There is a new craze going around these days, and it’s called Extremely Early Retirement. While the majority of this world struggles to live paycheck-to-paycheck, a handful of individuals are enjoying an extremely early retirement at the age of 40, 35, or possibly even as young as 30 years old. How in the world is this possible? Well, sites like MrMoneyMustache and EarlyRetirementExtreme lay out the calculations pretty clearly. All you have to do is live on less than 25% of your income (and invest the remaining 75%) for about 7 years and you can officially quit your job and live off of your investments!
The chart above might appear intimidating at first, but it is actually a fantastic tool to figure out how many working years you’ll have to endure at various savings rates and investment returns. As with anything, it’s probably best to explain the chart with an example.
So, let’s say that from this moment I decide to save 20% of my income, and I expect those savings to earn an average interest rate of 6% in the stock market. From the bottom of the chart I first find the savings rate of 20%, and then I’ll follow that line up with my finger until I hit that 6% line (the black one). When my finger hits the line I simply follow it straight left in order to see how many more years I’ll have to work before I can retire. With this plan, it looks like I can plan to retire in about 27 years.
For those radicals that are able to save 80% of their income and expect to earn that same 6% interest, they can seemingly retire in just five working years. I say seemingly because I see some large flaws with this method of extremely early retirement. I don’t want to be a hater….but this plan is just a little too cookie-cutter for me. I see some MAJOR problems for these early retirees down the road.
Problems With This Method of Extremely Early Retirement
The main plan of this group that expects to achieve an extremely early retirement is to throw a large sum of money into their corporate 401k, Roth IRAs, and their HSA funds. Once they reach a magic number (which is 25 times their yearly expenses), they hang up their corporate hats and start to live off the interest of their investment. And, if they have medical problems, they simply pay the expenses out of their beefy HSA fund, tax free. It sounds fairly cut and dry (and initially, somewhat ingenious), but quite honestly, I can see this plan failing….frequently. Here’s why.
1) Saving 75% of Your Income Is Simply a Pipe Dream For Many
As my friend pointed out to me the other day, many of the teachers of extremely early retirement begin their teaching with, “Let’s say you and your spouse earn $250,000 a year…”
Ummm….$250k a year? The average family income, the last time I checked, was just a hair over $50,000, so how many families earn more than $250,000 a year? Probably less than 5%. Already, the pool of early retirees is limited.
Now, I’m certainly not saying that if you earn less than $250k a year that you have no chance of living on less than 25% of your income. I make far less than that and I live on only 20% of my after-tax income. But, what about those people that earn an after-tax income of just $25,000 a year? Their minimum expenses for pure survival are probably around $15,000 a year, and that’s if they are completely debt-free. Saving 75% of a small income just isn’t going to happen, and therefore this method of extremely early retirement simply won’t work for them.
2) The Inevitable Increase in Future Expenses
Even if you are completely debt free and don’t plan to take on any more debt, your future yearly expenses will rise whether you want them to or not. Take healthcare for instance. Over the past 7 years, the costs of healthcare have nearly doubled, and this trend doesn’t appear to be slowing down any time soon. So, at the date of your extremely early retirement you can draw a line in the sand and say, “At this moment, we pay $300 a month for healthcare insurance, so that’s what we can plan on for the next twenty years as well.” This mentality is ludicrous. Based on the chart below, the cost of insurance will almost certainly rise and force you to pull more money from your retirement accounts than you planned, putting your future retirement at risk as you erode your lump-sum retirement fund.
Other expenses are likely to rise as well. Do you want kids? Will the cost of food increase in the future? As you get old, will you likely need expensive surgeries to fix medical issues? The answer to every one of these questions is probably a resounding “yes” and will cause your future expenses to rise.
3) You’re Stuck Living This Frugal Life…Forever
In order for many to retire early, they need to decrease their expenses severely. This means turning in their smartphones for dumb ones, cutting back to only one car, and eating out only once per month instead of once or twice a week. For many of you, these “sacrifices” don’t seem all that extreme, but do you realize that your extremely early retirement is dependent on these sacrifices on a permanent basis? To retire early, you must also keep your expenses incredibly low in retirement as well. This means your dumb phone, your one car, and your home cooked meals will be your only future options. Is it worth it? For some it is, but for many this just sounds like an eternal punishment.
4) You Have Zero Control Over Your Income
Do you know of anyone that controls the stock market? I mean, is there someone on your list of friends that wakes up in the morning, looks outside, and then decides whether to flip the “bear market” switch or “bull market” switch? Ludicrous right? Well let’s take it back a step. How many of you know professionals that can time the market? They study the market and its trends and they constantly pull out of the market before it falls and throw all of their money back in just before the market starts skyrocketing again. Again, ludicrous. Some people are more educated than others and might have an inclination that the market will rise and fall, but no one can consistently time the market. Nobody.
If you have your entire net worth sitting in stocks and bonds, don’t you feel like that’s a bit risky? You have no say whether your money will earn a return, and even worse, you can’t even make a prediction of when it will happen! The future of your retirement rests in the hands of chance. Frankly, for me, that’s just too scary. If the market falls 20% in one year, many of these extremely early retirees will probably be completely screwed. I hope they still have skills in the marketplace, because it may be time for them to get a job again soon!
The Better Method for Extremely Early Retirement
I’m not going to lie. I have thought about extremely early retirement quite a lot. The idea of stashing a bunch of cash away and saying “peace out” to work is obviously appealing. Based on my above reasons, the pile-money-into-your-401(k) method obviously isn’t likely to work, but I believe that there is another method that could still allow one to retire extremely early. In principle, it’s quite easy. In practice, it can be quite difficult. I’m talking about systematic passive income (or at the very least, semi-passive income).
In my post a few months ago, I outlined how one can earn a million dollars over a ten year span and I still stand by this belief today. Here are the basic steps from that article:
- Become debt free
- Live on less
- Earn more
- Purchase a cheap rental property with cash, fix it up, rent it out
- Build up cash from work income and rental income, and repeat the fourth step over and over again until wealthy beyond belief
With this plan, instead of loading every cent you own into the stock market and hope it goes up, one will instead put much of their money into real estate with the intent to earn a consistent income from quality renters. Over the span of just ten years, one could earn an income of $160,000 per year through rental income alone! AND, the total value of the properties will be well over $1 million as well! In my opinion, this is a much better option for an extremely early retirement because:
- You have control over your rental properties
- Your income is not dependent on unknown stock growth
- There are many income deduction options in real estate investing, thereby reducing your tax rate
- You can live large instead of watching your pennies all the time
- You have the means to continually grow your income
At this moment, I’m choosing real estate, but it doesn’t have to be. There a many other avenues besides the stock market to invest your hard-earned money. Start your own business, become an angel investor, rent out land to farmers, write books, write music, invent a product – the list could go on and on. If you want an extremely early retirement, please do not limit yourself to a pile of money in a 401(k). This option is too simplistic and could hurt you tremendously in the future. Expand your mind and do more with your money. In your extremely early retirement, you’ll be glad you did.
Are you considering an extremely early retirement? What is your plan?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.