So, you have read a few articles on financial independence and are liking the idea and fancy a slice of the financial independence pie but the big question on everyone’s lips is how on earth do you retire early?
If it’s that easy why isn’t everybody doing it and kicking back on a beach with a cocktail in their hand.
Why do we keep hearing reporters on TV, going how nobody is saving enough to retire and we will all be working till we are at least a 100!
Now you may think that the only way most people would be able to quit their job and live off their piles of money is a big lottery win, an unexpected inheritance from long lost uncle or something similar along those lines. However, the answer is a very simple one indeed.
The simple answer is …………you have to spend a lot less than you earn.
Saving money and delayed gratification
Which let’s face it, is a lot easier said than done!
In the era of cheap credit and advertisers everywhere telling you that you need the biggest house, flashiest car, holidays to far flung places and the latest gadgets just to survive in this fast paced, high tech world, spending less than you earn is very difficult indeed.
But the cold hard fact of the matter is that it must be done to have any chance of reaching financial independence.
To do this, you need to understand the truth that money saved today will mean a lot more tomorrow. This is plain vanilla “delayed gratification”. You put off enjoying something today so that it is there tomorrow, when you need it the most later.
Once you have understood this, the next is to increase your savings rate.
The Importance of your Savings Rate
The key factor to understand how much you need to save and how much longer you need to work for is your savings rate. This is the amount of money you can save every month from your take home pay.
If for example, your income after tax is 25000 bucks a month and you spend 20000 bucks (or more) a month, you will never be able to retire or achieve financial independence as you never have any money left after the month.
However, say you take home 25,000 bucks a month but only spend 10,000 a month, you will have 15,000 to invest with. If you invest this money into income-producing assets, over the year this builds up to 1,80,000 and together with compound interest, this will grow over the years into enough income producing assets to provide yourself with an income.
- Here is how I calculated how much I need for my retirement
- Here is a calculator to help you calculate how much you need to retire
Cutting down expenses to save more
One important aspect is cutting down your expenses.
This increases the amount of money left over to save every month and it also decreases the amount you need every month to live therefore, meaning a smaller amount of income producing assets are needed.
To retire early today you need to forget the conventional rules that say you need to save 10% of income for retiring. Unfortunately, if you want to retire early and have any hope of becoming financially independent, that savings rate is no longer enough. Think more in terms of 50% or more!
How much is enough?
So, how much in savings/investments do we need to be able to fund our early retirement?
The general consensus is around 28 – 33 times your yearly expenses depending if you want to follow the 4% or the 3% withdrawal rule or you can calculate how much you need using the formula here.
I hate formulas but this one is quite easy!
To work out your yearly expenses, you need to track how much you spend in an average year. Remember to minus any current work related expenses (as you won’t be working) and any current expenses you wont be paying in the future (i.e loan payments).
Multiply this number by 30 to get an idea of how much you need to roughly retire and be financially independent. Once you know this, start working backwards. Increase savings rate, decrease expenses and reduce stress. It will be challenging!
Anyway, what’s a challenge if it’s not challenging?