The Shockingly Basic Math to Retiring Early
Learn how to calculate how much you need to earn, save, and invest to retire early. Earn more money by diversifying your income, save money by cutting costs, and invest the difference to fund the early retirement you deserve.
I'm a little over 40 years old and I just realized I could have been retired right now.
The thing is, sometimes other things get in the way, like the fact that I always wanted to succeed first at business before even thinking of saving for retirement.
But if I had just done some simple math early on, I could have been cutting my expenses and saving for retirement all this while, and realized the goal of retiring at age 40.
It's too late for me to retire at 40, and that's fine, but I would still love to retire before I hit 60.
Rather than saving, cutting costs, and investing at age 25 to retire at age 40, I'm focusing on these same strategies at age 40 to retire around 55.
The math behind it is the same and you'll be shocked when you see how easy it is.
For generations, people have been told the normal retirement age is 65.
And we've embraced the idea that the earliest imaginable that retirement could happen is at 45—but that's only if the person was privileged and wealthy enough.
The problem with this mindset is, when people think of 65 as the age they'll retire, they usually end up getting themselves caught up in the rat race.
They work so hard for their entire careers, and yet they still end up with little or no money for their own retirement.
The good news is, people are rethinking the math behind, and their assumptions about retirement.
They're using simple math to prove retirement at the age of 50, 40, or even 30 is completely doable, as long as people do certain things to set themselves on the right path.
In fact, the math behind it is surprisingly basic.
I'm going to share with you the shockingly easy math that governs a person's attainment of financial independence and early retirement, along with strategies and tips to help make it work for you.
The One Factor that Determines When You Can Retire
Calculate your savings rate to see how much you can put away for retirement
Everyone has their own "savings rate," which is calculated as the percentage of your disposable income you set aside as a nest egg for your retirement.
Your disposable income is the amount of money you earn from all income streams after taxes are deducted (it's also known as your "take-home pay.")
Your expenses, including what you spend on accommodations, utilities, phones, and food, are subtracted from your disposable income to calculate your savings.
Divide your savings by your disposable income, multiply by 100, and then you've calculated your savings rate.
The math is easy, just plug your numbers in.Here's an example of a savings rate calculation.
Let's say a person has an after-tax disposable income of $60,000.
When they add up all the year's expenses, their total spending is $45,000.
$60,000 in disposable income, minus $45,000 in spending, means their total savings is $15,000.
If you divide $15,000 by $60,000 and multiply by 100, you get the person's savings rate which in this case is 25%.
You can substitute these numbers with your own to calculate your savings rate!
Compare your savings rate to the rest of the country.The average savings rate among U.S. households goes up and down depending on economic conditions.
In the 1970s and 1980s, the average savings rate for a household in the United States was 5–7%.
In March 2018, the personal savings rate in America was 3.1%.
Zero in on some of the numbers impacting your savings rate.Your savings rate is important because it calculates the relationship between what you earn and what you spend.
How much you make on an annual basis, and how much you can live on, are two crucial elements you need to focus on if you want to achieve early retirement.
By making changes to those numbers, you'll be able to adjust your savings rate in your favor.
Your goal is to set your savings rate at the appropriate level so that you save enough money to support yourself in retirement as early as possible.
Your savings rate is so important because it determines how much money is left for investment toward the goal of a comfortable early retirement.
Are you happy with your savings rate?
Once you've calculated your savings rate, there's a good chance you won't be happy about the number you see.
Hopefully, it's not a negative number, or you're going in the wrong direction (into debt).
Even if you've been saving at a rate close to the American average (at 3.1%) for the past few years, it's still not enough for an early retirement.
What you need to remember is the higher your savings rate, the quicker you'll have what you need to retire.
Follow the 4% rule.The general rule of thumb for determining how much you'll need to have saved in order to retire comfortably is known as the "4% rule."
By only withdrawing 4% out of your total retirement savings each year, you can keep a steady income stream without depleting your retirement accounts.
Experts say you should expect to spend about 70–80% of your normal pre-retirement expenses when you retire (adjusting for inflation at a rate of 2% per year).
It's the same math whether you retire early or later.Let's say you have current expenses of $45,000 a year.
