Wish you could retire right now? Give up the rat race, embrace a life of independence, reduce your stress, and have more time for what you value most — your family, education, travel? That might seem like a fantasy but early retirement is within reach of most Americans, if they would only take the steps to make it happen.
That’s not a sales pitch. It’s true. You, too, can retire the way you want, when you want.
While many think of retirement planning as a complex process, it doesn’t have to be. Below, we outline the key strategies learned by people who have done it — people who, without being millionaires, managed to retire in their 30s, 40s and 50s. If you’re eager to join the ranks of the financially independent, get going by following the steps below.
Step 1: How much do I need to save?
These days, a better term for “retirement” might be “financial independence.” That is, retirement isn’t connected to a specific age, and it may entail continuing to work or volunteer. It’s all about doing what you want, when you want.
And anyone can do it. Financial independence, after all, is a simple concept: you need enough money to create income to support your lifestyle for the rest of your life. That points to the crux of retirement planning: How much you need to save depends entirely on how much you spend.
“Your spending rate is the single biggest factor determining when you’ll be wealthy enough to retire,” says Mr. Money Mustache, also known as Pete, the operator of the blog MrMoneyMustache.com. He and his wife retired when they were just 30 years old.
The first step to financial independence is figuring out where your money is going now. Monitoring and, if possible, reducing, your current spending has two important benefits: it frees up more money to be put aside in savings, and it reduces the amount you need each year to live on, thus lowering the total amount you need to save.
To track your spending, sign up for a free online service such as Mint.com or check to see whether your bank or credit union offers an online tally of your spending. Alternatively, just create your own spreadsheet or simply get out pencil and paper. However you do it, figure out where your money is going and how much you spend each month. Can you reduce any unnecessary expenses? In addition to cutting out small expenses that you can do without, it’s important to periodically compare costs and shop around on larger expenditures, such as home and car insurance and cellphone bills.
Certainly, your spending will change once you retire. You’ll stop sending money to savings. You won’t be spending money on commuting. Other costs may rise. Perhaps you’ll want to travel more, or you may encounter higher health-care costs (more on those below).
Still, getting control of your spending as soon as possible will go a long way to determining when you can retire. For example, Mr. Money Mustache says he and his wife saved $600,000 and paid off their mortgage before quitting their full-time jobs. His family of three (they have a young son) now lives on about $25,000 a year.
Billy and Akaisha Kaderli, who blog at RetireEarlyLifestyle.com, are now in their 60s, but they retired more than 20 years ago, when they were both 38. They travel the world, living on less than $30,000 a year.
A recurring theme among early retirees: Even if they are traveling the world, their lifestyle is simple. If they own a car, it’s just one, and it’s far from new. (Your car costs more than you may realize. Early retirees often talk about car costs and the importance of reducing them. If your car costs $500 a month for loan payment and insurance, that adds up to $6,000 a year. If you assume a federal and state tax bill of 30%, you have to earn about $8,600 a year just to pay for your car — and that’s not even counting gas and maintenance costs)
The Kaderlis’ method for tracking spending — outlined in their book “Your Retirement Dream is Possible” — is based on figuring out their costs-per-day figure. Each day, the Kaderlis enter their previous day’s spending into a spreadsheet; they keep a running total, which they divide by the number of days. The daily average can fluctuate quite a bit; to smooth out the numbers, they continue to track their spending into the next year. So, their spending for Jan. 1 is the first day, and after 365 days, Jan. 1 of the second year is entry number 366. They’ve learned that, despite sometimes large daily fluctuations, their spending over each year is remarkably constant — and that has helped ease their minds over spending.
For his part, Mr. Money Mustache says he doesn’t keep a detailed budget. At the end of the year, he and his wife create a spending report from their credit-card statement (they purchase most items via credit card to earn the rewards; they never carry a balance on the card) to see where their money went over the year (they then post their spending details to their blog).
Another early retiree couple, Skip and Gaby Yetter — they quit full-time work in their early 50s and blog at TheMeanderthals.com — work with a U.S.-based financial adviser as they travel the world. But they, too, say that their early retirement, which included selling their three-bedroom, waterfront home in Marblehead, Mass., north of Boston, has fostered an awareness of just how consumer-focused they’d been. “As we rid our lives of accumulated things, we began to realize how much happiness we found in living simply,” writes Skip Yetter in their book “Just Go! Leave the Treadmill for a World of Adventure.”
One note: There is always an element of uncertainty in financial planning at any stage of life. For example, you could lose your job or face a debilitating illness. So, like any other financial planning, it’s necessary to embrace a little uncertainty.
Another example: you don’t know how long you’ll live, and thus it’s impossible to say how long your savings need to last. A number of early retirees interviewed by MarketWatch rely at least to some extent on the “4% rule”: In your first year of retirement, you withdraw 4% of your total savings; in each succeeding year, you withdraw the same dollar amount, plus inflation.
In other words, a rough rule of thumb is that, before you retire, you should save 25 to 30 times’ your annual spending.
While the 4% rule has come under attack in recent years — many financial experts argue that it’s too optimistic a number given the outlook for lower financial-market returns in the future — early retirees say it worked for them even in years when the markets performed poorly, such as the market downturn in 2009. The key is flexibility; that is, being able to trim costs so that you can withdraw less in years when the market is down.
Step 2: How do I invest?
Just as reining in spending is a recurring theme among early retirees, so is the idea of investing in a diversified portfolio of low-cost index mutual funds. Generally, mutual funds that track an index, such as the S&P 500 index SPX, -0.18% , will charge investors lower fees than mutual funds where the portfolio of investments is chosen and “actively” managed by a fund manager.
