Early retirement.
Early retirement may seem impossible, and the standard retirement age so distant, that we don’t consider it. But a small amount of thought early on can have a significant impact. The difference may be retiring decades earlier, travelling the world, retiring in our dream home, or being able to be very generous to loved ones. The options are endless, and everyone has different desires. If we establish our dream, it allows us to progress towards it, and our execution plan doesn’t need to be complicated. There are a few critical financial forces to be aware of, as they can either slow down or speed up our journey, but we don’t need to be financial experts. Imagining our ideal retirement gets us started, so what are our dreams.
Our dream retirement.
We typically know what we don’t want (the necessity to work) but don’t consider what we do want. If we haven’t imagined our dream golden years, creating it won’t be easy. Views of retirement can be vastly different for everybody. Some may see themselves lounging on an exotic beach, others desire to relax in comfort at home, and some want to explore the world. One person’s dream may be a beautiful home in the suburbs, while another’s is a luxury apartment in the city. Some may be aiming at early retirement. Considering our dream retirement allows us to start creating it.
Achieving our retirement dreams.
Once we have established our retirement vision, we can look at a few key financial components, without making it overly complicated. Planned expenses are a critical part, but also boring, so we can take a simplified view. If our retirement vision is similar to our current lifestyle – just without working – then our expenses will be roughly the same as they are now. We may be thinking our expenses will go down as our mortgage will be paid off, but other expenses may increase and equal out overall. For example, our medical expenses in retirement may be higher than during our working years. Or our entertainment budget may increase as we have more time available.
We could work out our planned expenses exactly, but if retirement is decades away a lot may change. Let’s start simple. If our retirement lifestyle will be similar to our working years, then we could plan our expenses to be the same. If our golden years are going to be filled with adventure, our expenses may be more. This isn’t a problem, we are factoring in our desires, everything is possible, our expenses are just a little higher. Once we know what we need, we can look at when we need it. This is where we can plan for early retirement.
Early retirement.
If we control our retirement plan, we control the age we retire. We do need to plan accordingly and still have a lot of flexibility. We may plan our retirement age, and choose to retire even earlier. Or we may choose to retire later, so we can have more spending money in retirement. The decision is ours to make. Now we have a rough idea of expenses, and retirement age, we can start making it happen. Let’s first look at just saving for retirement – which is what we are supposed to do – to realize that it doesn’t work too well by itself.
Saving for retirement.
Typical suggestions are saving 5-10% of our salary is ideal, but it doesn’t get us far. That doesn’t mean that we need to save more, there are many methods to achieve better results. But let’s start with a saving example to see where it gets us.
Sally is an office manager with an after-tax income of $50,000 per year. Somehow she had the same salary for the last fifty years. She saved 10% of her income ($5,000) each year and amassed $250,000. Her expenses are the same as her current income of $50,000. If Sally retired and started living off her savings account, it would be empty in five years. Fifty years of savings, to be broke in five doesn’t seem like a great plan. To make matters worse, we aren’t accounting for inflation.
Inflation’s Impact.
Inflation is the increase in the cost of goods and services over time. In the short term, inflation doesn’t make a huge difference. For example, if a loaf of bread costs $2.50 today, it may cost $2.55 next year. In the long term, however, inflation adds up. If we consider the cost of bread fifty years ago was approximately $0.25, and now it is $2.50, it has increased tenfold in fifty years. This means over the long term inflation quickly erodes the buying power of any savings.
So what does this mean for Sally? A more realistic scenario would be her pay rising at the same amount as inflation. Wage growth and inflation aren’t the same things. But considering them the same for Sally is a more realistic example, then having the same wage forever, and ignoring inflation.
If we approximate inflation and her wage growth to 3% for the past fifty years, it would significantly reduce her savings. As we backtrack each year, her salary decreases by 3%, which also reduces the amount she saved each year, even though it was always 10%. Going back to the start of her working career fifty years ago, her wages would have been $11,400 per year. Her 10% savings in that year would have been $1,140, which is a lot less than the current year of $5,000. After totaling her savings for the fifty years she would only have $134,000 in her savings account. This cuts her retirement savings nearly in half. Her retirement fund now wouldn’t even last three years.
What about saving more.
We could consider saving a higher percentage of our pay, but it doesn’t help much. If Sally planned to have twenty years of retirement on $50,000 per year, she would need one million dollars saved. She would have had to save about 75% of her income, over the last fifty years to fund her retirement years.
