So You Want to Retire Early? It’s All About the Numbers

A comment from a reader on my last post, Would You Rather Have Money…or Look Like You Do?, asked for some ‘nuts and bolts’ information on our ‘retire early’ strategy.  I was planning on writing this in the near future anyway, but moved it to the front of the pack. So “Paul V”, this one’s for you. My motto “Live Smart. Save Money. Retire Early.” pretty much sums up our strategy. We’ll go through them one-by-one.

1.   Live Smart.

This means cutting back on at least the ‘big ones’…housing, car expenses, food…and, when possible (it often is), increase income.  We made most of these changes as soon as we decided to turn our financial life around.

Efforts we made to LIVE SMART:

• Downsized our home.  (This may mean renting out your current home and renting something smaller and less expensive, or selling your freakishly-large McMansion with the equally-large property taxes.  Don’t be afraid to make a big change, especially if it means big monthly savings.)  Even a $500 monthly savings = $6,000 a year.  We saved thousands per month when we downsized.
• No car payments.  If your current vehicle is worth more than $10,000…sell it and buy something less expensive and practical.  There are plenty of used cars that are economical and would pass the coolness test.  Once you sell, invest the cash difference, if any.
• Cook more, eat out less (when you do eat out, go somewhere that gives you high pleasure-per-dollar.  If you’re going to pay someone else to cook and bring you food, it should be WORTH IT.)
• Buy groceries in bulk – we shop almost exclusively at Costco.
• Make sure you’re getting paid what you’re worth.  If not, seek out a higher-paying job.  (My husband found a new job making 30% more, even in a depressed job market. It’s worth the effort.)
• Increased our auto insurance deductibles to $1,000, and because our vehicles are paid off, dropped comprehensive coverage completely.  These two changes cut our monthly premiums by 50%.  We comparison shop every year, and the best value the last 3 years in a row has been esurance.com.
• Lowered our heating/cooling bill by 30-40% after installing The “Nest” Smart Thermostat. Paid for itself in 3-4 months.
• Learned some DIY tricks.  Treat every repair/maintenance issue as an opportunity to do it yourself.  This won’t always be possible, but it’s always worth looking into.  Start with small projects, and work your way up to bigger things.
• Once we made the changes above, the monthly cash we freed up skyrocketed.  We eliminated our debt, and then started Step 2…Save Money.

2.    Save Money.

• Before you can know your own savings strategy, you need to play around with the numbers and see what different savings models do to your timeline. Go to Networthify.com and use their early-retirement calculator.  I suggest using 9% as your rate of return, and 4% as a safe annual withdrawal rate.   We plugged in our numbers, with a 60% savings rate, and it gives us an estimate of about 7.5 years until retirement.
• For those with a net annual income of $100k or more, you should be aiming for a 50% savings rate…if you want to get hard-core, and really shorten your timeline, aim even higher.
• Our first savings efforts went towards our employer-sponsored retirement plans (401k).  Next we each opened a Roth IRA at Charles Schwab.  Then the rest of our savings is invested in a regular taxable brokerage account, also at Schwab.  I like Schwab; their website is intuitive and simple to use, and opening a new account is as easy as it comes.  They process deposits and purchases quickly as well.
• Invest in low-cost index funds
  • The mutual funds you invest in should never have expense ratios of more than 1.0%.  (Take a look at the ‘fact sheet’ for each mutual fund, and search for ‘expense ratio’ or ‘net expense ratio’.  This is how much the fund manager will charge you to manage your investments.)  That’s why index funds are so great.  Their expense ratios are usually 0.25% or less, which means they take a much smaller cut of your money to manage it.
    • Example:  If you have $250,000 invested in “Mutual Fund A” with a 2.0% expense ratio, they will take $5,000 out of your fund in fees each year.  If you have that same $250,000 invested in an index fund, “Mutual Fund B” with a 0.25% expense ratio, they will only take $650 each year.  Invest in index funds and keep more of your money.
  • The majority of our money is invested in four (4) index funds.  50% is in an index of the S&P 500, 20% in a medium-cap index, 20% in a small-cap index, and the last 10% is invested in an international index.  We’ll eventually move some of our balance to a bond fund (less risk) as we get closer to our retirement date.

3.    Retire Early.

• If you used the handy calculator I suggested in Step 2, you should have a good idea of what your savings strategy will be and the timeline until retirement.
• When your investments reach the point that a 4% annual withdrawal rate will cover your desired expenses, you are financially independent.
• When you retire, you’ll continue to live smart, spending money on things that mean the most…for us this will be travel and eating good food.  In every other category, we’re going to live as economically as possible.
• Check out one of the best posts I’ve seen on the math behind early retirement, by a blogger known as Mr. Money Mustache.  Both he and his wife retired at 30 years old.  He does a much better job explaining the early retirement strategy than I ever could.

Once you understand the power behind extreme savings rates and compound interest, the goals you can reach will blow your mind. Someone starting with a $0 balance, who begins saving 50% of their 100k net income can retire in 13.7 years with nearly $1.4 million dollars.

After my husband and I started living smarter, we were able to quickly pay off our debts.  Then the extreme saving/investing started.  We couldn’t believe how much we were able to put away.  Many times we’ve said to eachother, “Why did we wait so long to wake up?”