Do you dream of retiring early? Enthusiasts of the FIRE movement (Financial Independence, Retire Early) are encouraging more and more people to achieve their dream of retiring before the commonly accepted retirement age. It’s not an entirely impossible feat if you plan ahead and invest your money wisely. Still, significant challenges remain that even the best-laid plans may be unable to account for.
Running out of money
The single greatest issue is running out of money. Within that single challenge lay many factors, such as the lifestyle you expect, where you live, and how healthy you are. With all other things being equal, you simply need enough cash to last until your final days to call your retirement successful.
Now, figuring out how much cash you’ll need is not an age-old question, as not until recently did life expectancies and retirements begin to lengthen drastically. Here are three factors that affect this greatest of retirement issues.
Early retirement Problem #1: Less time for compound gains
Unfortunately, most Americans don’t start saving for retirement on time, let alone early enough to be able to retire early. To save enough money for retirement, you must start young and be consistent. Let’s compare two people who started consistently investing at different ages and their account balances upon hitting 62.
frank
Started consistently saving at 35 years old, retiring in 2023 at 62 years old.
- Initial investment: $10,000
- Yearly Investment: $10,000
- Ending account balance: $1,023,268.86 (assuming an 8% Rate of Return)
melissa
Started consistently saving at 25 years old, retiring in 2023 at 62 years old.
- Initial investment: $10,000
- Yearly Investment: $10,000
- Ending account balance: $2,365,615.59 (assuming an 8% Rate of Return)
Melissa more than doubled her savings (but didn’t get close to doubling the investment period). But what if Melissa hadn’t had an initial investment? We shouldn’t assume a 25-year-old has $10,000. Well, she’d still have $2,193,159.48! You don’t need much money to start investing; you just need to start! Even if she had put in only $5,000 a year, she would still end up with $1,096,000. Time is simply on Melissa’s side.
Time is your greatest asset – use it wisely!
Early retirement Problem #2: Inflation Erodes Your Purchasing Power
Retirees didn’t have to worry much about inflation in the past, as the average time spent in retirement was much less than it is now, with many people currently looking at thirty-year-long retirements or more! But what can happen to your retirement savings in only 30 years? You can easily expect it to be half of what it was when you retired. In fact, $100 in 2021 was worth $50.26 in 1991. Those who simply stuff their savings into the mattress are in for a rude surprise once they start making purchases with those funds and realize how expensive everything is.
Another perspective is to imagine that you have $1,000,000 for retirement. Assuming a 3% inflation rate, you would need $2,427,262.47 in 30 years to have the same purchasing power as that original $1,000,000. But, you will have been taking steady withdrawals over that time and paying taxes, thereby shrinking your savings a great amount every year, all while getting throttled by inflation simultaneously. It’s not a pretty picture!
Longevity Risk
And the possibility of living to 100 or more is greater each year with advancing technologies and greater awareness of senior health needs, such as diet and exercise. Of course, everyone wants to live a long and healthy life, but you’ll have to pay for it somehow. You shouldn’t depend on social security benefits either, as we never know what way the winds will blow when it comes to funding social programs. By 2036, retirees are already looking at a 20% reduction of their social security benefits if Congress doesn’t take action.
Even if you have a string of great years in your portfolio, you always have to outpace inflation to keep making gains. This isn’t always an easy feat, especially during periods of high inflation like we saw in 2022. Even in November of 2022, inflation rates were still at 7% – and how many people’s portfolios managed to outperform 7% in a time of sluggish stock and bond performance? Probably not many, but that’s why we consistently invest and utilize dollar-cost averaging and portfolio rebalancing strategies to compensate for those tough periods.
Early retirement Problem #3: Extended Market Exposure Means more Risk
The longer your savings are at the whims of the markets, the greater the chances it will take a hit from market downturns. Worst case scenario, you enter retirement the year before a recession, and your portfolio never recovers. Naturally, your investment portfolio should become more conservative as you age by placing a greater emphasis on less volatile investments such as bonds. But, as we saw in 2022, bonds did just as poorly as stocks. Sometimes, nowhere is safe.
Negative Sequence of returns risk
Since WW2, a recession has hit about every five years. Since 2000, the S&P 500 has fallen 18.58% over the entire course of a recession on average while taking 647 trading days to reach pre-recession levels. Can your portfolio survive if that happens six times in your 30-year retirement? While at the same time getting hammered by inflation and taxes?
We don’t want to sound all gloom and doom. We just want our readers and clients to fully comprehend the risks they are taking when opting for early retirement. If you do want to take the risk, below are some strategies you can employ that might boost your chances of success.
Early Retirement Strategies
If you are determined to retire early, there are ways to increase your chances of success. Here are some strategies to consider.
#1 Delay taking social security to maximize benefits
While it may be tempting to start pulling from social security when you turn 62 instead of your investment portfolio when you retire early, you’ll definitely see much better benefits by holding off as long as possible. At 62 years of age, you only get 70% of social security’s promised benefits, and only at 67 do you get 100%. But if you hold off until you’re 72, you will get a 124% payout! Considering that social security increases to help fight inflation and lasts for life, you should make as much use of it as possible.
#2 Pursue riskier but more profitable stocks over bonds for a longer time
Using an asset allocation calculator, we can make some simple projections. If you invest $15,000 into an aggressive asset allocation of 90% stocks, 5% bonds, and 5% cash, there will be about a 50% chance of having a net portfolio worth between $112,368 and $322,906 in 30 years. There’s also a 50% chance it will be above or below those net worths.
A moderate portfolio of 65% stocks, 35% bonds, and 5% cash would yield a 50% chance of having a portfolio balance between only $123,445 and $249,187. You may not rise as high, but you probably won’t fall as hard. It all depends on your risk tolerance!
#3 Utilize Roth and Backdoor Roth Conversions
Of course, getting rid of taxes would eliminate at least one of your portfolio’s three challenges in early retirement. But, while you probably can’t eliminate taxes entirely, you can at least max out your Roth IRA for tax-free cash flow in retirement. You can also convert to Roth during bear markets to lessen the tax blow.
Don’t know the difference between a Traditional and Roth IRA? >>> Read our article about it here!
If you have a 401(K), your employer may have a Roth component that you can put into. If you’re a high earner, you may not be able to put directly into a Roth, but there are backdoor Roth conversion strategies to make use of if that’s the case.
#4 Spend less money in retirement
The less you spend, the longer your savings will last. It’s as simple as that. You can always retire to countries with lower living costs, such as Central America, to help stretch out your savings. To reduce medical bills, try to live a healthy lifestyle full of exercise, fresh air, and a healthy diet, and cut out unhealthy habits such as smoking and excessive alcohol intake.
In Conclusion
Are you considering retiring early? Do you feel that you are on the correct retirement path? We’d be more than happy to go over your portfolio and give our professional input. Just click the button below!