Saving for retirement alone doesn’t produce great results, and if we account for inflation it’s even worse. But saving is only the first step, opening the door to huge potential. It’s like trying to fill a dump truck with coins by hand, we could get better results using a shovel, and much better results using heavy machinery. But there may not have many coins to scoop up. That’s not going to stop us. We can use tools that can turn coins in the truck into multiplying ones, that breed like rabbits. All of a sudden our dump truck fills so quickly it overflows. The great news is there are plenty of tools that do just that. But let’s jump straight to the best money breeder out there, which is exponential growth.
Exponential growth.
Exponential growth occurs when an amount increases, and repeats in a cycle, causing larger increases in further cycles. For example, if we had a dollar that doubled every day, on the second day it would be $2, on the third day $4, and the fourth day $8. While that doesn’t sound too impressive, early on exponential growth doesn’t shine, but given time it will show its magnificence. Twenty-one days of doubling adds up impressively to over a million dollars. After thirty-one days, it grows to an unbelievable billion dollars. So we just need to find a dollar that doubles every day… easier said than done. But we can use exponential growth to our advantage, by understanding the three influential factors.
Three influential factors of exponential growth.
There are three big considerations to maximize exponential growth, which are time, growth rate, and contributions. If we consider time first when the exponential growth is given time to repeat its cycle, it has a huge impact later on. The growth in a single day increases, as the base amount grows due to previous cycles. For example, if we consider our doubling dollar, it increased from one to two dollars on the second day, which is unimpressive. But fast-forwarding to the thirty-first day, it increased by half a billion to a billion dollars, which is very impressive. Previous cycles add up a lot given enough time.
Another key factor is the growth rate. Seemingly small changes in the rate, have a large impact over time. If we changed our example and instead of doubling daily (which is 100%) we had 10%, we could guess the result would be a tenth. But over the same thirty-one-days period with our dollar enlarging by 10% daily, it would have only increased to seventeen dollars. That’s insignificant compared to the billion dollars initially. The growth rate is not something that should be overlooked.
The final component is the contributions. If we started with two dollars initially, the results would double. The doubling dollar would grow to two billion after thirty-one days. But consider if we add another dollar on the thirtieth day. The initial dollar would have grown to over a billion, but the second dollar is only on day two, so it would only double to two dollars. The final result would be over a billion from the first dollar, plus two from the second dollar. Late contributions don’t give exponential growth time to work its magic.
Now we know the negative impact inflation has on savings. We also know how important exponential growth can be, and the influential factors. Let’s unlock the potential of exponential growth by investing our savings.
Investing our savings.
There are many avenues for investing, it can be stocks, property’s, businesses, etc. They each have different strengths and weaknesses, but any can be used. Our primary goal is investing to unlock the power of exponential growth, and beat inflation.
Let’s go back to Sally, and see how she goes investing, instead of just saving. If her investments had achieved 10% growth per year, over the fifty years. Her investment would have grown to an incredible 2.2 million dollars. She is a multi-millionaire. That’s quite a difference from the $134,000 that she had saved. If we consider her retirement expenses of $50,000, her retirement fund is forty-four times that. Now we are progressing, Sally can comfortably retire. We could think therefore that her retirement fund would last forty-four years, however, it would last forever. Her investment would be growing quicker than her planned expenditure. She could have retired earlier.
Investment growth more than expenditure.
There is a critical point where investments grow more than expenses. Looking at Sally’s investments, she had built up 2.2 million dollars. This means in the year after retirement her investment would still increase by 10%, which is $220,000 for the year. Her planned retirement expenses were $50,000, so if we deducted that amount from her investment, it would still grow by $170,000. We can backtrack to work out how early she could have retired, by finding when her investment growth was more than her expenses. As we roll back the years, the great news is expenses go down due to reversing inflation. So if her investment growth is more than her salary, it can replace her income. For Sally this was after thirty years of work, she could have retired twenty years earlier.
Thirty years is still a long time, but time is only one factor. Another possibility would be increasing contributions. If Sally had invested 20% instead of 10%, her investment growth would be more than her salary after only twenty years. We shouldn’t forget the third factor of the growth amount. If she was able to save 20% and also get a 20% return, her investment would cover expenses after only ten years. That certainly sounds better than working fifty years, for our retirement fund to run out in under three.
What works for us.
We now know about the three key factors that can empower exponential growth, to achieve our retirement dreams. They are time, growth, and contributions. All of them can be changed to suit our desires. If we want to retire early, this would reduce our time. We can compensate by increasing either or both of the other two factors, contributions, and investment growth. Increasing our savings to invest, is a skill we can learn by saving. Increasing our investment growth is a skill that can be developed, more easily when we have investments. Action is the key. If we want to achieve our early retirement dream, we can. And now we know how.
