In Part 2 we concluded that in order to retire with an average income of $64,000 per year, we needed $1,600,000 in cash to invest. And we concluded that $1.6 million is a ton of money that would take forever to acquire so retiring seems out of reach so why try? I’m here to teach you a bunch of tricks now to bring that number down and make it easier to retire.
Lesson 1: Budgeting is the critical skill that enables retirement to be attainable.
The first thing we are going to notice is that if we spent less money than the average American, we can retire sooner because the less we spend per year, the less money we need to retire with. This is doable because most people don’t spend intelligently. Learning how to spend intelligently can save us money by reducing our costs.
According to this website, the average expenditures for an American are
$800 per month for rent
$750 per month for transportation
$600 per month for food
$250 per month for health care
$200 per month for fun
$100 per month for misc.
Total of $2700 per month or $32,400 per year. You’ll notice I excluded all debt payments from the website. I did this because you often have the option to ask for a delayed debt repayment plan which allows you to go several years without any or with minimal debt repayments. Thus you can get that cost close to 0 while you’re executing the plan I’ll explain next.
If you learned to spend more intelligently than the Average American, then you could easily get that cost down to $30,000 per year or even better. The key point here is that the less you spend per year, the more you save. For example, if you earned $64,000 per year and you spent $64,000 per year. At the end of one year of working you would have saved $0. Meaning that you still need $1.6 million to retire. If instead you earned $64,000 per year and you spent $30,000 per year, then you would have saved $34,000 at the end of one year. And because you only spend $30,000 per year, the amount you need to retire is:
x * ($4 / $100) = $30,000
x = $750,000
and if you are saving $34,000 per year, then it would take you $750,000 / $34,000 = 22 years to retire. Just think about that. Most people work from 18 or 21 years of age until they are 68. Some people never get to retire, but taking the worst case scenario of working from 18 to 68, that’s 50 years of working in order to retire. By spending intelligently and making an average American income, you could retire in less than half the time of everyone else. 22 years instead of 50 years. Then you would have 28 years of your life BACK. Freedom for 28 years to do anything you wanted every day every hour.
Key Lesson 1: Lowering your costs and saving money can enable you to retire 28 years sooner than everyone else.
Lesson 2: The Government provides low risk opportunities to make money out of the money you save.
We can do better than retiring 28 years faster than everyone else actually. Here’s another trick to retire even faster: Instead of keeping the money you save in cash, invest it. One thing you can invest it in is a Certificate of Deposit. This is essentially investing in the USA government. The only way you lose is if the USA disappears. Therefore, the risk is low for this investment.
Risk is how scary something is. It determines how likely you are to lose. Higher risk means you will lose more, lower risk means you lose less.
Looking at historical data from this website, we can see that recently the CD options can return roughly 2.5% per year. What this means is if you invest $30,000 for one year, you would earn $750 back.
Let’s say that instead of saving $34,000 as cash into a bank account, you put this into a Certificate of Deposit paying 2.5% per year.
|Start of the year, how much you have||During the year, how much you save||How much you earned in interest||How much you have total at the end of the year||Inputs:||During the year, how much you save||Interest rate on savings|
It takes 17 years to save $750,000 if you invest your money in a 2.5% Certificate of Deposit
By investing it in a 2.5% return Certificate of Deposit, you can retire in 17 years instead of 22. You’ve saved an additional 5 years of your life with this knowledge for a total of 33 years of working life saved!
Key Lesson 2: Investing your saved money in a Certificate of Deposit can allow you to retire 5 years faster for a total of 33 years of working life saved!
Lesson 3: The stock market provides a low to medium risk opportunity to make money out of money even faster, if you are able to keep the money in the stock market for over 5 years.
The stock market is another common choice for investment. Over long periods of time, it has been shown that the stock market returns 7% per year (here is an article explaining why 7%). The key here is that you have to keep your money in the stock market for many years in order for that to be true. What you need to understand is that if you put $100 into the stock market today, that money could become $20 in a year, or it could become $180 in a year. However, if you DO NOT SELL, then it will eventually become roughly a 7% return per year over 5-10 years. Running the numbers again:
|Start of the year, how much you have||During the year, how much you save||How much you earned in interest||How much you have total at the end of the year||Inputs:||During the year, how much you save||Interest rate on the stock market|
It takes 13 years to save $750,000 if you invest your money in the stock market with 7% average annual returns
By investing it in the stock market with an average 7% annual return, you can retire in 13 years instead of 17. You’ve saved 4 additional years of your life with this knowledge for a total of 37 years of working life saved!
Side note: The stock market goes through cycles of good years and bad years, much like life does in general. During the good years, stock prices go up and you earn lots of money for the money you give to the stock market. This is called a bull market. Bull markets earn you money. During the bad years, stock prices go down and you lose money when you give it to the stock market. This is called a bear market. Bear markets lose you money.
For this reason, the calculations above are unrealistic because depending on whether you start saving money during a good year or a bad year, you may have to wait a few more years past 13 years in order to retire. However, the key point is valid, which is that investing in the stock market provides better returns long term than investing in a Certificate of Deposit
Key Lesson 3: Investing your saved money in the stock market can allow you to retire up to 5 years faster than investing in a Certificate of Deposit, leading to a total of 37 years of working life saved!
Lesson 4: If you are willing to take on more risk, you can retire even faster by using leverage to accelerate your investment earnings.
If you can borrow money for less than 7% per year over many years, then doing so will allow you to earn money on the difference between the profit and the debt interest payment. For example, if you can borrow $10,000 at a rate of 4% per year over 5 years, then you should wait for a Bull Market and then put that $10,000 into the stock market to get 7% per year for 5 years. $10,000 * (1.07) ^ 5 = $14.000. Thus you will earn $4,000 from the stock market. You will pay $1000 in interest fees (using this calculator) and therefore earn $4,000 -$1,000 = $3,000 this way. This is higher risk because you are trying to predict the future and if you are wrong then you can lose money. However, if you’re willing to take the risk then you should learn more about this opportunity. Doing this can earn you extra money to save and therefore retire even faster.
