Historically, the idea of retirement has been an odd one.
It’s a date that’s set in stone, depending on your employer and the country you live in.
It’s the date at which you can finally start drawing that pension, enjoying your free bus pass and spending your time gardening, painting and sleeping in.
The problem with setting your retirement date on a specific age is that many people over the years have found that their pension barely covered their costs.
Sometimes their pension has been devalued over time, other times they’ve failed to put enough away.
The end result is that many “pensioners” struggle to make ends meet – and an increasing number of people are turning their back on the classic idea of retirement, being forced to work until they drop.
That’s not cool.
But then there’s another perspective on retirement; one that isn’t controlled by age.
Instead, a more modern version of retirement is based on finances.
There’s a reasonably simple equation for when you can retire; it’s when you’re earning enough money from passive sources (pensions, investments, savings etc.) to cover your monthly living expenses without needing to work.
Whether you hit that goal at the age of 35 or 65 matters not; what matters is the financial independence you enjoy.
Looking at things in this way, retirement looks rather more tempting.
No more waiting to travel the world until you’re too old to enjoy it. No more working the night shift stacking shelves in your seventies to try and make ends meet. No more feeling that retirement is, in many ways, the end of the world.
No – viewed in this way retirement is one of the most juicy and appealing ideas around.
Finally – an opportunity to stop worrying about getting up while its still dark, struggling through rush-hour traffic or dealing with a boss who is a complete a-hole.
Instead you get to live life on your terms.
If all this sounds appealing to you (and it sure does to me) then the next question is how you can retire early – and do so comfortably, without having to worry about whether you can afford to have the heating on in winter.
Early Retirement Through Frugality
Remember that simple equation we discussed earlier? That’s your route-map to success.
All it takes are two things; high levels of investments and low living expenses.
Lets take two examples to demonstrate how this might work in theory…
John and Jane work at the same company, managing similar departments. They both earn the same money, but their lifestyles are entirely different.
John earns $3000 a month, puts 10% into savings and investments, and enjoys himself with the rest. He has a nice house, a new car and takes foreign holidays. He’s comfortably middle-class and has few financial worries.
That $300 a month he’s putting away – a generous figure by most measures – is accruing all the time.
All he needs to do is wait until he’s earning enough to cover his living expenses each month – roughly $2700 in his case.
How long would that take?
Let’s run some over-simplified math –
In order to earn $2700 a month ($32,400 per year), John needs his investments to provide this on a monthly basis. Assuming he earns 5% on his money, this means that he’ll need 32,400×20 = $648,000 saved at a bare minimum. A higher figure would be safer.
So how long will it take to save that much? 648,000 divided by $300 a month is…
2,160 months, or 180 years.
It doesn’t look like John will be retiring early after all.
But what about Jane?
Oh, she earns the same $3000 a month, but she saves half her income. John is always laughing at her frugality, but how do the figures work out?
Firstly, her living expenses are half that of John, so she needs less in investments to cover her.
Secondly, she’s putting aside way more.
She needs to earn $1500 a month (or $18,000 per year).
She’ll want at least $360,000 in savings and investments to provide that.
Fortunately, at $1,500 a month of savings, that’s just 240 months of saving.
Jane will be comfortably retired in under 20 years – and never have to worry about money again.
Suddenly, Jane’s frugality doesn’t look quite so easy to mock, does it?
She’ll be retiring 160 years before John – even though they both earn the same salary.
Of course, the above math is oversimplified. We haven’t factored things like compound interest or inflation into the equation.
Such figures actually mean Jane will probably manage to retire even earlier.
According to this chart, based on her savings rate, she could actually retire in just 17 years.
Let’s also remember that this is starting from scratch.
How To Retire Earlier
As you can see from the above examples, the theory behind early retirement is as follows:
- Live well below your means – this means less investment income is needed to cover your expenses, and you have more to save/invest
- Increase your income as much as possible in order to put more away.
- Aim for high interest rates – the more compound interest you can enjoy, the quicker your money will grow and the sooner you can retire. Work hard to protect your money from losses while looking for the most favourable savings and investment returns. Just a fraction of a percent can make a big difference over a long-enough time period.
- Save as much as you can.
That’s it, in its simplest form.
As you can see, arguably the most powerful factor of all is living frugally; simply because it affects two different elements of the equations.
What are you doing to prepare for (early) retirement? Do you have concrete plans yet? Do you believe early retirement is even possible? Please leave your thoughts in the comments section below…