My hope is that The Money Habit community becomes a place where you can find new strategies each week that will help you earn, save, and grow their money by thousands of dollars, and eventually retire decades earlier than the average American. Keep a look out for the next post, which goes up on Tuesdays and Thursdays.
Until then, here is The Quick Start Guide to Early Retirement and the Four Step Blueprint to Retirement to get you started.
The Quick Start Guide To Early Retirement
Welcome to The Quick Start Guide to Early Retirement! We will cover:
- The Four-Step Blueprint to Retirement
- How To Calculate How Much You Need to Retire
- Identifying Your Target Savings Rate
- Financial Benchmarking: Where You Stand In Relation to the Rest of the US in Income and Net Worth
The Four-Step Blueprint to Retirement
When you get right down to it, the pattern we all follow to reach retirement escape velocity is very much the same.
Our nest eggs are all governed by the same two simple equations.
As you can see, there are four universal levers we can use to ultimately grow our nest egg.
- Master spending control
- Expand your income potential
- Deploy your money for optimum growth
- Minimize your tax exposure
You’ll notice that because “savings” is the item from the first equation that feeds into the second equation, there is a specific order in which you should tackle these steps for maximum effect. You want to tackle the first two before spending significant time on the second two. Put simply, even if you have the best investment strategy in the world that yields 5% more a year than other strategies, you won’t see a huge impact if you only have $10 in savings to put to work in it. So plan to get good at at least one of the first two drivers (increasing income or cutting spending) before tackling the other two (optimizing investment strategies and taxes).
Step 1: Master Spending Control
Folks who retire extremely early have very high savings rates, typically 50%+ and most definitely over 25%.
The best place to start is with your largest line items: housing and food.
My first job was in New York City, one of the most expensive areas in the world. I took a roommate to keep costs reasonable. And while we picked a safe neighborhood (Upper East Side), we picked a shitty little apartment that was a multi-flight walk-up, with bars on the one set of windows in the entire space and no natural light in the living room. It was safe, warm, and clean, but my mother admitted years later to me that she cried after she saw my apartment for the first time.
Luckily, I was too young and too used to living in crappy dorm rooms for it to bother me. That one decision probably helped me put away $15k more a year than my peers. 5 years of that is $75k, but deployed in the stock market over those years, the true amount it’s created for me is about $90k.
That’s enough to send me on a $2,700 vacation every year for the rest of my life.
Or, I can set that aside now and have it pay for private college for two kids. One decision I made for a few years while I was too young to be bothered by it has set up my future kids for life.
Remember that the cuts you make can be temporary, but they will yield beneficial results forever by giving you savings that can grow.
Focusing on big ticket items can get you to perhaps a 20-30% savings rate, but the rest of your progress will likely be made up by small enhancements. Don’t be discouraged when you look at your budget now and can’t imagine how you can get to a 50%+ savings rate. You need to make small incremental improvements over time, such as finding the most efficient credit card bonuses, finding the right airfare comparison tool, and other tools that will push your savings rate up. The most important thing is that you start and that you maintain momentum.
If you show up consistently and make one improvement to your spending system each week, you will find you have a 50%+ savings rate in no time.
Step 2: Expand Your Income Potential
There are an incredible number of opportunities to expand your income potential and increase your savings rate. The key to this is changing your mindset and viewing yourself as the CEO of your own business. You can make a better product and learn to charge more for it (i.e. getting raises and promotions at your full-time job) or you can expand to multiple product lines (i.e. side hustles).
To get the fastest promotions and highest raises, you want to focus on your strengths, not your weaknesses. You want to become known for something specific, the guy to go to for ____. If you can’t name this easily, then you need to keep working at it.
You will want to look for a new job every two to three years. Lateral hires can make 20-30% more than employees who have climbed internally for years. This is because companies need to compete in an open market for a lateral hire, and that competition makes the new hire’s demands for pay and title more urgently heard. Note that this doesn’t mean you need to actually leave your firm every two to three years. While I stayed at the same firm all 7 years of my career, I approached them ready to leave for a different position. That year, I was told I received the highest bonus of anyone in my position.
We live in a golden age for side hustles. The internet has leveled the playing field. If you are looking for truly low activation energy, lucrative roles, my top five recommendations are here.
These two factors – income and spending – determine how much you are able to save each year. Since these are the only two levers that contribute to savings, you must get good at one or the other of these.
Step 3: Find Good Places To Grow Your Money
You have successfully whipped your spending into shape and oversee multiple streams of income. Now you are looking at your money pile and thinking to yourself, “not bad.”
At some point, your money pile grows to a size where focusing on growing your nest egg will have a much more material impact to your net wealth than further reductions on your spending.
Say you make $70k a year and have steadily put away good money for a few years. Now you’re looking at maybe $120-$150k of savings. If you are able to get a better yield on your savings by 2%, that’s $2.4-$3k a year.
If you are able to get a total 10% yield on your money, you will be adding $12k-$15k a year to your stash while you sleep.
Try using savings jiu jutsu to have that level of impact. It makes shopping for $0.75 vs $0.90 toilet paper rolls seem less worthwhile, or camping out with a convoluted coupon plan to save $5 on soap seem silly.
So when should you start actively working on this step?
My rule of thumb is to start thinking about these topics seriously once you have 2x your income in savings.
The reason you need to start early is that it takes time for you to build up a knowledge base and framework for thinking about investment. You want there to be that vague memory of an article you read about backdoor Roth IRA’s planted in your head by the time you hit the tax bracket that eliminates roth IRA eligibility. You want to already know a little about how you feel about real estate and what the returns look like before you have enough money to put a down payment on a rental house.
Step 4: Minimize Your Tax Exposure
As your nest egg gets bigger, your focus usually switches to tax efficiency.
Say you have $150k in savings. If you are able to avoid taxes on all your gains by contributing to tax advantaged accounts vs taxable accounts and they’re growing 10%, that can be a difference of $15k*Tax bracket = approximately $4k a year.
This is also when you start thinking hard about what sort of investments go in your taxable accounts vs tax advantaged accounts like 401k’s and IRAs. Ideally the investments that must actually realize gains and income (for example, selling options, getting dividends that aren’t tax exempt) should go in the tax advantaged accounts.
Chart from Bogleheads
Your Own Personal Army
Working on income and spending is like managing a single employee: yourself. Every time you go to the store, you’re thinking should I buy this? How is the side hustle I’m working on? When should I respond to that email?
When you are working on growth and tax minimization, you have vast armies of employees our disposal. Every decision you make has huge impact simply because you are leveraging more dollar workers. You are thinking “What should my dollars be working on? Where should they be deployed?” rather than what work you need to be doing.
You want to accumulate employees as quickly as possible, freeing you up to think about strategy while they do all the work.
Take The First Step
You improve what you measure. Take inventory on where you are now and track your progress with a financial dashboard. I use Personal Capital, which offers a free net worth and expense tracker. You hook in all your different accounts and it allows you a single command central from which to see all your finances in real-time. It also benchmarks your investments’ performance against their peers and suggests ways to optimize your holdings by limiting fees paid to mutual funds.
Where To Next?
Get your “number” by reading this article which covers the best academic research on safe withdrawal rates and which takes you through three scenarios to triangulate on a safe nest egg target.
Case studies and data showing how you much you can make with my favorite side hustle: blogging.