I don’t think there’s any working-class citizen out there who wouldn’t want to retire early. Seriously, who wants to bust their backs longer than they have to? Sadly, retiring early doesn’t mean you will be free from life’s expenses, as you will still have bills to pay. These include electricity, food, transportation, clothing, medical bills and the list goes on. What this means is quite simple — Even at retirement, you still need to have a source or multiple sources of income. These streams of income will be your means of taking care of yourself and enjoying the rest of your days.
Unfortunately, your retirement won’t plan itself, it is up to you to do that. For you to enjoy your retirement, there are several steps you have to take, well ahead of time. So what are these steps? Read on to find out!
Step #1: Assess Your Current Financial Position
For you to plan an early retirement, you need to assess your current financial state. There are several factors you need to take into consideration which would help you define the moves you need to make to achieve your early retirement goals.
These factors include: - Your debts
- Your savings and
- Your financial commitments
Let’s see how these factors will affect your plans for an early retirement.
First are your debts. If you’re in debt, then your plans of retiring early may not be possible, as you will have to continue to work to pay them off. This however depends on the amount of debt you owe. You may find some debts easy to offset, while some others could prove difficult. Multiple unpaid credits will affect your credit rating, which will make it difficult to access other forms of credit. To have a realistic chance of retiring early, you need to clear off all your existing debts. Failure to do so will mean more working hours.
Next are your savings. You can’t assess your current financial situation without taking account of your savings. While the money saved itself cannot guarantee your financial freedom during your retirement years, it can be used to invest in physical assets or stock. Physical assets your savings can buy you include rental properties which can offer you a method of receiving cash flow to help fund your retirement.
Finally there are your financial commitments. A financial commitment simply means a commitment to an expense or multiple expenses at a future date. The expense could be major or minor. Generally, it is a financial responsibility associated with your cost of living. Some financial commitments are one-off payments, while others can be stretched over a long period. These commitments don’t necessarily have to be business-related, they could also be personal.
For one to plan an early retirement, all his or her financial commitments, both in the long and short term must be considered. To be comfortable in retirement, these pledges, or responsibilities need to be taken care of by a stream of income. For this reason, all financial commitments must be factored into an individual’s early retirement plan.
A few examples of financial commitments include:
A Financial commitment to a supplier — In a case where you send a supplier a purchase order, you have a commitment to pay on an agreed date in future
A Financial commitment to lenders — When a lender (bank) approves your loan, you have a financial commitment to pay back at an agreed date, according to your contract or
A Long term responsibility to family — If for instance you and your partner have a baby boy, you both will be committed to raising him. This will involve feeding, clothing, medical care, tuition fees etc. This is a very long-term financial commitment
Step #2: Set Retirement Goals
This is the second step you must take in your quest for early retirement. There are 3 things involved in setting your retirement goals. They are:
Your desired retirement age
The amount to be saved before retirement
Your desired retirement lifestyle
Let’s look deeper into each of these factors.
Factor number one is your desired retirement age. Most people retire when they get to the ages of between 60 and 65, but if you plan to retire young, then you’re probably targeting the age of 45 to 50. Setting a specific age bracket when you would like to retire will help guide you in knowing what you must and must not do to achieve your goal on time.
Factor number two is the amount to be saved before retirement. Surely you don’t plan to retire with an empty bank account. There needs to be a substantial amount of money saved before you even consider the idea of retiring. It is up to you to figure out how much you will need to have stashed away before you call it quits. As I mentioned before, having money saved doesn’t necessarily guarantee financial freedom. Money is just a tool used for exchange of goods and services. It is also a tool to invest. That being said, you need to set a savings target and meet it. The money saved can be used to invest, buy a home of your own, and take care of other financial commitments in the future.
Factor number three is your desired retirement lifestyle. What kind of life do you want to live during your retirement years? Do you want to live a simple, low-key life, or do you want to go on expensive vacations every year?
After figuring out the kind of lifestyle you want, you need to ask yourself another important question — Will your savings and earnings from your existing investments support the kind of lifestyle you want during retirement?
