Those of us who made the decision to take control of our finances and set goals for financial independence and early retirement know we need to develop our personal Strategic Retire Early Plan. There are 5 Fundamental Steps to Retire Early that need to be covered by the plan’s two crucial basics, Spending Discipline and Saving/Investing. Early Retirement success will come down to focusing in on these fundamentals.
There is a lot of information and ideas from industry experts, your 401K administrators, and many financial sites/blogs. Learn as much as you can and apply the ideas and strategies that will best work for you. When all else fails get some help from a CFP fiduciary financial planner.
Money- The first of the 5 Fundamental Steps To Retire Early
It takes cash to retire early. The earlier you start or started saving in your career the faster it will grow. Time is your ally. If you start when you are young saving 10% plus having a company 401K match means you can easily grow a nice 6 to 7 figure retirement savings balance over your full working career. That is if you keep it up without interruption.
Since we never know what will happen. It is a safer bet to save 15% as early in your career as you can. The longer you wait to start saving for retirement. The higher percent of your income you will need to save to reach your early retirement goals.
Think percent of income instead of total dollars saved
When you start don’t worry about a target savings total sum. Make plans around the percentage of income you can save and push yourself to save as much as you can. Do so with the thought that you will purposely incrementally increase your savings rate as time goes on. As more income comes in then increase your savings rate
That said, be aware that early retirement will require a higher percentage than 10% of income saved to get there. But it is not impossible as some will claim. So start at a rate you can and commit to increasing your savings rate when you can.
I started in the 6% range to get all my company match. But every year I increased it with my raises to a point where I was maxing out the 401K contribution limits. Then I began saving in IRAs, Roths, and other accounts. In my last working years in career number one I was saving 50% of my after tax income. I retired at age 51.
I started with a low savings percentage but ended with a substantial percentage targeted to retirement savings. To recap the first fundamental step. Save as much as you can handle as early as you can do it. Then ramp-up your savings percentage over the years as your salary increases and your debt is paid off.
Spending Discipline- The Second of the 5 Fundamental Steps To Retire Early
You can’t save money if you spend everything you earn to support your lifestyle. You can’t be a consumer of the latest and greatest doohickey every time it comes out. Trying to impress or keep up with the Joneses is off the table. Anyone who is committed to retiring early while they are still young enough to enjoy it is done with that stuff.
This covers both your lifestyle budget and debt. It is OK to use your credit card but only if you pay it off each month and only if you use it to buy things you need and would use cash for anyway. You can also reap credit card rewards by using your cards this way.
You must set a budget that pushes your frugal living threshold by dropping all and any spending waste in your lifestyle. Cut back but not to where you feel you are living a deprived life. That way your frugality and budget will be sustainable over the long haul.
Pay off all debt.
If you start saving in the 10% to 15% range then focus all extra money from your income to debt payoff. Once debt is gone you then should add to your savings percentage.
Always keep in mind that you want to create a lifestyle similar to what you will live in early retirement and lower your lifestyle costs.
The lower your lifestyle cost the less you will need to save to support it. Obviously there may be more travel or recreation in early retirement. But set yourself up for a smart frugal lifestyle that you will be happy living as a rat-race escapee.
Investment Strategy- The Third of the 5 Fundamental Steps To Retire Early
Having the right investment strategy is all about diversification in your portfolio to manage risk. Yet still offer a good chance of investment returns necessary for you to reach your goals. Stuffing your savings under your mattress or safely deposited into your savings account isn’t going to give the returns necessary over time to get the portfolio balance necessary to retire early.
Understand your risk tolerance
The point of starting to save early is to take advantage of time and the positive impacts of compounding investment gains. Your investment strategy must also be aligned with your risk tolerance. If you are unsure of your investment risk tolerance. Then go through a Vanguard questionnaire (free) that may help you come up with your portfolio Stock to Bond ratio. Your 401K plan may offer a similar risk assessment questionnaire.
Once you understand your risk tolerance and proper stock to bond ratio you can build a diversified but low-cost index fund portfolio. The simpler the better. Concentrate on U.S. stock funds, a total U.S. bond fund and if you want to add a little more diversity a smaller allocation to a total international stock fund.
You will most likely start your retirement savings within your company 401K plan and be limited to funds offered within it. However once you can also start opening IRA and/or Roth accounts, even non-retirement investment accounts, Vanguard, Schwab and Fidelity have low-cost funds to choose from. With a little research you may find other companies too but pick one and open an account.
Do a little research and begin saving/investing for the long-term with low fund fees that are preferably less than 0.50% per year.
Rebalance your Stock to Bonds ratio
You can manage your portfolio with a goal to keep your cost down. Leave your investments alone when the market moves the wrong direction. Once a year check your investment diversity balance. Rebalance your Stock to Bonds ratio as needed to restore your risk tolerance allocation.
As you get close to retirement or start your early retirement. Look at possibly lowering your investment risk by rebalancing your portfolio to a higher Bond percentage.