For a straightforward guide to low-cost investing, look no further than MarketWatch’s Lazy Portfolios. Each of the eight Lazy Portfolios holds 11 mutual funds or fewer; a couple of the portfolios hold just three mutual funds.
Among these portfolios, the current top three performers — the Coffeehouse portfolio, Dr. Bernstein’s No Brainer portfolio, and Second Grader’s Starter portfolio — have returned 8%, 9% and 10%, respectively, on average over the past three years (data are through Dec. 8, 2015).
The current top performer, the Second Grader’s Starter portfolio, comprises just three mutual funds: 60% of the portfolio is in the Vanguard Total Stock Market Index Fund VTSMX, -0.14% 30% of the portfolio is in the Vanguard Total International Stock Index Fund VGTSX, -0.07% and 10% of the portfolio is in the Vanguard Total Bond Market Index Fund VBMFX, +0.09%
Worried about investing for retirement? All you need to do is try to match one of these portfolios. That doesn’t mean you need to invest in precisely the same mutual funds; the point here is to pick a portfolio and then mimic it by investing in similar mutual funds, e.g. an index fund that invests in a broad group of international stocks.
If you’re investing through a 401(k) or other workplace account, your investment options will differ, but you can try to get as close as possible to these suggested portfolios. You don’t have to stick with Vanguard mutual funds (though that company is known for its low-cost funds).
Once you’ve picked a portfolio and done your best to match it given the investment choices available to you, then allocate your money as per the portfolio (e.g. 60% to a total stock market index fund) and stick with it. You don’t need to know any more than that to invest. That said, you should monitor your own investment portfolio regularly to make sure your percentage allocations don’t get out of whack. When, for example, the U.S. stock market gains steeply, you may need to rebalance, i.e. push some of your investment money toward bonds or international stocks, say, to get your portfolio allocations back to the percentages stated in your chosen Lazy Portfolio.
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Step 3: Housing costs in retirement
A key piece of retiring early is keeping your housing costs low. If you plan to live in the U.S., the ideal situation is to pay off your mortgage before retiring, as the Money Mustache family has done. But as noted in No. 1 above, the key to retiring early is a simple function of how much you spend versus how much you have in income. If you save enough such that you can cover your mortgage costs after retiring, then there’s no inherent problem with holding on to a mortgage.
Many retirees cite the significant psychological value of carrying no debt when they quit working, but with interest rates as low as they are, others argue that holding the mortgage and investing in the financial markets the cash that otherwise would pay off the mortgage can be a smart financial move.
For some retirees, however, the proceeds from selling their home may in fact fund a good chunk of their retirement, whether they end up using some of the money to buy a smaller house in the U.S. or on cheaper accommodations in foreign lands. For example, the Yetters chose the latter path. Now, thanks to housesitting websites such as TrustedHousesitters.com and MindMyHouse.com, they say they live rent-free about 70% of the year, in places such as England, Italy and Greece.
The danger of relying on home equity to fund retirement is that it assumes the local housing market is strong when it comes time to sell the house and retire; it’s crucial to take this uncertainty into account and build a flexible timeline into one’s retirement plan.
For their part, the Kaderlis travel the world, yet they own a home in an active adult community in Arizona. They lease the land and pay “lifestyle fees” for the various amenities, such as a swimming pool and cultural activities, which they enjoy when they’re in the U.S. Most of the time, however, they’re traveling the world, staying in hostels and hotels, renting apartments and housesitting. They enjoy discounts by booking longer-than-average stays and going to places in the off season. They live on about $30,000 a year, including health-care costs, airfares, housing and living expenses.
Step 4: Paying for health care
Early retirees deal with the issue of health insurance in a variety of ways. Individual costs will vary widely, depending on the situation. Certainly, the availability of health insurance in the U.S., thanks to the Affordable Care Act, has made it easier for individuals to quit jobs they might otherwise have kept for the health insurance.
Mr. Money Mustache, the popular blogger and early retiree based in Colorado, said last year that he relies on a low-cost, high-deductible health plan purchased on the individual market. The plan costs about $275 a month to cover his wife, son and himself. Should that plan expire, he said he would switch to a bronze plan, available via his state’s health exchange under Obamacare.
Meanwhile, the Yetters spend most of their time traveling internationally. They purchase health insurance for about $120 a month from a company called World Nomads. When they visit the U.S., they buy temporary catastrophic coverage.
Like the Yetters, the Kaderlis spend a good chunk of every year living in other parts of the world. When they travel to the U.S. they purchase a temporary traveler’s insurance policy for U.S.-based care. When they’re elsewhere, they pay out of pocket.
Step 5: Manage your taxes
Just as when we’re working, taxes are a consideration in retirement, whether you retire early or not. It’s crucial to include an estimate of your annual tax bill in your “total savings needed” amount.
Your tax bill may come in a variety of flavors. If you’re pulling your income out of a taxable brokerage account, you’ll most likely owe capital gains on those distributions.
If you’ll be withdrawing money from retirement accounts such as IRAs and 401(k)s, you’ll owe income tax. If you’re younger than 59-1/2, you’ll also face a 10% penalty, but there are ways to avoid it. Be sure to familiarize yourself with the “72-T” rule. This rule outlines a precise process for distributing retirement funds such that you avoid the 10% penalty on early withdrawals.
Also, your Social Security benefits are taxable if your income exceeds a specific amount.
Keep in mind that, if you continue to do consulting or part-time work after your official retirement, then any Social Security benefits you’ve claimed will be temporarily reduced.
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