Early Retirement, Part 1: The Mindset
Since about the first day I started working, I've dreamed of retiring. It's not that I don't like my profession. It's more that I want the freedom to do what I want, when I want. And I want more time. I have so many hobbies and interests and not enough time to devote to them as I would like, not to mention the many new ones that would be fun to try out. Working 40 hours a week takes up way too much time.
I have lots of thoughts to share on this topic. So many that I couldn't fit it into a single post, so I'm going to make it a series. Like all great trilogies, mine will have three parts.
Part 1: The Mindset
The Mindset covers my philosophical approach to early retirement. In part 2, I cover plans for income during retirement. In part 3 I will detail managing expenses both to enable early retirement and while in retirement.
Disclaimer: I am not a financial professional. For your own financial safety, nothing in here should be considered investment advice. I've tried to frame this blog as an explanation of what I have done for illustrative purposes, not what you should do. In other words, don't sue me if you try what I did and f it up! If you take advice from someone with 'dumb' in their name, that's on you.
The Early Retirement Mindset
I'm in my mid 40's now and while I have not yet retired, I may already have the financial independence needed to retire today without a major change in lifestyle. If it weren't for tough-to-predict healthcare and college costs, I would've already parted ways with a 9 to 5 job. As it is, my growing financial freedom allowed me to change jobs and arrange with my new employer to work less hours when the workload permits. I'm loving that arrangement! It's a good bridge to full retirement.
Some people enjoy working. Their job is their identity, and they have no plans to retire. This blog isn't for them. Some people have no choice but to work until age 65 (or later) because they can't afford to retire early. That's the path I'm trying to avoid. Hopefully I can present some ideas here that will help other people avoid this fate as well. It starts with believing it is possible for you to retire early so you are motivated to take active action to achieve this goal. How do you develop this mindset? I'm glad you asked. Read on!
Get Educated
I've read lots of books and articles on wealth building and some of the FIRE (Financial Independence, Retire Early) commentary that is currently in vogue. I apply a mishmash of different techniques from all of these to my own situation. I don't think there is one formula that is going to work for everyone, so my suggestion is to read lots on the topic and figure out what is appropriate for you. The good news is you don't have to start a company or be a brilliant stock picker to do this. In fact, my stock investment returns probably haven't beaten a market index fund over the past 25 years.
In addition to learning how others retire early, read about investments. Learn the basics of economics. Learn what investment vehicles are available to you and what the tax implications are of various investments. Doing your own taxes is especially enlightening (though frustrating!) Learn about risk and correlation. Some people hire a financial advisor to do this for them, but that doesn't align with my mindset. I'm not going to advise against bringing in outside help, but make sure you understand and agree with all of the advice they are giving you and ensure they don't have any conflicts of interest (like commissions for selling you high expense funds.)
Start Saving Yesterday
Not only did my retirement dreaming start with my first job after college, but the prep work also started then. It started with a mental mandate: save, save, save. In high school I read the book "The Millionaire Next Door" (commission link- help fund my retirement!). Its basic premise, as I recall it, was save your money. Don't waste it. Don't live beyond your means. Most millionaires are frugal, and you would never guess they are that wealthy because they are not living in the fancy house with a new Range Rover and boat parked in the driveway. What you save then earns interest and dividends which compound over time. That "over time" part is key. Everything you save early in your career gets compounded over a longer period of time. A dollar saved today will have turned into much more in twenty years.
Everything is an Investment
This point goes along with the frugality mentioned above and is, for me, the way I achieve it. I view every transaction I make as an investment and expect a return on it. If that return is not worth the expense, I don't make that transaction. That sounds obvious when it comes to buying a stock or a house, but I am also talking about going out to dinner, taking a fancy vacation, buying lunch instead of bringing it to work, etc.
I like the concept of marginal utility. Strictly speaking it is referring to the marginal benefit you gain from consuming more of any given product. I like to extend the concept to comparing different priced options for a product or service. For example, say name brand Cheerios are $4 a box and the store brand version is $2 a box. Even if there is a difference in taste between them, does that marginal difference justify double the cost? Maybe it does. Maybe it doesn't. That is a personal decision. What about buying a first-class plane ticket vs. economy? The end result is the same- you are transported from one place to the next. Is the marginal utility of the first class ticket worth 4X the cost? Early retiree answer hint: heck no! Unless you are already so rich and retired that you have more money than you know what to do with, save that extra money.
Is a $10K trip to Europe worth that much more than a $2K week at the local seashore? I don't know. Maybe for a once-in-a-lifetime trip, it is. Making a trip like that every year? Probably not. I'm not saying I won't take an expensive vacation, just it won't happen very often. Too much of a good thing erodes its marginal utility. I make sure I stay on the right side of that equation. Even better- if you can find a way to get that $10K trip down to $5K you can then enjoy the vacation even more!
