wanting to reach this kind of goal. I do think that this type of big
goal works better if you have a strong life reason for doing it.
How Much Will We Need?Because we’ve spent the last several years budgeting our money and
tracking our expenses, Sarah and I recognize that we could enjoy more or
less the same life we’ve enjoyed for the last several years on about
$26,000 a year in today’s dollars.
Our actual annual expenses are higher than that. If Sarah no longer
worked outside the home, we could easily drop down to one vehicle.
She’d also lose the extra expense of fuel and of a professional
wardrobe. Eliminating those expenses drops our requirements quite a
What about you? The easiest way to figure out this
number is to just track your spending over the course of a year and see
what it all adds up to. Then, remove expenses from that total that are
related to your job, like travel expenses, clothing expenses, and so on.
That’s what your income expenses need to be.
How Will You Invest?Right now, we’re investing almost all of our money for early retirement in the Vanguard Total Stock Market Index. If you take a look at that fund,
you’ll see that it has a pretty strong track record. It’s returned an
average of 8.31% per year over the past ten years and 9.60% per year
since the fund’s inception (remember, that’s an average).
Still, Sarah and I are sticking with Warren Buffett’s projection for
the future health of the stock market. He projects that broad stock
market investments will have a 7% annual average return. That’s the
number we’re using for future projections.
The Vanguard Total Stock Market Index is exactly that – a broad stock
market investment. It has really low fees and we’ve been happy with
how Vanguard has treated us.
Sure, 8.31% per year looks like a lot sweeter than 7%, but we’re also
riding on the fifth or sixth year of a bull market, so I expect that
number to go down over the next several years. Plus, we’d rather
slightly underestimate our returns and have things go a bit ahead of
schedule. 7% seems very realistic for us.
What about you? You can use whatever estimate you
want for future projections. Using the average annual return since
inception of your investment would likely work just fine.
What About Inflation?Inflation can be a really tricky problem with calculations like this.
Clearly, prices are going up over time, so we’re going to need to have
more money in the future.
Our solution is to just subtract 3% from our investment growth each
year. Since we figure that inflation is going to stick at 3% or below
annually, we’re going to use that as our benchmark. By subtracting 3%
from our annual investment return, we’re keeping all of the dollar
amounts in today’s dollars, making the calculations a lot easier.
This 3% number is based both on the Consumer Price Index and on Warren Buffett’s projections for the future.
What about you? You can adjust that number as you
wish, but subtracting 3% from your investment returns is probably a
great way to adjust everything for inflation.
How Much Do We Have to Save Each Year?Here’s where the rubber meets the road. Right now, we’re assuming
that our investments will pay out a 2% dividend each year which is based
on the dividend history
of our investment. So, in order to pay out the $26,000 a year we would
need to live in perpetuity, we would need to save $1.3 million. This
amount would definitely allow us to live in perpetuity at that income
level, even accounting for inflation (remember, our investment is
growing at a faster rate than inflation, so our dividends would also
grow at a rate faster than inflation).
So, our target number is $1.3 million in today’s dollars.
I’m fully aware that such a target is pretty conservative. We’re
assuming a slowdown in the growth of the stock market and also assuming
that we need our investments to continue to grow after inflation.
Now, as we mentioned earlier, we’re assuming a 7% return on our money
and we’re also assuming 3% inflation, so we’re figuring that our
money’s actual value will grow at 4% per year. We’re only looking at
actual value here, so that’s the number we’re using – it takes inflation
out of the picture.
Let’s look at a few simulations, then. First, let’s assume we start at $0.
If we were able to save $10,000 a year for early retirement and we
reinvest all of our dividends along the way, we would have to save for
37 years to make our investment target. That’s pretty rough. Sarah and
I would be 72 at that point, so it would be a normal retirement.
If we were able to save $20,000 a year for early retirement and we
reinvest all of our dividends, we would only have to save for 27 years
to make that target. That would put us at age 62 – a bit of an early
retirement. We’d also have Social Security at this point to help us.
What if we were able to save $30,000 a year? This would be a very
significant chunk of our annual income. In that situation, we’d only
have to save for 22 years to get there, letting us retire at age 57.
