Many people would like an early “out” from work in order to pursue something that they are passionate about, whether that be entrepreneurship, traveling, volunteering, or something else entirely. However, retiring early is a difficult goal to achieve for anyone who is not independently wealthy. It requires patience, discipline, self-control, and, of course, careful saving and astute investing. It’s a goal that some may not even want – early retirees have reported feeling bored and unhappy when deprived of the structure and socialization that a job provides.
If you’re up to the challenge, however, it can be done. Here are the six steps that lay out the path you should follow in order to retire early.
1. Define “retirement” as it relates to your situation
Backtrack a bit and think about the word “retirement.” Do you still want to have a job after you retire? Retirement means not having to work to live, i.e. financial independence, and it doesn’t necessarily mean that you will have to stop working if you don’t want to. Maybe you’d like to leave a corporate job to freelance in a field of work that you’ve always wanted to try. Look towards the future and ponder what a day-to-day schedule could look like for yourself.
2. Take inventory of your finances
This is crucial in order to plan for the future. First, calculate your net worth by subtracting your liabilities from your assets. Next, calculate your annual spending – start by multiplying your monthly expenses by twelve. A hotly debated subject amongst people pursuing early retirement is how much one needs to save in order to retire early. The general rule of thumb, however, is to have between 25 to 30 times your annual expenses, plus a year’s worth of expenses in cash. Take a look at your own expenses and find this target number. To see how close you are to this target number, subtract your current retirement savings from this goal that you’ve set in mind.
3. Save as much as possible and live below your means
In order to build the wealth required to retire early, you need to earn more than you spend and live frugally.
Make a point of reducing your biggest spending categories, which are likely to be food, housing, and transportation. Here are some tips for all three:
- Food: Make meals at home and avoid deliveries and dining out. Buy less meat. Buy food in bulk. When comparison shopping, calculate your cost per unit. Making your coffee each morning instead of buying it could save you a lot of money – a “small” $5-a-day expense amounts to approximately $2,000 a year.
- Housing: Suffice it to say, don’t buy an expensive home. Not only is it a weighty long-term expense, a high-end house also requires costly maintenance and often higher utilities. You can also try house hacking, in which you offset or cover your mortgage or rent by renting or buying a two-to-three room apartment and renting out the additional rooms.
- Transportation: Walk, bike, or use public transportation. Don’t buy a car if you don’t need to, and if you must buy one, buy a used car. The average American works for a year and half just in order to buy a new car.
It’s also beneficial to lower your expenses on entertainment, travel, and hobbies.
4. Add to your income
In order to make the difference between your earning and spending even greater, it helps in a big way to increase your income. You could start optimizing your 9-to-5 by asking for a raise or, if possible, working remotely so that you have more time to pursue side hustles. A lucrative side gig, such as real estate, also generates a positive cash flow that is both a passive and long-term source of money. Making deliveries, chauffeuring, flipping products on eBay, and selling products on Amazon could all earn you varying levels of income that can be saved.
5. Max out your retirement accounts
Do everything in your power to max out your retirement accounts. Consider utilizing tax-advantaged retirement accounts – IRAs and/or 401(k)s. In 2020, the contribution limit for IRAs is $6,000 plus an extra $1,000 for those 50 and older.
Keep in mind that there’s one caveat – you won't be able to take out money from your 401(k) without being penalized until you've reached the age of 59-and-a-half. However, you can withdraw from your Roth IRA – which is funded with money on which you’ve already paid taxes – at any time, tax-free.
6. Form an investing strategy
After you max out your retirement accounts, a robust investing strategy can get you further in achieving your early retirement goal. Low-cost and low-risk index funds are investments that track a financial market and are favored by financial planners. You could also invest in stocks, bonds, and real estate, though keep in mind that it is wise to only invest in what you understand. Speculation could lead you to lose money and make your early retirement plans impossible.
Though many people would like to retire early, few actually get it done. If you’re ready to take that goal head-on, be sure to invest wisely, live a frugal lifestyle, and save every dollar you can towards your target.