Although there isn’t just one path to early retirement, here are some essential steps to take if you want to retire by 40: do the math, boost your savings rate, and focus on growing equity
The average retirement age in America is 63, according to an analysis by financial technology company SmartAsset. Still, there are a lucky few who manage to retire early — often long before their peers. Although a survey by the Employee Benefits Research Institute found that only 9 percent of workers expect to retire before 60, some Americans actually manage to give up the 9-to-5 by age 40.
Although there isn’t just one path to early retirement, here are some essential steps to take if you want to retire by 40.
Do the math
“You’re not going to get there without a plan,” said Todd Tresidder, who retired nearly 20 years ago at 35. Tresidder said that he began his career with an eye toward early retirement.
To get started, you will need an idea of how much income you’ll require. A good rule of thumb, according to Fidelity Investments, is to save enough to replace 85 percent of your working salary in retirement.
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Of course, the amount can vary depending on the lifestyle you want. However, it’s important that you factor in the cost of all expenses, including health care insurance premiums.
Once you have an estimate of the annual income you’ll need in retirement, you can determine how much to save to reach financial independence. Tresidder has a retirement calculator on his site, FinancialMentor.com, that can be used for this purpose.
Boost your savings rate
The standard 10 to 15 percent of annual income that financial advisers recommend saving is based on the assumption that you’ll be saving that amount over a period of 40 years and that you’ll spend 4 percent a year in retirement.
Individuals who aim to retire before 40 need to save more than 15 percent annually. In fact, Doug Nordman, founder of The-Military-Guide.com, recommends saving at least 40 percent of your income from the age of 20. That savings rate assumes that you have an investment portfolio with a 6 percent annual rate of return.
The author of “The Military Guide To Financial Independence & Retirement,” Nordman retired from the U.S. Navy’s submarine force in 2002 at the age of 41 by saving at least 40 percent a year for about 20 years. Based on Nordman’s math, aspiring retirees’ assets need to be equal to 25 times their expenses to withdraw 4 percent annually from savings in retirement.
It’s important to note that the assets in your portfolio should have a growth rate that’s greater than the inflation rate. For those saving for early retirement, Nordman recommends holding a portfolio of passively managed index funds with low expense ratios and an asset allocation of at least 80 percent stocks.
Focus on growing equity
Aside from — or in addition to — building savings by setting aside a hefty percentage of job income, Tresidder suggests that individuals can achieve early financial independence by building equity directly through a business or real estate. This route typically involves leverage, or borrowing money to acquire assets with the goal of increasing the return on investment.
“Getting in debt to reach financial independence is counterintuitive, but income-generating debt, such as a mortgage for a real-estate rental, can help you leverage your savings and build wealth faster,” said Pauline Paquin, founder of ReachFinancialIndependence.com. She used her real-estate investments to leave the 9-to-5 world at age 29.
Paquin’s first investment was a $400,000 rental property, which she purchased with a 25 percent down payment; she borrowed the rest of the sum. Later, Paquin was able to buy two more properties using cash.
“I make enough in passive income to cover my lifestyle and then some,” she said.