Of course, this isn’t completely accurate. We do have some retirement savings. As many of you know, we’ve been living
on Sarah’s income and saving my entire income each year for retirement,
so we currently have a healthy savings built up, plus we have our
pre-existing retirement savings. Let’s say we already have $200,000
saved for retirement.
In that situation, saving $10,000 per year would get us to our goal
in 25 years (retiring at age 60), saving $20,000 per year would get us
there in 20 years (retiring at age 55), and saving $30,000 a year would
get us there in 16 years (retiring at age 51).
Given our current account balances and current trajectory (remember, we’re saving my entire salary right now), we’re hoping to be able to do it in the next decade or possibly even sooner than that.
How Can We Increase Our Income?As I’ve stated many times, the key to personal finance success is to spend less than you earn. It’s the fundamental rule, in my opinion.
In between those two numbers – the amount you spend and the amount
you earn – is a number I like to call “the gap.” It’s the money you can
use to save for your future and make all your giant dreams come true.
The bigger the gap, the faster you get to your dreams.
There are two ways to make that gap bigger – earning more and spending less.
Let’s start with the “earn more” part of the equation. Here are five
strategies Sarah and I could apply to earn a little more income.
Publish a book on the Kindle Store. I could write a
book of some kind and publish it on the Kindle Store. If I could sell
it for $2.99, earn a 70% royalty on it, and sell 100 copies a month,
that earns us $210 per month. Of course, this requires us to write a
decent book worth reading, format it correctly, design a cover for it,
and then promote it.
Publish some Youtube videos. We could create a set
of Youtube videos on a certain topic. Individual videos might not earn
much money (via ad revenues), but a healthy collection of videos on a
topic of wide interest can earn a surprising income stream (say,
$100-200 a month).
Hang out my freelance shingle again. In 2003 to
roughly 2007, I did freelance computer work for people. I’d go to their
house, diagnose computer problems, and fix them. I had a nice little
network of customers – mostly elderly people – and I’d often stay and
share a cup of coffee with them after I finished their computer work.
While the work was irregular, it did earn a decent income for the time I
invested in it.
Design a standalone ad-supported website. I could
invest the time to develop a standalone website that focuses on
information on a specific topic. I’d just put some ads on it then link
to it in a few places, causing the site to generate a bit of traffic
over time. I’ve designed these in the past (in 2006, I designed
several, some of which are still earning a trickle of money with no
upkeep for almost a decade).
Buy and sell trading cards. I’m strongly familiar
with the secondary market for Magic: the Gathering cards and other
trading cards and I’m pretty good at exploiting inefficiencies. With a
nice bankroll to start with, I could get back in the business of buying
and selling cards, something that I earned a bit of money with in 2006
All of these strategies could contribute to our total income, and all
of that income would go straight into our gap, bringing our retirement
income a little closer. If I could come up with just $5,000 in
additional income a year from these sources, I could literally shave years off of our goal.
How Can We Decrease Our Spending?On the flip side of that coin is the “spend less” objective.
Sarah and I are frugal people. We find lots of ways to avoid
spending money to the extent that more than a few readers have called us
cheap. So, how can we possibly spend less?
Here are four strategies we could consider to cut back on our spending right now.
Sell one of our cars. We could very easily drop one
of our automobiles. I work from home, so I don’t have any commuting
needs. The biggest restriction is that I’d be stuck at home during the
day, which could cause a few minor difficulties but nothing we couldn’t
work around. Doing this would give us a big burst of cash, plus it
would reduce the ongoing cost of that automobile – registration,
maintenance, fuel, insurance, and so on.
Move to a smaller home. We really don’t need a
larger home; in fact, we really don’t need a home of our current size.
We use an awful lot of our space just for storage, so if we simply sold
off a lot of our unused stuff, we could easily move into a smaller home.
That move would save us money on insurance, property taxes, home
maintenance, and energy bills.
Cut out cable. We still have a cable television
service, something that I basically don’t use. Sarah watches a handful
of programs and the children watch a number of recorded PBS Kids shows,
but aside from that, it’s not used. We could easily ditch cable, stick
with Netflix, and save ourselves $50 a month.
Eliminate all of our magazine subscriptions. We
subscribe to five or six magazines, adding up to perhaps $100 a year.
Most of those magazines go unread, with only occasional browsing
happening in our living room during idle moments which could easily be
supplanted with web surfing.
