August 27, 2018

The Principles of Early Retirement, Or How To Win Your Freedom

We are today in the midst of an Early Retirement renaissance.  Never in history has the freedom of Early Retirement been so available to so many people.  And thanks to the internet, never have so many people been aware of the possibility.  The path to early retirement is simple:  save as much money as possible for 10-15 years, invest it in low-cost index mutual funds (or other appropriate investments, such as real estate), and you should be ready to retire.  Sounds easy, right?

principles of early retirement infograph

It all comes down to how much you save.  More specifically, it comes down to what percent of your income you save.  If you save only 5-10% of your income, or less, like so many American workers, and you spend the remaining 90-95%, then you’re going to need to replace nearly all of your income in order to maintain the same lifestyle once you retire.  To do this, you will need to work much much longer than 10-15 years.  You will be warming your office chair well past your prime.

However, if you save 50%, 60%, or more of your income, you can retire in MUCH LESS TIME.  You can enjoy your free time while you are still young.  You can have the freedom to define your life.


“THAT’S RIDICULOUS!,”  You say.  How can anyone possibly save over 50% of their income?  Nobody does that!


Well, you’re almost right, very few people do it.  But it is very possible for many people.  Most people choose not to, because they aren’t playing the long game.


Buying a new car every couple of years?  Then you surely must enjoy working.  Upgrading your house?  Buying all the latest gadgets on credit?  Eating out every day?  These expenses really add up, and they directly translate into more working years for you.


Let’s look at some numbers for a colleague, Carl.  Carl earns $75,000 per year.  Watch how quickly Carl earns his Early Retirement Freedom, with different savings rates.  Assuming Carl invests his savings in low-cost index mutual funds earning 10% per year.

Savings Rate Annual Expenses Years to Retirement
10% $67,500 33 yrs
20% $60,000 26 yrs
30% $52,500 21 yrs
40% $45,000 17 yrs
50% $37,500 14 yrs

By saving 50% of his income, Carl cuts nearly 20 years off his career!  That’s a lot of time that Carl can enjoy his freedom.  This is, of course, a very over-simplified analysis in part because it ignores taxes.  Under the US’ graduated tax rules, Carl would in reality be able to retire SEVERAL YEARS EARLIER, because his tax rate would plummet after he retires.  With a little effective tax planning, Carl can easily retire in 10 years if he saves 50% of his income – decades before most of his colleagues.


The Keys to Happiness

“But why would I want to live like a monk??  I don’t want to make the sacrifices it takes to save 50% of my income.”   Yes, if you are still plugged into the Matrix, that’s probably what you’re thinking.  I am here to offer you the red pill.


If you take the red pill, you will learn what truly makes us happy.  Hint:  it’s not a new car.  I spent three years as a Peace Corps Volunteer in Bolivia in the 1990s.  One lesson that was burned into my memory is that people in Bolivia are generally just as happy as people in the US, despite a much lower per capita income.   Let me repeat that:  People in Bolivia are generally just as happy as people in the US, despite a much lower per capita income.


“How can this be?  How is this possible?  There’s not even a single Apple Store in Bolivia”  Well, there are just a few basic things that we humans seem to require to be happy, and these things are universal across cultures and across income levels.  They are:

  1. Health
  2. A Steady Supply of Good Food
  3. Shelter
  4. A Purpose
  5. A Few Close Relationships
  6. A Community To Belong To
  7. Access To The Great Outdoors
  8. Some Physical Activity

That’s about it.  Everything beyond these things is FLUFF.


Save, Save, Save

“But I really want those new shoes!  They will make me happy, too!”   OK, let’s not confuse happiness with the emotional rush we get when we buy something new.  No doubt, it is a rush, but it is as about as fleeting as that new car smell.  Meanwhile, you will have parted with some very hard earned dollars – dollars that will happily continue working for you, gaining compound interest for years and years so that you can have the freedom to focus on the 8 things I listed above.


In Bolivia, people are happy because they have the above 8 things in spades. The higher income of the average American worker is usually spent on other things, which do not contribute much to their true happiness.


When you focus like a laser on these 8 drivers of happiness, you begin to realize that so much of the crap we fill our houses with is unnecessary FLUFF.  Step back, and focus!  Driving an old car is OK! Buying things on at the thrift store is OK! Sharing an apartment is OK!  Quit throwing away your money on crap, get your priorities straight, and become laser focused on trying to achieve your happiness instead.  Your future self will thank you.


OK, it is certainly not only about cutting your expenses.  It is about saving.  I often focus on spending because we have more control and influence over our spending than any other area.  But, there are two sides to the saving equation:  your income, and your expenses.  You can also achieve Freedom by making more money.  Go get a side hustle, or make a career change to earn more money (and then save it, don’t spend it).  Finally, as a CPA, I also have to mention the importance of some good tax planning.  After all, taxes are usually our single biggest expense during our working years.  A little effective tax planning will go a long way towards dramatically increasing your savings.


Invest Like A Magician

The final piece to the puzzle of Early Retirement is what to do with all those savings.  About the worst thing you can do is keep your money in cash savings.  Many people fall short of their retirement goals because they don’t know how to invest, or perhaps they do, but they listen to their emotions too much.  They rely on poor advice from friends, family, or professionals with improper incentives.  And when the shit hits the fan, they panic.


Investing is in fact simple, if you take some time to educate yourself, and take a disciplined approach.  Start Here to learn everything you ever need to know about investing.   One tried and true path is to invest in low-cost index mutual funds.   Then, sit back and DON’T LOOK AT IT again.  Real estate is another wonderful option.  If you invest in good performing assets such as low cost index mutual funds or real estate, you will benefit from the MAGIC OF COMPOUND INTEREST.  Compound interest will make your investment DOUBLE in about 7 years, if earning 10% per year.  With continuous contributions each year, in about 10-15 years you can achieve enough savings to retire: about 25x your annual spending.  How’s that for magic?


So that’s it, in a nutshell.  Early Retirement Freedom is about saving as much as possible, investing, and focusing on the things that truly matter in life.


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