Key Lesson 4: If you can find opportunities to earn more money than it costs to borrow money, you should consider learning more about that opportunity to decide whether to take that risk or not. Doing so will allow you to earn more money faster and retire sooner.
Lesson 5: An extremely good way to accelerate your investment earnings is through real estate. Real estate enables you to make medium risk investments with high leverage multiples. Doing so can rapidly accelerate your retirement opportunities.
Real estate prices rise roughly 2.38% per year (according to this website). This sounds low compared to the 2.5% that Certificates of Deposit offer and the 7% that the stock market can offer. The difference is that with real estate, you rarely pay for the whole house upfront. Instead, you borrow money from the bank in the form of a mortgage, and then make payments on the mortgage while owning the home. For example, if you buy a house for yourself or for a family member, you can put down 10% of the price of the home. Let’s say the house costs $100,000 and you put down $10,000. Even though you only paid $10,000 in total on day 1, you own the house. The title and the deed for the property is under your name. What this means is that after one year, when the house earns 2.38%, it earns that 2.38% on $100,000, the total price of the house. This means you’re earning $2,380 per year. Since you put down $10,000, that means you earn $2,3800 / $10,000 = 23.8% per year on your investment. You put down $10,000 but your profit is based off of $100,000 so your leverage factor is $100,000 / $10,000 = 10. You get 10x the return you would normally get. Which makes sense because 2.38% * 10 = 23.8%.
Thus, if you change your strategy so that the first year you save $34,000 you put that money as a downpayment to a house at 10x leverage (meaning you buy a place that’s worth $340,000) and then every year after the first year you put $34,000 into the stock market, then your investment returns look like this:
|Start of the year, how much you have||During the year, how much you save||How much you earned in interest||Total at the end of the year from Stock||Start of the year house value||House Appreciation||End of year house value||Net Profit from House||Total from both Stock and House|
This might look like you’d still be retiring in 13 years, so why buy a house the first year instead of putting all your money into the stock market? Well for one, you would own a house. Second of all, with a house you get a lot of tax break benefits. First, you can tax deduct the interest payments you make on your mortgage. Second, instead of paying your rent to a landlord, that money gets to go into the mortgage that you pay to buy your home. Third, in most places, a $340,000 place is a seriously nice place with many bedrooms and bathrooms. What this means is you can rent out your extra bedrooms, or convert your living rooms and garages into more extra bedrooms to become a landlord and generate more income. Generally speaking, you can get about 5% of your home’s value in rent by renting out rooms you’re not living in. If you put that 5% rental cash flow into stocks, then your chart now looks like this:
|Start of the year, how much you have||During the year, how much you save||How much you earned in interest||Income from Rent||Total at the end of the year from Stock||Start of the year house value||House Appreciation||End of year house value||Net Profit from House||Total from both Stock and House|
As you can see, you can retire in 10 years, a full 40 years faster than everyone else, AND you can own a house at the end of it.
And we haven’t even begun to scratch the surface of all the tricks and tools you have at your disposal if you learn more financial engineering intelligence.
If you are privileged enough to be a Software Engineer in San Francisco, you can retire in 4 years. Here’s the link to that spreadsheet.
This concludes the introductory course of Retirement 101. I will hold an advanced course someday in the future. If you have any questions please leave a comment below or message me at email@example.com
In Part 1 we said we need $64,000 per year to retire. In Part 2 I’ll discuss some options for how to get this without working.
To my knowledge in 2018, these are ways you can make money without working:
- Licensing deal: you help someone else’s business and in return they pay you for that help for the rest of the life of that business. An example might be you create a new toothbrush holder. Someone with a business like Walmart will buy your creation from you, then manufacture and sell the toothbrush holder you designed and for every one they sell, they give you some of the money they get. Another example is you work in a movie as a lead actor. Then every time someone buys the movie, you get some of that money.
- Investing: just by having money, you can make money. This is a big topic so I’ll just stop at the main point.
- Business Ownership: Similar to investing, you buy or create a business that hires employees to work for you so that you don’t have to work yourself in order to make money.
Each of these options has a varying range of success. A key point is that Licensing and Business gives you money because of work you did in the past, and your future earnings is dependent on the success of the work you do. Investing is much safer, because it’s dependent on the success of the world. Eventually, you want your core income to come from a reliable source, and investing is that reliable source.
The current term for this idea of being financially independent and retired early is called FIRE and there are multiple resources on this that go into more detail so I’ll leave a few links for you to read if you want more detail, and just cover the basics here.
What is investing? It’s making money out of money. It’s magic. It’s breaking the laws of what you think is allowed. But capitalism strongly supports this: if you have money, the system is designed so you can get more of it by investing. If you live in capitalism, investing is its core.
How much money can you get from investing? The real answer ranges from 0 to infinity, but there are specific strategies geared for retirement that you can hire someone else to do for you. So given that you hire someone else to do it for you, how much can you get from investing? Well, roughly for every $100 you invest, you can get $4 per year to spend. (For the purpose of simplifying investing, we will go with that. The second article above can go into more detail as it is a complicated subject.)
Doing some math
x * ($4 / $100) = $64,000
x = $1,600,000
we find that for the Average American to retire in 2018, they would need to have $1,600,000 cash.
Some of you may look at this and go: that’s never gonna happen. $1.6 Million?? How can I ever get that much money when I barely make a fraction of that? The answer is financial discipline, tax saving, and leverage. And we will get into those topics in part 3: how to achieve financial independence and retire early.