The Four Pillars of (Early) Retirement

Is your goal to retire early? Or perhaps you would rather be able to afford a comfortable lifestyle when you become financially independent. In this article, we will explore the four pillars of retirement and how you can use this knowledge to achieve your retirement goals. These four pillars apply to all retirement portfolios, whether you invest in stocks, bonds, real estate, art, or a combination of asset classes. Although simple, the four pillars are so important that if you fail to apply this information it could cost you years, or even decades, to make up for the mistake. The four pillars can be used to retire early or to retire in style (or somewhere in between), depending on your personal goals. Like many things in life, these principles are simple to understand, but useless unless applied consistently.

The first pillar

Let’s start with the most obvious pillar of retirement: time. Building a nest egg with enough money to allow you to cover all your expenses for several decades takes time. And the sooner you start saving for retirement, the longer your money will have to compound (pay attention to this one, Millennials!). The chart below shows you the impact that time has on your retirement savings. If you start saving $100 a month at the age of 20, assuming an average return of 7%, you will end up with $364,000 by the time you’re 65. If on the other hand, you start investing the same $100 a month at the age of 35 (10 years later), you will only have $174,000 by the time you’re 65. Those 10 years ended up costing you 52% of your future nest egg!

Unfortunately, time is the one pillar that we have little control over. The way to use this pillar to your advantage is to start investing today, regardless of your age. And it’s important to remember that no matter how young or how old you are, chances are that you wish you had started investing sooner. So if you haven’t already started doing so, open an account today! If you are not sure where to get started, this page reviews a few of the many options available.

And by the way, if you happen to find yourself at a later stage in life with limited retirement savings, do not despair. First of all, you are not alone. Sadly, there are millions of Americans who have saved very little towards retirement. Secondly, you might be able to make adjustments to the other pillars to make up for lost time.

The second pillar

The sooner you start investing, the less you will have to save each month to reach your magic number. However, if you don’t save enough, you probably won’t end up with a large enough nest egg to be able to retire early. Which brings us to the second pillar of retirement: the net amount you invest each month. Look at the chart below. It shows you how different amounts, invested over 30 years, can result in drastically different nest eggs.

We are assuming an annual rate of return of 7%, which some investors might consider overly conservative. Feel free to use a higher (or lower) interest rate in your calculations. The bottom line is that once you figure out how large a nest egg you need to retire, your next step will be to determine the monthly investment needed to reach that amount. You may want to first assume that you will retire between the ages of 65 and 70 and see how much you would need to save (here is a calculator you can use to determine that amount).

If your goal is to retire early, see what it would take to decrease the time needed to reach your desired nest egg. By decreasing the number of years, the calculator will give you the amount you would need to invest on a monthly basis. If this amount seems impossible for you to reach, think of different ways you could increase your monthly savings, while still maintaining a reasonable standard of living. Would you need to find a “side gig” or start a business? Could you sell some items that you no longer need?

The Third Pillar

We just talked about ways to increase your income to allow you to invest more every month. The flip side of the coin would be to decrease your monthly expenses. The third pillar is your cost of living. In other words, your monthly expenses. This is the pillar over which you have the most control. It is also a critical factor when it comes to retiring early or for those who are starting to invest later in life. The reason for this is because for every dollar you spend in retirement, you’ll need at least 25 dollars saved in your nest egg (based on the 4% rule). So, the less you spend, the smaller nest egg you will need.

Do you have any recurring expenses which could be reduced or eliminated? If you examine your monthly expenses, you will likely find a number of “financial leaks”, such as eating out multiple times a week, expensive smartphone or cable TV bills, or excessive entertainment, to name a few. Write down a list of your expenses and next to each item determine whether it is a basic necessity or whether you could live without it. For example, do you really need a TV package with 140+ channels? Probably not. Is it worth delaying your financial independence? That’s for you to decide.

There is a direct link between the amount you need to live on and the length of time it takes you to reach financial independence. In other words, the more money you spend (as a percentage of your income), the longer it will take you to become financially independent. Conversely, as your monthly expenses decrease, you will be able to save and invest a larger percentage of your income. The chart below shows you the approximate number of years it would take you to retire based on the percentage of income that you save, regardless of how much you make. For example, if you save 15% of your income, it will take you approximately 35 years to retire (assuming a 7% rate of return). If on the other hand, you save 45% of your income, you’ll be financially independent in less than 17 years!

The Fourth Pillar

We’ve talked about the importance of investing as much money as you possibly can (second pillar). In addition, we also need to reduce our living expenses (third pillar). Some people boast of saving a large amount of money when compared to other people, but their expenses are so high that they are unlikely to retire before people who are making less money but are saving a larger percentage of their income. While there is nothing wrong with spending money on things you enjoy, if your goal is to retire early you will need to increase your savings while simultaneously decreasing your cost of living. The good news is that the two usually (but not always) go hand in hand: as your savings increase, you are usually living on a smaller percentage of your income.

Once you’ve decided to save a significant amount of money every month and you have found ways to reduce your cost of living, the final step is to ensure that your money is working as hard for you as you are working for it. The fourth pillar is the rate of return you earn on your investments. The goal here is to take reasonable risks with your portfolio to allow it to grow over time. For most people, this will not involve investing in individual stocks (as that might bring too much risk to your portfolio), but rather in low-cost, well-diversified index funds. The chart below shows you how $400 invested every month will grow over 30 years at different interest rates.

Conclusion

Notice how the pillars work together: if you save a large amount (second pillar) but are not willing to take on enough risk with your portfolio (fourth pillar) then your money is unlikely to grow enough to allow you to retire, much less retire early. For example, there are many Millennials who are so afraid of stocks that they invest most of their money in bonds or Money Market Accounts. Conversely, if you start investing at a young age (first pillar) but only invest 5% of your income (third pillar), it will likely take you over 50 years to retire!

Whenever you see someone experience issues with their retirement, they have inevitably broken one or more of these principles. They either started investing too late, didn’t invest enough, didn’t properly manage their expenses, or didn’t take enough risk with their portfolio. The key is not to beat yourself up if you’ve made any of these mistakes (because everyone has at some point), but rather to use the four pillars to your advantage.

Are you making good use of the four pillars in your retirement? Let us know in the comments section!