When I started down the path of financial independence, I confess, I was confused by this whole notion of early retirement. Could I retire in my 40s? Have people really retired in their 30s? Tell me how to begin. Show me how to do it. How do I invest? Can I really invest my way to retirement? The answer was a resounding YES! Below are the 7 steps you need to fast-track early retirement and reach financial independence sooner.
So many people overspend because they truly don’t know what their income and/or expenses are. In order to set financial goals, you must get clarity on your current situation. Calculate your expenses by gathering all of your bills, banking statements, and look at what you actually spend money on.
Math It Up! Pull out a pen, paper, a highlighter, and a calculator. Use an app. Or if you are like me, put it on a spreadsheet. Do you know how much was spent on transportation last month? Include fuel, uber, taxi cabs, tolls, public transportation, and any other transportation-related expenses. You may be surprised how much you really spent on entertainment and dining out. For me, the biggest surprise was groceries. I was spending less on groceries than I had budgeted and had no idea where the surplus went. Know your financial numbers.
I’ve warned about deprivation in the past. Paula Pant says it best, “You can afford anything but not everything.” Would you prefer a $500 handbag or weekend getaway? Would you prefer 8 $10 meals or one $50 meal? Yes, you can buy the latest iPhone but what will be the worth of that phone 3 years from now? What if you used that money to open an investment account, how much growth could you see in 3 years? If you can afford to get on a monthly iPhone payment plan then you can afford to save.
In order to know how much money you will need in retirement, you have to know how much money you are spending. As a general rule, you need to save 25 times your annual expenses to retire. This is not equivalent to your salary. When I first learned about the 25x Rule, I assumed that I would never be able to retire. This is why it’s important to know your true expenses.
It’s almost impossible to reduce expenses if you don’t know what they are. Now that you know your numbers, focus on minimizing the four greatest expenses: housing, food, transportation, and debt. Take a look at the expenses that remain. What’s optional? What’s essential? Ask yourself the following: Do you really need Amazon Prime, Hulu, and Netflix? Would your quality of life be jeopardized by eating out once a week rather than three? What if you reduced it to eating out once a month? Can weekend expenses be lowered by inviting friends over for drinks, snacks, and a game night instead of spending $10 per cocktail and $16 on a bad burger?
Prioritize what is most important. This is not about living a mediocre life forever, it’s about living your best life every step of the way. Rather than dinner and a movie date would a hike and a picnic allow for the same quality of time desired? Perhaps, it’s cooking in and renting a Redbox. Find creative ways to do what you love while spending less money
There are competing opinions on this. What works for us is automating practically all of our finances. Both of us participate in our respective employer-sponsored retirement plans. Why should the government be the ones to get first dibs on our paychecks? The more we contribute to a 401k or 403b plan the less money the government will collect from our paycheck. For example, if you earn $1,000 and contribute $200 (20%) to your retirement plan you will only be taxed on the remaining $800.
Pay yourself first! 401k plans are tax-advantaged accounts. (Tax-advantaged accounts are any type of investment, account, or plan that is either exempt from taxation, tax-deferred, or offers other types of tax benefits.)
One of the most common questions I am asked is “How can I start investing?”
Disclosure: This post contains affiliate links. If you click through and make a purchase, I’ll earn a commission, at no additional cost to you. Read my full disclosure here.
Contributing to a retirement account is the simplest way to begin your investment journey. “That’s it? That’s boring!” Yes, investing should be boring. It’s simpler that way and it works! Retirement plans can be overwhelming. I highly recommend J.L. Collins’s book, “A Simple Path to Wealth.”In it, J.L. Collins describes why active investing, i.e., picking stocks should be left to the Warren Buffets of the world. (Guess what, there is only one Warren Buffet.) Unless you are going to spend hours reading through financial reports and comparing business records stick to passive investing, i.e. index funds. If you are willing to just pick a stock that feels right, then you are not investing. That is called gambling. Buying an index fund means that you are buying a basket of stocks designed to track a certain index, such as the Dow Jones Industrial Average or the S&P 500.
