Over the past decade, the FIRE movement (financial independence, retire early) has gained traction, encouraging young folks to live frugally, save as much as possible, and invest intelligently in order to retire in their 20’s, 30’s, 40’s or 50’s. If early retirement seems like an attractive option to you, continue reading to learn how you can begin applying some essential principles to your personal finance.
Retirement
First things first. What is retirement? Retirement is when a person stops actively working, withdraws from their paid occupation and is able to continue to be financially independent because their expenses are supported by other income sources (e.g. perhaps the support of a loved one, productive investments, savings, a pension, etc.).
In the past, most folks retired later in life, typically between ages 60 and 70, but also had the luxury of being able to begin saving for retirement later. However, due to many factors – student debt, increased cost of housing, stagnant wages – millennials know that their retirement futures probably look a lot different than those of their parents and grandparents.
Investment and early retirement
Investing money in order to attain early retirement is considered essential by many. In this case, is vital to earn a return on investments that can sustain your lifestyle without additional income. Consider these diverse opportunities to get started investing in productive assets that could help you finance your retirement years.
- High yield savings accounts: This kind of savings account makes more in annual interest than typical savings accounts with very low risk for investors.
- CDs: Certificates of deposit are sold by a range of financial institutions and state that the holder of the promissory note will be paid a particular interest rate on their initial investment. CDs are considered relatively low risk and there are a number of options, from 6 months to 5 years.
- ETFs: Exchange-Traded Funds (ETFs) are an investment fund which can be bought or traded like stocks. Investment funds are individual shares of a group of diverse securities like bonds, stocks, and cash alternatives. The diversification built into investment funds help reduce investment risk.
- Mobile apps: Investment apps like FlexInvest help you make small investments and grow them over the long term.
Having a range of diverse investment opportunities, at least some of which are low-risk, can help you secure a prosperous retirement.
Retirement timing
So, after you’ve planned out your investments, how do you figure out when you will be able to retire? Next, it’s important to get your numbers straight.
Determine your budget
To determine how much of your annual income you can spend, calculate your necessary expenditures and savings rate. Your savings rate is your income minus expenses. If you spend all or most of your income, you will have no savings and no investments, meaning that you will never be able to retire.
Once you crunch the numbers, you may be a bit shocked at how much you need to save annually in order to retire early. Perhaps you have been following a budget like the 50-30-20 spending rule, which recommends putting only 20% of your earnings toward savings and other financial goals. An early retirement goal may require much more savings–perhaps 60-70% of your income. Whatever you goal ends up being, make sure it is realistic and allows you to take care of your needs.
Determine your annual withdrawal rate
Your annual withdrawal rate is the amount of money you will need to cover expenses each year of your early retirement. Knowing your annual investment return and annual withdrawal rate will help you calculate how much you need to make off of your investments in order to retire safely. Your annual investment return-or how much money you make off of your investments-must be greater than your annual withdrawal rate.
The higher your savings rate and the lower your expenditures, the earlier you can retire. Eliminating debt and non-essential spending, as well as living simply are essential steps towards early retirement. In order to calculate how much you should save of your monthly income, take into account your essential spending, in how many years you hope to retire, debts, investments and your life expectancy.
Working with these numbers will indicate how much you need to save annually until your projected annual retirement date.
Emergency fund
When planning for early retirement, another essential step is taking into account planning for an emergency fund. An emergency fund can prevent you from falling into debt and is important to have during your productive years, as well as after retiring.
Around 55 million adults are thought to have no emergency savings at all and around 60% of millennials report being unprepared to handle a $1,000 emergency. Having an emergency fund is essential to your financial security, early retirement plans and general well being because it can prevent a bad situation from getting worse.
If you already have your essentials covered for the next several months when a crisis strikes, you can avoid being forced into debt from last-minute, high-interest borrowing. Ultimately, something that can turn a seemingly short-term crisis into a long-term financial problem.
In essence, an emergency fund is like an insurance policy that you negotiate with yourself to make sure that the essentials are covered. Check out our article on how to create an emergency fund to incorporate an emergency fund into planning for your early retirement.
Planning for retirement, whether around the corner or a few decades down the line, is an essential part of creating a healthy financial future for yourself and your loved ones. Retiring at any age requires long-term financial independence and careful personal finance management. As you begin planning for this important chapter of your life, make sure to check out the rest of our Academy financial literacy library for more helpful tips and tricks!