There is a financial writer I read that loves to harp on the ubiquitous advice to give up your daily Starbucks latte to save $100 a month. His rebuttal is that $100 a month isn't going to make much of a difference in the long run. I agree with him that $100 a month savings isn't going to make or break your retirement, but what he is missing is you need the mindset to recognize that a daily $5 cup of coffee is a poor investment. When you apply that thinking to everything in your life, it all starts to add up. Maybe someone can justify $100 a month on lattes and still make good investment decisions everywhere else, but I expect that is a rare exception.
For the record, I use a drip coffee maker to make my morning coffee that probably costs me about $0.15 per cup. I'm satisfied with my $0.15 coffee. Would a $5 latte taste better? Most likely, but I don't need more. I could eat ice cream for breakfast lunch and dinner every day because it tastes good, but that would be a poor decision for my health, just like a latte every day is a poor decision for your financial health. I might get a fancy cup of coffee once or twice a year when I feel like a treat. That isn't, and shouldn't be, a daily expenditure. Even if a cappuccino were $.15 like my drip coffee, I still probably wouldn't be getting one every day. The extra time to drive to the coffee shop, wait in line, wait for your order, etc. Adds up. If that is 10 extra minutes a day, that is nearly an hour a week. Which brings me to my next point.
As they say, "Time is Money". You can also apply the investment concept to time; but be careful! Say your employer pays you $50 an hour. This doesn't mean all of your time is worth $50 an hour, so you should pay a gardener to mow your lawn for $20 an hour and a maid to clean your house for $20 an hour. Instead, how much is that 2 hours of TV you watch at night worth? For me, not much. I'll go take care of the lawn myself. For this particular task, the decision is even easier since the lawn service companies in my area charge MORE to do a lawn than I make in an hour. More on that in part 3.
You Can't Spend What You Don't Have
Remove the temptation to spend. I have always maxed out my 401K and other retirement plans. I regularly move a chunk of my paycheck into an investment account and don't withdraw it (except, perhaps, to buy real estate). That last bit is vitally important if you want to retire early. You can't live off of your 401k and social security until you are in your 60s, so you will need non-retirement savings to bridge the gap from when you retire until when you can start to take penalty-free retirement fund withdrawals. I take advantage of an HSA when I can and max it out. I put money into 529s for my kids that grows tax-free. I get used to living on what is left after taking all this money out. I find that much of the expensive luxuries don't contribute to fulfillment or happiness. Financial independence does. And don't try to keep up with the Jones's. They are likely living beyond their means and will be worrying about money all through retirement. If they can even afford to retire. My goal is financial freedom as soon as possible.
What about Credit Cards?
I'm hesitant to even include this section, because I think it is so obvious it isn't needed. You've all heard the advice to cut up your credit cards. For most people this is bad advice, but it depends on you and your situation. I am shocked that ANYONE carries a balance on a credit card. A ~20% interest rate is flat out robbery. If you are so bad at math and self-control that you still spend what you don't have on credit cards and willingly get robbed on every purchase by only making minimum payments, I guess you should go ahead and cut them up. For the rest of us, credit cards are a convenient way to pay for purchases and earn cash back or other rewards and we pay off our balance in full every month. That is how they should be used.
Learn to Love the Spreadsheet
I love spreadsheets! I make one for just about everything. The most relevant ones for this topic are a spreadsheet tracking yearly income and expenses and another one tracking investments. The income/expense is crucial for planning. I have many years of data to draw on and can pretty well estimate what my expenses will be going forward. The investment tracking one has useful charts that track growth as well as balances between retirement assets, non-retirement accounts and real estate.
I recently added a new spreadsheet that tries to predict cash flows if I retire today with parameters configurable for inflation, college expenses, 401K withdrawals, investment returns, etc. It shows me how much liquid assets (cash, stocks, etc.) I would expect to have left by the time I qualify for social security and can tap into retirement accounts. It shows that with worst-case scenarios for inflation and returns, I will run out of non-retirement liquid assets a couple years before I can collect social security and withdraw from retirement accounts. But, if we get average inflation and returns, I could make it without fully depleting my accounts. Doing this kind of analysis is critical if you want to be sure you have a large enough nest egg to not run out of money. Without these spreadsheets I would have no clue how much I need and when I could retire.
Summary
There you have it. My early retirement mindset:
- Study up on how other people retire early and learn all about the financial implications
- Save early and save often
- Treat everything as an investment
- Live below your means and enjoy it
- Track your cash flows and extrapolate to the future to determine when you have enough to retire.
Parts two and three will provide more details and examples of how to control expenses and generate income.
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