In effect, investors who buy shares of an index fund, own shares of stock in hundreds or even thousands of different companies indirectly. If you don’t have access to an employer-sponsored retirement account, check out Vanguard.com where you can open an account.
In the list of available funds for your retirement plan, look for funds that are described as total market index funds. These tend to have lower expense ratios and have performed well over the long term.
Here is the part so many overlooked, including me. If you have reduced all discretionary spending and are living as frugally as you can but still don’t have money to save, it’s time to increase your income. This can be done in a variety of ways. Asking for a raise, starting a side hustle or looking for a new job is a shortlist. I know it’s easier said than done, but if you are making $20,000 a year saving half of your income will be incredibly difficult. (I must add, all though difficult, it’s not impossible.)
Recently, a friend of mine created the most beautiful shadowbox artwork I’ve ever seen. She is a nurse and is beautifully creative. By selling her art on Etsy, she can easily make some side income. She’ll have the flexibility to take in as many orders as she wants. She could start a side hustle.
A former colleague of mine is a complete sneakerhead. Her side hustle includes buying limited-edition Air Jordans and reselling them for top dollar.
If part of your monthly expenses includes credit card debt, student loans, and car notes, it’s time to get aggressive and pay the debt down. Increasing your income is one of the best ways to kick-start your finances. If you have consumer debt, use any extra income to pay off that debt first. Don’t inflate your lifestyle expenses by increasing your spending with that bonus check. Pay off debt, then save or invest the rest. You may want to reconsider those non-essential items in your budget. This may mean foregoing eating out and buying the latest concert tickets. You know those shoes you wanted to replace, well, now is not the time to head to the mall. Perhaps it means, holding off on putting additional money into savings.
Math it Up! What good does it do to save $100 a month at 1% if you are paying 18.9% interest on a $1,000 a month credit card bill? Pay off that bill then save. Depending on your monthly debt payments you could potentially free up several hundred dollars that could then be invested.
Working for 30 years is an option but is that what you want? Probably not since you are reading a blog about early retirement and financial independence. You have probably earned money since you were at least 18. Are you content with where every dollar has gone? I urge you to create an account at SSA.gov There, you can request an employment/earnings history from the Social Security Administration. It’s eye-opening when you compare your earnings so far vs. your savings. I’ve been working since I was 14!
Now that you have reduced expenses, increased your income, and have paid off your debt, it’s time to increase your emergency fund. Having five months of living expenses (not salary) in a savings account gives us a nice buffer and peace of mind. If either of us or both of us lose our jobs or cannot work, we won’t have the added stress of losing our home. For some, three months of living expenses is enough for others its nine months. Imagine if you lost your job, how many months of expenses would you need in order to minimize an already stressful situation?
Remember, savings is the money you aren’t spending. So how much should you save? How much will you need to retire? How long do you need to work? Generally, the simplest way to calculate the amount needed is to multiply your yearly expenses (not salary) by 25, the 25x Rule.
Here are a few examples:
Abigail’s yearly expenses are $35,000 a year. Using the 25x Rule, she needs $875,000.
Johnathan’s yearly expenses are $50,000 a year. He needs a nest egg of $1,250,000
Michelle’s yearly expenses are $80,000 a year, she’ll need to save $2,000,000
The amount of time it will take these three to save the amount needed will depend on three things: 1) Savings Rate 2) Annual Return Rate 3) Years until retirement
In the above examples, I’ve assumed that they are starting with zero dollars in retirement savings. If you already have some money in retirement investments, you can reduce your monthly savings or retire earlier.
Decreasing your expenses, increasing your income, raising your savings rate, and investing your new savings is the simplest and quickest way to cut the number of years until financial independence and early retirement. It’s not about saying no to life it’s about saying YES to a living fulfilling life!