There is a new trend going on in the world of personal finance: retiring in your 30s.
Or, more precisely, having enough passive income in the form of investments to stop working in your 30s if you so choose. If you do want to work, then you can continue building your wealth.
This begs the question, can it be done? Can you avoid having to wait until 65 to retire from working? Can you really accomplish this in what seems like a few short years?
Apparently yes, but first we should mention that early retirement may go by a couple of different names. You see, early retirement has become synonymous with financial freedom or financial independence. It's simply the idea of not having to rely on a job for money.
It's the same thing you would need to accomplish by retirement age; it's just that now people are doing it earlier than ever in their 50s, 40s and even in their 30s.
Meet The Ones Who've Done ItBefore jumping into how to achieve early retirement, it would be beneficial to see an example of someone who has accomplished this. This helps solidify that it can be done and doesn't necessarily require special privileges or circumstances.
First, we have Peter Adeney otherwise known affectionately by his pseudo name, Mr. Money Mustache. He is perhaps the best-known early retirement advocate who has a fierce and loyal following of people he calls Mustachians. Former software engineers, Adeney and his wife, both saved and invested enough money in their 20s to retire in their early 30s.
We also have Jason Hull, certified financial planner and Chief Technology Officer at myFinancialAnswers, LLC. My wife and I reached financial independence before age 40, he says. He's also had several clients who've managed to retire in their 40s and 50s.
Save Your MoneyMany early retirement advocates often talk about two things: drastically slashing expenses and making more money.
In the case of Adeney, he and his now wife saved 50% of their incomes while they were working and put the surplus into Vanguard Index Funds and a couple of rental properties
Even still, you don't need to save half your income to retire early. Of course, the more you save, the better, but you probably don't have to save as much as you think to retire much sooner than your colleagues.
Advocates of early retirement have done the math time and time again. Adeney even went as far as crunching the numbers on his website. Even if you save just 30% of your income and invest into a fund with a 5% return, you can retire in 28 years. If you begin saving this much at 22, then you can retire when you're 50, far before everyone else.
The biggest piece of the puzzle is your savings rate, echoes Hull. He commented on a study conducted by Dr. Wade Pfau; that found that Americans would need to save 16.4% of their income to retire with half of your expenses covered — assuming that Social Security picks up the rest of the tab. That means you'd need around 32% to cover everything.
If saving this much sounds drastic it's because it is. The average savings rates in the U.S. are dismal by comparison. According to the U.S. Department of Commerce's Bureau of Economic Analysis, the average savings rate in the U.S. is 5.8% — this is a far cry from the 16.4% rate you would need to be able to cover half your expenses at retirement age.
Increase Your IncomeAccording to Hull, another inescapable factor is increased income. The average annual income of the 11.7% of the [myFinancialAnswers] users who we project to be able to retire before age 60 is $97,031 per person. The lowest family income of that 11.7% was $65,000.
In other words, curb your expenses and find ways to make more money. Since you won't ever be able to reduce your living costs to zero, it's important that you find ways of increasing your income. This could be adding to your skill set, asking for a raise or starting a business on the side. By combining these two forces, you'll have more money to save.
Calculate Your Spending In RetirementThe final piece of the puzzle for reaching financial independence? Accurately determining how much you will be spending in retirement. Studies show that one-third of retired people are spending more money in retirement than when they were working, says Hull.
Hull also points out how we tend to underestimate long-term care costs or falsely assume that Medicare will take care of everything us. Medicare only covers 100% for the first 20 days. The rest is on you, he says. If you retire far before 62 then you won't even qualify for Medicare, so you'll have to take healthcare costs into consideration.
Ultimately, how much you need to save will depend on how much you plan on spending during your retirement — regardless of whether you are retiring at 35 or 65. To accurately figure this out, you may have to assume the worst.
The Bottom LineRetiring early — whether it's in your 30s, 40s or 50s — can be done. It requires a fierce focus and dedication to saving as much of your income as you can. It also requires increasing your income so you can close the gap. Ultimately, though, you can retire early if you truly work hard at it.