If your expenses will cut back to 80% of that number in retirement, it means you'll expect to spend $36,000 a year.
$36,000 each year is 4% of a $900,000 total retirement savings nest egg.
Which means you need to build a $900,000 retirement fund.
By putting your savings into a low-risk investment portfolio you should be able to outpace the 2% rate of inflation and the 4% you withdraw each year.
Basically, you'll be enjoying life as a retiree by living off the investment dividends and interest from your $900,000 nest egg.
When you pass away, the money you worked so hard to save will be passed down to your family.
How to Buy Yourself the Freedom to Retire Early
Earn more income, spend less, and save more
You can use the calculations I've outlined above to determine how much you need to save before you can retire.
The numbers can also guide you toward the pace you need to save money at in order to retire at any given age.
Now take your own personal retirement calculations and compare what it will take to retire early to what it would take to retire at 65.
You can't get there by keeping it "business as usual." If you're like a lot of people, what you'll realize is you can't retire early unless you can change the factors influencing your savings rate.
You need to earn more money, spend less of it, and save more of it to make the dream of early retirement a reality.
Increasing your income gives you more money to work with
If you're between 25 and 50, you're in your peak earning years.
You need to make the most of your earning potential and set yourself up with some passive income streams that you can continue to profit from post-retirement.
Diversify your income streams.Set yourself a goal to develop more earning streams in a specific amount of time.
For example, create a goal for having three new income streams by the age of 50.
For example, you could renovate your garage to create an apartment and rent it out on Airbnb.
Other potential side hustles include making money by selling things on Craigslist, mowing lawns, tutoring students, or participating in paid market research.
Aim for getting a promotion at work.Most jobs will give you an increase of 1–3% each year to keep pace with the increases in the cost of living.
But what you need if you're going to increase your income enough to retire early is a promotion and a raise.
Talk to whoever would be in charge of promoting you and discuss areas where you could add new value to your job and the company.
Use that conversation as your playbook and make targets to achieve the goals you discussed within six months.
Put together a list of all the problems you've solved since your discussion and a list of the problems you could solve if you were promoted.
Meet again with your manager and present your recent progress and the progress you could achieve in the future.
You probably won't even have to directly ask for a pay increase, since your manager will be so impressed by what you've accomplished, your passion, and your initiative.
Start a business.Changing from working for others to working for yourself usually also means an increase in income.
Take what you've learned from your career so far and bump it up another level.
For example, if you've been an IT engineer for the past 15 years, set up a consulting service where you can pass along your experience and wisdom to new IT companies.
If you've been working as a carpenter for a real estate development corporation, consider going out on your own and building houses as a general contractor.
Scale your existing business.If you already have a business, think about how you could expand it or make the most use of your current assets to generate more income.
For example, if you have your own craft brewery you could invite other smaller breweries to rent your bottling line from you when it's sitting idle.
If you own a restaurant, you could expand to include catering services or run a food truck on weekends or at events.
Get rid of debt as quickly as possible
One of the biggest barriers to saving enough for retirement is debt.
If you're carrying a lot of high-interest debt, the money you could be putting away for retirement is being drained on interest payments.
The types of debts you might be paying interest on include your mortgage, car loan, student loan, credit card balances, or personal loans you took out to cover other expenses.
If you're struggling with managing different types of high-interest debts, you could benefit from consolidating them all into one single loan.
A debt consolidation loan can help you regain control of interest rates by repaying your debt in a fixed time-frame while also having the ability to pay fixed rates.
Choose to attack debt with either the snowball or the avalanche approach. Experts have identified a couple of effective strategies for getting rid of all your debts.
In both approaches, you maintain minimum payments on all your debts, then put everything left over toward paying off one debt at a time.
The "debt snowball" method involves paying off your debts from smallest to largest and rolling the payments from the smaller debts you've paid off into your bigger debts.
The "debt avalanche" approach takes aim at the debts with the highest interest rates first, then works its way down through the lower interest accounts.
Get smart about taxes
Another drain on the money you could be putting toward your retirement savings is income tax.
Talk to your accountant about ways to sync your retirement savings with reducing the tax you're paying now.
