The take home pay is how much money you’re able to collect after you have paid off all your income taxes and other expenses that come directly off your paycheck. I have charted out several scenarios below. The amount of income you’ll have in retirement is based on the 4% withdrawal rule. Although not perfect, the 4% rule estimates that you can withdraw 4% of your portfolio every year, forever. The average market return is about 7%, 4% of that is coming from real returns while 3% of that is coming from inflation. By withdrawing 4%, you’re only taking away the 4% real return and using that for your expenses.
To read the charts below, pay attention to the two axes. The left axis shows the number of years that it will take for you to retire while the bottom axis shows the savings rate. The blue line in the graph shows the different retirement scenarios for the rate of return labeled in the title of the graph. I hope that didn’t confuse you any more!
Depending on your savings rate and rate of return, it is definitely possible to retire within 20 years. It just takes a lot of discipline and frugality. You may need to cut back your expenses drastically. You may need to move to a new area with a lower cost of living.
The key is to be able to save and invest enough during your working years to build a sizable nest egg. Then figure out how much you need to live in retirement (probably less than your salary since you won't need to put away money anymore). If you withdraw 4% of that nest egg annually, is that amount large enough to cover your annual expenses? For example, if your family only needs $40,000 to live comfortably, then a portfolio of $1,000,000 will be enough to cover your annual expenses.
Please note that the calculations above do not take into account your tax rate when you retire. Depending on the tax bracket at the time, your income may be lower. Therefore, you may need to add additional years of savings or lower your expenses in order to achieve financial independence. Please use the above as general guidelines and not as an exact formula to achieve financial independence.
Other Ways to Retire
Consistently saving and investing your money over an extended period of time is a simple and effective way to achieve financial independence. However, it is not necessarily the quickest way, and definitely not the only way. There are many other ways to achieve financial independence that are beyond the scope of this post. Some of these ways include blogging, real estate income, stock options, creating and selling a business, dividend stocks, and many forms of passive income. Although I will not get into those topics in this post, I want you to get into the habit of believing and thinking that it is indeed possible to retire early and to think about the various approaches. Think about your lifestyle and expenses, then think about how to cover those expenses with minimal time and effort. Think about what kinds of skills you have and where your interests lie. The intersection of your skills and interests may be the key to unlocking your financial independence.
Professional Development and Personal Finance Blog