If your answer is no, then you need to save more, and invest in more streams of income. But if your answer is yes, then you’ll be fine. Without setting these goals, you will have nothing to aim at, and this simply means you will miss!
Step #3: Determine Your Investing Requirements
Early retirement is just not possible without profitable investments. Investments are usually meant to yield profits over the long term, and there are so many viable investments one can have. The main factor to consider when choosing your investment method is whether these vehicles will yield you the returns that will support the desired lifestyle you identified in step number two. For instance, investing in bonds as your sole asset will give you steady but rather underwhelming returns meaning your retirement nest egg likely won’t support much of a financially fruitful retirement. Investing in stocks on the other hand, which have a higher potential for future growth will give you more options in your retirement years. Ultimately, the more money you will need in retirement, the more aggressive you will have to be in your investing decisions.
After you know your investing requirement figure, you need to ask yourself if you want to achieve it using active or passive investing.
Active investments require you to be actively involved in how the business is run. This may not be the best choice for someone who wants to retire early, as being actively involved with work automatically defeats the whole purpose.
Let’s say you’re a baker who has worked in a bakery from the age of 25 to 45, and you manage to save and open up your own bakery. If you go to the bakery every day to keep an eye on how things are run, or still baking, then you aren’t really retired, you’re just self-employed.
On the other hand, if you only go to the bakery once every 2 weeks, and do minor tasks like sign checks, then you could still assume the status of being retired.
Passive investments do not require your full attention before it yields you income. Passive investments mainly require the initial investment and work at the beginning stages, after that, it pays you without the need for you to lift a finger.
Examples of passive investments include rental property, P2P lending (Peer To Peer), stocks, bonds, etc. If you really want to kick-back in your lawn with your feet up, without a worry in the world, then passive investments are best for you, as they do not require much effort from you.
Step #4: Identify Your Asset Mix For Investing
After you have grown your emergency fund, set your goals, determined how much they would cost, and are certain of how much risk you can take, the next step is to consider which securities to purchase.
Remember, you have to choose the ones that will help you reach your goals in the long term. Your asset allocation is your portfolio’s blend of stocks, bonds and cash, and finding the right asset mix is very important if you want to achieve your goal of early retirement.
Unsurprisingly, many financial advisors are of the opinion that finding the perfect asset mix is more important than even choosing great investments. Thanks to a variety of online calculators and tools, it is now easier for an investor to determine their optimal asset allocation. The asset allocation that will work best for you at any given point in your life will depend mainly on your time horizon and your risk tolerance.
The time horizon is the estimated number of months or years you will be required to invest to reach a certain financial goal. Investors who have longer time horizons are usually more comfortable taking on higher risk investments. This is because the investor can bear the slow economic cycles and the expected market fluctuations. On the flip side, an investor saving up for a teenager’s college education would be more comfortable with a lower risk investment, due to a shorter time horizon.
Risk tolerance is an investor’s willingness to lose a part, or all of his or her original investment, in exchange for better potential returns. An investor with a low-risk tolerance will likely go for investments that will preserve their original investment, but this risk aversion may lead to prolonging their working years or reducing their standard of living in retirement.
Step #5: Automate Your Investments
Automated investing involves having a fixed sum of money channeled from your salary (or bank account) every month, and invested into a pre-determined allocation. A perfect example of this is contributions to retirement plans at work. If your employer withdraws money from your paycheck each month and automatically invests in the 401k or 403b, then you have automated your investing. For you to have an early retirement, then this is something you must consider. There are 3 major advantages that come with automated investing.
First, you can’t spend the money. When you automatically move money into your investment account, it means the temptation to spend the money on something else has been defeated.
Next, there are less conflicts. When you automate your investing, you also automate your savings, and that leaves limited room for conflicts on how much you should spend or save. Finally, there is no work required. It would take a little effort to set up, but not a lot. Once everything is put in place, you can relax and reap the benefits. There you have it, 5 steps you must take to retire early.