Save on taxes by saving for retirement.For example, by putting money into registered retirement savings accounts like 401(k)s or IRAs, you can defer paying tax on the income until you cash them in.
Since your income will be a lot less when you're retired, you will probably be in a lower bracket and you'll save money.
Reducing spending is as important as increasing your income
One thing I've seen time and time again is people achieving their goals of earning more money, but not making an effort to save it.
It might feel great to spend a lot of money in the short term, but soon you'll realize that the money could have been put to much better use if invested toward retirement.
Tighten up your everyday spending. You'd be amazed at how much our little daily indulgences add up.
You don't have to cut out things you really enjoy, but you could be more mindful of where your dollars are going.
Waiting until something you want is on sale or finding wholesale sources for things you consume in bulk are two great ways to reduce your expenses without cutting stuff away from your life.
Avoid a lifestyle creep as your income increases.When people increase their income, it's natural to expect changes in their lifestyles.
If you want to retire early, keep your expenses exactly where they were before you were making more money.
Then take the difference and save or invest it.
Cut your housing costs.For most Americans, their single biggest expense is housing costs.
If you're willing to put in the effort required to lower your housing expenses, you could definitely save a ton of money.
If you own a home, you could renovate part of it and rent the suite to students or to Airbnb customers.
Or you could move into the guest suite and rent the whole house for much more money.
Plan ahead for medical costs.Keep in mind as you get older, some costs increase, especially the costs of medical care and health promotion.
Health care is a huge expense for most Americans, since, even with health insurance, out-of-pocket expenses like deductibles and copays can really add up.
Having good health insurance is essential to managing the costs of care, but another great strategy is to put money into a health savings account (HSA).
An HSA is a fantastic way to save up money for health costs you may face in retirement.
It's also another way to defer paying tax on your current income (you pay the income tax when you withdraw the HSA funds in retirement, hopefully at a lower tax bracket).
The Last and Most Critical Key to the Early Retirement Puzzle
One word: Invest!
Your pension will probably not be nearly enough to let you live the life you want to live in retirement.
When you're saving money for retirement, don't bother stowing your money in a bank savings account or a Certificate of Deposit (CD).
Since these rarely yield you interest of more than 2% per year, your money isn't growing fast enough to keep up with the rate of inflation.
Inflation is your #1 enemy since it eats away at the purchasing power of your entire savings.
If you don't plan appropriately, inflation can destroy the financial security you've worked so hard to achieve for your retirement.
The best advice is to create a cushion by investing your money wisely.
If your money multiplies at a rate higher than inflation, you won't have to worry about your savings funds losing value over time, and you can stay financially secure.
Max-out your retirement savings contributions.Retirement plans like the aforementioned 401(k) and IRAs are designed to help you save for retirement and put off paying income tax.
401(k)'s are set up by your employer to be taken off your monthly paycheck and often include a matching portion from the company.
IRA's are accounts you set up with a bank or brokerage firm to hold retirement investments like stocks, bonds, and mutual funds.
Each of these retirement plans has a cap on how much you can contribute each year, which you should always try to hit.
Consider other taxable investments. Investing your retirement savings in the stock market, mutual funds, and bonds have the potential to grow your money a lot faster than the rate of inflation.
Real estate is also a lucrative investment for retirement since you can collect income as a landlord and then sell it later and profit from the appreciation on the property.
Retiring early is simple if you know the math
There's a saying that goes, "The best time to plant a tree is 30 years ago… or today."
Even if you haven't thought of saving for your retirement until recently, there's no time like the present to actually start.
If you're really on top of it, and you're reading this as a 25-year-old, I'm happy to tell you that retiring by the age of 40 is an attainable goal.
If you're like me and you're already in your forties, there is still time to give your savings rate a boost, so you can retire a whole decade before everyone else does.
In either case, you have to be willing to do whatever it takes to earn more, spend less, and invest the savings strategically.
Retiring early isn't a dream reserved for people who inherit massive fortunes—it's something you can achieve if you set yourself on the right path and stick to it.
Are you thinking of retiring early? At what age?
What strategies do you plan to implement to increase your savings rate?
Have you saved enough money as a nest egg for an early retirement?
Any success stories or tips you'd like to pass along?
If so, please share them in the comments below!