Steps to Early Retirement

There is certainly no shortage of opinions on the steps to early retirement. In this post I’m going to outline the steps that I will be following and feel are necessary to successfully retire early.

Step 1
Realizing that you Actually Need a Retirement Plan – this sounds simple but it’s amazing how many people don’t have a real retirement strategy. Many people save for retirement but have no idea how they are doing or how close they are to retirement. I’ve talked to people who’s “retirement strategy” is to work until 60 and then retire…but they have no idea of how much money they’ll need at 60, how much they’ll be receiving or how much they should be saving or investing. I think “Realizing that you Actually Need a Retirement Plan” is the most important but often overlooked step in many people's retirement journey.

Step 2
Now that you know you need a real retirement plan you need to determine exactly how much money you’ll need each month and then add 10% to that number as a safety cushion. Probably the easiest way to do this is to keep track of your current monthly expenditures and then add and subtract any expenses/expenditures that you think you’d have in retirement ie- increased travel costs, decreased commuting cost etc...

Step 3
Determine how you’re going to generate the required income you calculated in step 2. This isn’t an easy task and if you have no interest in investing or finance may require the help of a retirement planner or investment advisor. I’m not going to go over all of the available strategies as your retirement strategy should be tailored to your specific needs and risk tolerance. Personally, I am pursuing a dividend growth strategy, the rational for my decision can be found here.

Step 4
ELIMINATE ALL DEBT – I personally believe that it’s crucial to ensure that when your retirement date arrives you have no debt of any kind (this certainly includes your mortgage). After you retire your employment income will be 0 so to protect yourself from unforeseen events (ie- rapid rise in interest rates) I am going to make sure that I am debt free when I retire. Some people will argue that it’s OK to retire with a small amount of manageable debt…but I disagree.

Here is a link to my personal retirement philosophy. It will probably be different than yours but it works for me. As always comments are welcome.

High Yield Bond Risk

Although I don’t plan on making fixed income part of my retirement plan I thought that I’d highlight some interesting facts from an article I read recently by Neil Reynolds on www.globeinvestor.com

In his article Mr. Reynolds makes the case for investing in a basket of high-yield non-investment grade bonds instead of investing in a single triple A rated bond. He states in his article “it is a fact that most high-risk borrowers make their mortgage payments. Therefore you can achieve - depending on the bundle of mortgages you buy - a risk not much greater than a triple-A security. A portfolio of non-investment-grade bonds offers risk-adjusted returns greater than that of an investment-grade portfolio.”

Just something to think about before you buy your next AAA rated 5% government bond.

Pay Down the Mortgage or Invest?

What should you do with your extra cash? Pay down the mortgage or invest? This is a common dilemma that many people have and I think the right answer depends on the individual and their unique situation, lifestyle, investing strategy etc... So I’m not going to say one is better than the other…instead I’ve gone over my own situation and here is what works for me.

Personally, I pay the minimum amount on my mortgage and take all of my extra money and invest it in the market. I’ve chosen to do this because I currently have a low 5 year fixed interest rate (5%) and believe that over time I’ll be able to do better in the market. Part of my strategy is to pay the same in mortgage, maintenance and taxes as I would if I chose to rent. That has been my strategy since I bought my house and as such pay a few hundred dollars less a month than a friend who rents a similar sized house in a similar neighborhood. As rents go up in my city I intend to increase the amount that I’m contributing to my mortgage. This strategy would obviously not work for everyone. It took me quite a while to find a house that was both comfortable enough for my wife and would allow my monthly house expenses to be comparable to rent (I ended up buying a semi-attached home from a couple on the very brink of bankruptcy). Additionally, I don’t plan on adding any fixed income to my portfolio. However, if I did I would probably use the fixed income portion of my portfolio to pay down the mortgage as both the long and short term fixed income rates are so low.

My Retirement Philosophy

Unlike most people my goal for retirement isn’t to sail around the world, discover myself, read the classics, volunteer at a worthy charity or even travel (to tell you the truth - I like where I live and would be happy if I never ventured more than 50 miles from my home (ever), and instead spent all my time visiting friends, family, cooking/eating, camping, fishing, watching movies and of course following the market). My goal is to retire early and live a typical middle class lifestyle (without having to work anymore). Globe trotting and expensive toys/dinners are not for me.

Now some of you ambitious big spenders out there must be wondering “Why on earth would you want to aim for average?” Now I’ve been asked that before, so I have a good and simple answer: well… (drum roll) the reason is that I don’t have expensive needs or hobbies and absolutely love my lifestyle (except for the working thing). I don’t want a lavish retirement and personally don’t see the point of working until 65 saving a huge pile of money and retiring in “luxury”. Instead, I have chosen to aim to retire at 40 live more modestly than the 65 year olds that have built a huge nest egg, but because of my relatively simple needs I would get more benefit from an additional 25 years of retirement than I would from annual vacations from 65 to 75 year old (health permitting). In my opinion 25 extra years of freedom/time flexibility is worth more than an extra star in the review of the hotel I stay at between 65 and 75. Now here’s where I get the “jaded” or “pessimist” accusations…I know I know many of you are saying “why do you keep saying 65 to 75? Why not 65 to 95?” well before I’m labeled as a pessimist I’d just like to say that I do fully expect to live to 95 (partly from the reduced stress of being retired early) but from observation --- after 75 most people have given up (or reduced) most of their expensive hobbies/activities as they age from their mid seventies to their eighties (ie- the need for: globe trotting, world traveling, walking in/cleaning their huge house, driving new expensive cars seems to fade with age). Now I’m not saying that old people have less fun I’m just saying that for any number of reason (health or just don’t care about keeping up with the Jones anymore) as people reach their senior years their needs seem to become simpler and therefore less expensive. I can certainly relate to this and have already been told by friends that I am “the oldest young guy they have ever met”. (which of course I take as a complement)