“As in all successful ventures, the foundation of a good retirement is planning.” –Earl Nightingale
“The question isn’t at what age I want to retire, it’s at what income.” –George Foreman
Believe it or not, I wasn’t always the frugal, super saver I am today. I think back to my early twenties, after I graduated and started working at my first full-time engineering job. I was making a lot of money and I didn’t know what to do with it! Mind you, I was doing a masters part-time, but my dad graciously offered me a place to live and I happily accepted. I lived with my dad for three years and in that time, I didn’t have any bills to pay. Life was hakunah matatah. In fact, it was amazing! For all my dad’s frugality, we always seemed to have cheese, juice, smoked salmon, grapes and avocados in the fridge. I haven’t eaten an avocado in four months and grapes are premium fruit that are priced well outside my comfort zone. G/d I miss those days. As good as they were, I was aimless. I paid into my employer pension plan at work and thought nothing more about retirement. In fact, I remember leaving my first engineering job, which was in the public sector, to move to the private sector (in my twenties) and remember my dad pleading with me to consider my public sector pension plan before jumping ship. I found it absurd that he wanted me to consider my retirement benefits at such a young age (and early stage in my career) and I went ahead and chased the exciting, new experience.
I don’t regret that job change but what I do regret is not making a financial plan earlier and sticking to it with discipline. The first financial plan I did make happened by accident. I was at a barbecue and was conversing with a friend who recently got hired at a bank. He knew my income and my mortgage and asked me why I wasn’t working to pay off my house right away… which I couldn’t answer. Why wasn’t I paying off my house faster? That conversation initiated my financial planning momentum. Sometimes all you need is a nudge – I just wish it happened sooner.
On that note, the best time to invest was 10 years ago. The second best time is now! So let’s get to it: how do you know how much money you need to retire? The answer to this is highly personal and dependent on each person’s circumstance. Here are a few ways to look at this question. The first thing is to consider what ‘retirement’ means to you. Two or three generations ago, it seemed more acceptable to stop working at 65 but nowadays, you might want to just consider changing careers or working on contract or part-time. Life expectancy has increased dramatically, as have flexible work options, which makes working past 65 a reality for most people. Personally, I don’t want to wait until I retire to pursue the lifestyle I want and my hope is that by age 55, I’ll be able to do what I’m doing but just on contract and at my own pace.
My dad retired several years ago at the tender age of 67. He’s in phenomenal shape and has a wide array of interests outside of his engineering career. He’s extremely fit and goes to the gym every day and he’s also tutored kids in math and science during his working years, as a side hustle. My hope was that he would have time to pursue these interests into retirement. He might still do it but he retired without having a plan to work in place. He felt like he needed some time off and he’s not reliant on any additional income; but I can’t help feeling that starting a small business might have been easier to do when he was working as opposed to already retired with no structure to his day. Long story short, retirement should be about not having to work but still wanting to do something that brings you joy – and maybe generates some income. You should think about different things you might want to do and how much money you would need to live on if you retired and didn’t have a steady income from your current work. On that note…
Step 1, how much money do you think you’ll need by the time you want to ‘retire’? This number will be your objective or goal in order to understand your savings and investment objectives today and for the following years until ‘retirement’. This will be the goal post that you’re working towards today and will dictate your actions in the next 5, 10, 15, 20 years. The starting point is to work backwards. If you know you’ll need $60k per year when you retire, apply the 4% rule (or 3% rule?) to determine what sum of money you need in order to passively generate your living expenses. The 3 or 4% rule (or rule of thumb, as I like to think of it) basically states that a certain sum of money, invested wisely in broad market index funds with low fees, can generate 3-4% of passive income annually without consuming the original base sum for about 30 years. This means that you would be living off the passive profits generated each year by your portfolio and your savings could sustain you for 30+ years. In this example, a nest egg of $1.5M is needed, invested wisely, in order to generate $60k per year using the 4% rule of thumb. I’ve recently heard theories, however, that you may want to consider a 3% rule instead, which brings your total required nest egg up to $2M in order to secure a $60k per year lifestyle.
The majority of articles I’ve read on this subject advocate a “buy and hold investment strategy” in the market. While this is a solid plan, there are other ways to achieving income objectives into the future; a big one of which is through real estate investments. While there are tax implications to this (dividend income is generally taxed much lower than regular income, including real estate income), real estate income can often facilitate a higher yield rate than the market. A great article by Paula Pant from Afford Anything outlines how the 4% rule in the market can be equivalent to a 6% rule in real estate returns. They key at this stage isn’t too get discouraged and to keep your mind open to different options available to you while you work your way through the steps.
Step 2, analyze your current income and savings rate. How much are you making and saving today? Some quick math can show you (through compound interest) the gains you’ll make year over year with your current savings rate. As an example, if you’re saving $10k per year today, and if we assume a 7% return rate from the market, in 20 years, that level of savings will give you over $400k! The key to this step is determining what savings rate is actually attainable by you and your family. Remember, material pleasures today is short term gratification and can result in delaying your financial freedom for years. This will form the basis of your plan but it can always be updated, if you’re able to pick up additional income, or if your income is temporarily reduced.
Step 3, start saving and investing! This is the implementation step of your plan from step 2. A key part of financial independence is making sure that your money is working as hard as you. If you’re not investing it in the market, you’re risking not keeping up with inflation and definitely leaving money (from market gains and dividends), which only compounds over years.
Step 4, track your net worth gains (and losses). Tracking your finances (I track my net worth on a monthly basis much like J. Money and his million dollar journey) is important because it ensures you’re staying on track with your plan. If there are changes that need to be made to your investments or savings rate, you’re not waiting too long to adjust your plan accordingly. It’s also a great way to stay motivated and see the gains you’re making monthly and annually!
This should get your started! Drop me a line and let me know how your plan is going!