How to Retire Early

Reaching 401(k) contribution limits instead of spending your wealth on conspicuous consumption can help make early retirement a reality for you, and become the ultimate status symbol.
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By Richard Barrington

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retire-early

Keeping up with the Joneses is about this one thing – status.

But what could be more frustrating than chasing a moving target?

Your neighbor just drove up in his flashy, new car. Your best friend loves to entertain in her 4,000-square-foot house. Your brother just got back from a week-long luxury cruise. How can you keep up?

You don’t.

What it’s like to work toward early retirement

Not that you don’t make a good income. In fact, between you and your spouse, you pull down more money than most of the people in your life.

And yet, you chose a modest house; your car is more sensible than sexy (and is now about eight years old); and when you take vacations, long car trips and camping are more your style than five-star hotels and cruise ships.

Most of the time, you and your family are comfortable with that lifestyle. But every now and then you feel a twinge of envy for those people who always seem to live larger than you.

Again, don’t — and not just because envy is a destructive emotion.

If you feel the need to compare yourself against other people, keep in mind that you are on track to have the last laugh. Your friends will envy you when you’re the first to retire. And all because you took every opportunity to save and make larger 401(k) contributions.

How to build retirement savings faster and retire early

In the long run, being able to afford a comfortable retirement is a great source of freedom and peace of mind. Early retirement means being able to enjoy that feeling even longer.

Unfortunately, people derail their retirement finances by spending money on short-term status symbols rather than long-term security.

Remember these concepts to help get you in position to retire at age 60 rather than having to work until the traditional retirement age of 65….

1. Fancy cars undermine retirement savings

According to Kelley Blue Book, the average price of a mid-sized car is $25,000, but several models list for over $50,000.

If you put that extra money toward retirement savings at age 25 instead of spending it, you could add over a quarter of a million dollars to your nest egg by the time you are 60, assuming a 7 percent annual investment return.

2. Keep your car longer – it’s a double-win for your wealth

According to Edmunds.com, the average new car depreciates in value by 19 percent in the first year of ownership. The rate of depreciation then slows down after that.

Keeping your car for a longer period of time can help you avoid that first-year depreciation for a longer period too.

Also, if you’re borrowing money to buy a car, holding on to your car longer means more years without a car loan, which can help you make larger 401(k) contributions so you can ultimately reach your 401(k) contribution limit.

3. Smaller houses are more cost-effective investments

Buying a home can be a good investment, but paying mortgage interest negates some of the value of that investment.

A smaller mortgage means paying less interest, especially if it allows you to afford a shorter mortgage at a lower interest rate.

If you put that money toward 401(k) contributions rather than to some loan company, you could move up your retirement date substantially.

4. Retirement lasts longer than a vacation

According to Cruise Market Watch, the average cruise costs $1,791 for about a week — about $3,582 for a couple.

Put that money instead toward a larger 401(k) contribution at age 30 and it would grow to an extra $27,267 of retirement money by the time you are 55, at a 7 percent annual return.

5. Eating out means eating up retirement savings

Let’s say you and your spouse like to eat out once a week for an average cost of $75.

If you refrain from doing that just once a month from when you are 25 until you are 60 and put that money into your 401(k) contributions instead, it would add a little over $129,000 to your retirement nest egg assuming a 7 percent annual return.

6. Enjoy your old favorites a little longer

According to the Bureau of Economic Analysis, the average American spends $1,166 per year on clothing and footwear.

If you get just enough extra wear out of some of your older clothes and can cut that figure by 25 percent every year beginning at age 25, it could add nearly $43,000 to your retirement savings by age 60.

These common-sense choices are not always easy. There is a natural desire to keep up with your social group.

But you shouldn’t let others dictate your lifestyle – especially when many Americans have massive debt and inadequate retirement savings.

Keep your eye on the long-term prize of being able to afford retirement sooner, and resist the temptation to keep up with the Joneses. After all, peer pressure may not have ended when you left school, but it certainly got more expensive.

Frequently Asked Questions

Q: I will be getting about $129,000 very soon. I need about $1,500 a month for living expenses. Ideally, I’d like to invest the money and just draw off the interest to meet my expenses, but this doesn’t seem possible at today’s interest rates. What is your advice for how I can invest this money to get the return I need?

A: You are absolutely correct that today’s interest rates won’t come close to yielding the type of income you want. According to the FDIC, the average rate on savings accounts was just 0.11%. On an investment of $129,000, that would yield only $141.90 in income annually. A five-year CD could get you up to around 1%, and you could probably add another percent on top of that if you shop for the best CD rates. Still, this would leave you at around $2,580 in annual income, or $215 per month — still well short of your goal.

The problem isn’t just that interest rates these days are unusually low. Even under normal circumstances, your income target would be overly optimistic. $1,500 a month would come to $18,000 in annual income. That would represent a return of nearly 14% on a $129,000 investment. CD rates have rarely been that high, and not since the early 1980s. Even stocks have not generally produced returns of that size, and in any case, a heavy stock allocation is risky when you are withdrawing a significant amount from a portfolio, because withdrawals tend to amplify market volatility.

Under the circumstances, there are two things you should consider:

  1. Rein in your income expectations, ideally to 5% or lower. This would mean $6,450 in annual income from $129,000, or $537.50 per month. Even 5% isn’t a sure thing, but if you withdraw any more than that you will increase your risk of drawing the principle down over time.
  2. Try a mix of stocks, bonds, and short-term income securities. You’ll want to keep the mix pretty conservative because of your withdrawals, but having some stock representation will give you a shot at earning more than today’s low interest rates, and also give you a better chance of keeping up with inflation over time.

It’s a shame that you can’t count on the level of income you had hoped for, but you are doing the right thing by asking these questions in advance. Too often, people fail to plan for a sustainable level of income, and don’t acknowledge the problem until their principle has been dissipated to the point where income production is severely compromised.

About Author
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Richard Barrington
Richard Barrington has been a Senior Financial Analyst for MoneyRates. He has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications. Richard has over 30 years of experience in financial services. He has earned the Chartered Financial Analyst (CFA) designation from the Association of Investment Management and Research (now the “CFA Institute”).