These techniques would each cut a big chunk out of our annual
spending. All told, we’d save thousands per year with these changes,
which would bring our early retirement goal at least a couple of years
Can We Utilize Tax-Advantaged Accounts?For example, if we’re saving for retirement, does it make sense to
use 401(k)s or Roth IRAs? That’s a complicated question without an easy
First of all, you can tap into money that’s in a 401(k)
before a normal retirement age by taking SEPPs – Substantial Equal
Periodic Payments. In other words, you have to subscribe to a very
specific method of pulling money out in a series of very small payments
over a number of years, but if you do that, you can get the money out
before age 59 1/2 without a big tax penalty. This Forbes article explains things.
So, you can do this, but should you do this?
The big benefit obviously is the tax benefit. If we save some of our
money in a 401(k), we don’t have to pay income taxes on it right now.
Instead, we pay it later on – theoretically, when we’re in early
retirement and thus our income taxes should be really, really low
But it’s not all roses. This isn’t an automatic decision.
For one, Sarah’s retirement plan does not offer investment options
anywhere near as good as the options offered by Vanguard. If you
compare similar investments, you’ll find that you’ll be paying 0.3% or
so more in expenses to use the options in her 401(k). Over the course
of twenty years, that difference eats up most of the tax advantage, at
least in my calculations.
There’s also the issue of whether something significant changes in our life, which I discuss a bit more below. If we choose not
to retire early, that money in the 401(k) essentially becomes strict
retirement savings. We can’t really use it for most other things
without a tax penalty. What that means is that by using a 401(k) for
retirement savings, we do lose some flexibility.
So, what are we doing? We’re balancing. We’re making very healthy
contributions to her retirement plan, but we’re saving far beyond that
in normal taxable investment accounts. When we do retire early, we’ll
use her retirement savings first during that period where we’ve had the
minimum number of years for the poor options in the 401(k) to work
against us and also when our income taxes are at their lowest because
Social Security hasn’t kicked in yet.
Not only that, mixing our strategies protects us as much as possible
against future changes in the tax code. Will the SEPP rules change in
the next ten years? I’d say it’s likely that they’ll change at least a
little. Spreading out our money protects us in any event.
What If Something Changes?When you look at a giant goal like this, particularly one that’s many
years in the distance, it’s easy to paint a mental path that leads
straight to that goal.
However, over the course of the next decade, things are bound
to change in my life. Will someone get sick? Will our goals for the
future change? Will someone unexpectedly pass away? The landscape of
our lives can drastically change.
Here’s the nice part of this goal, though. It’s all about the savings.
No matter what might change in our lives, that money we are saving
will be there for us. If we decide we don’t want to retire and want to
follow other goals, that money will still be there for us.
That’s the advantage of savings-oriented goals. Even if your life path does change, you’ll have that money to support that change.
Goals that worry me with regards to changing plans are the ones that
aren’t as transferable. For example, if you spend three years going to
school to study a subject only to realize that it’s not something you’re
skilled at or passionate about, then it’s going to be devastating. If
you invest all your money into building a workshop for a side business,
only to find that you didn’t enjoy it as much as you thought (or an
injury leaves you incapable of using it), you’re suddenly selling
everything at a big loss.
Savings, on the other hand, will always be there for you. Money
folds itself around almost any goal that you have, so even if our life
changes or our goals change, that savings will work perfectly fine for
our new goals.
Final ThoughtsThat’s our game plan. Right now, our big goal is to retire as early
as we possibly can. We’re throwing almost everything we can at that
goal – living on one income and living a pretty frugal lifestyle. We’re
planning ways to increase our income and we have options for further
reducing our spending.
Is it perfect for everyone? No. No investment plan is. There are
always options that work better for some people and work worse for other
people. Some people might prefer to put their money in real estate,
buy homes for rent, and spend their spare time being a landlord. Others
might want to be more risky with their investments – or perhaps more
conservative. Still others might believe in a higher average annual
return going forward or might believe in a higher (or lower) inflation
rate going forward. All of those factors would change our plans, of
For us, though, our path to early retirement follows the road I’ve
described here. Hopefully we achieve that dream and I can write to you
in several years announcing that we’ve made it.
- The Simple Dollar