If this is more than you want to handle then you can simplify your investments even more. You can do this by investing in a target-date retirement fund. This is a type of fund offered by Vanguard, Schwab and Fidelity as mentioned above for low-cost funds. They are most likely also offered in your 401K plan. These funds give you a fully diversified portfolio which automatically becomes more conservative as you age and start your retirement. You leave the yearly investment diversity rebalancing to them. Of course as always if you need help, GET IT.
Reassess and Tweak- The Fourth of the 5 Fundamental Steps To Retire Early
Once you start your strategic retire early plan you can’t just let your spending discipline/budget or your saving/investment plan slide-by on autopilot.
You need to make yearly assessments and sometimes sooner if life situations change (big raise at work, a loan gets paid off, started a side hustle, etc.) to make sure you are both on track and whether there are opportunities to increase your savings rate. The idea is to tweak your plan when you can to improve your goals or if bad things have happened you can tweak things down until you get back on your feet.
When life’s “it” hits the fan the last thing you want to do is simply abandon your plan and wing it. Having and keeping a plan is a must even if it’s a temporarily ramped down one. Now that you have started your portfolio reassessment then next is visualizing what you see as your early retirement lifestyle and what it will cost to fund it.
Run your numbers through a retirement calculator
You should by now have some experience living on your smart frugal living budget and know what that cost is. Pad anything reasonable for hobbies and travel while dropping your work related costs like commuting, parking, clothes, your 2nd car, etc. Then go to a Monte Carlo type retirement calculator to see if you are on track or whether you will need to work longer or ramp up savings sooner. I like to use FIRECalc.
How To Use FIRECalc
Starting on the first page
Enter your desired Spending amount (early retirement lifestyle cost), your current portfolio balance, and the number of years you need to fund your retirement (how long you think you will live).
Other income/spending tab
Take figures from your Social Security estimate and the year you believe you will start your benefits. If you work where you will get a pension add this info here too.
Not Retired? tab
This is where you enter the year you wish to retire and how much you will save each year until then. The calculator automatically considers inflation in its calculations.
Spending Models tab
This defaults to inflation CPI and set to a Constant Spending Power but read the page and make changes to see how it impacts the results.
Your Portfolio tab
This tab allows you to enter your stock to bond ratio and other information that you can change or add.
Portfolio Changes tab
This allows you to add future lump sums or cash to your portfolio. Maybe you plan on selling your house at a future date or sell some fine art or other asset(s). Maybe you see yourself living the “retire early and often” lifestyle working part-time or full-time bringing in extra money pursuing opportunities aligned with your interest and passions. If you have nothing to add then leave the tab blank.
The Investigate tab
This tab allows for you to plug-in different details to see how it changes your outcome. On any of the tabs there is a “Submit” button and a new window will open giving you the results based on 115 past investment cycles and your percent of success. Seeing 80% and higher is a good sign. As you get closer to early retirement you want to see that success rate in the upper 90s if not 100%.
If things don’t look good in the results then play around with the calculator to get a feel for what you will need to change to make your goal-set retirement date.
Does waiting another year to retire and save do it or maybe instead of funding retirement until you are age 100 and changing it to a number like 85 or 90 will make the desired result.
Is changing your Spending Model from Constant Spending Power to Bernicke’s Reality Retirement Plan make the numbers fall in your favor? If saving more money is necessary each year then find what that amount is and then find a way to get there.
This is how you know you won’t be completely surprised when the time comes. It is much easier to make small tweaks earlier in your plan than later where it may take drastic and sometimes disappointing changes to get it where you want to be.
Income Strategy- The Fifth and last of the 5 Fundamental Steps To Retire Early
Hopefully after successfully completing the first 4 of the 5 Fundamental Steps to Retire Early above you are set to meet your financial independence and early retirement goals. The last fundamental step is creating your reliable retirement income strategy out of that sum of money you have invested.
This strategy will include you eventually starting your Social Security and any pension you may have coming your way. It starts by knowing what your retirement budget looks like to have a sense of your required income needs. Then coming up with a plan for funding through savings and a withdrawal strategy like the 4% withdrawal strategy, bucket strategy, purchasing an annuity, or a combination of all until your Social Security starts.
Then figure out another funding strategy to include Social Security and hopefully relax some of the draw-down from your retirement accounts. You may also look at tax strategies associated to Social Security and the eventual required minimum distribution (RMD) at age 70 ½ that looms over all of us with IRA accounts in the U.S. Your income strategy will be to get the most you safely can from your account but not go bust during your lifetime.
This takes some careful thought and returning to the first 4 of the 5 Fundamental Steps to Retire Early as part of your routine.
Final comments about 5 Fundamental Steps To Retire Early
Nobody cares more about your retirement and your money than you do.
Make tweaks as necessary and early when issues are discovered.
There are also the non-financial steps to retire early that you will need to take that were not mentioned here.
You will have all the time to pursue your passions and what interests you.
You have the rest of your life to live on your terms and it all has to be figured out.
Stick to the 5 Fundamental Steps to Retire Early and start dreaming.