Many people look at their retirement plans and give up because it looks so overwhelming to plan for such a far event in the future when you have so many pressing issues that need attention right now! Follow a systematic approach, however, and you too can become Financially Independent, perhaps even Retire Early (FIRE)! I will be taking some liberties in this post and try to keep it simple and holistic. We will go into some more FI-nuance in later posts.

How much do I need to retire?

To retire, you need to accumulate 25x your annual expenses.

First identify at a minimum level how much it would cost you and your dependents for basic expenses for a year (rent/mortgage, groceries, some entertainment, occasional travel). Typically, you wouldn’t include your children if after college presumably they will be independent.

Once you reach a saving of 25x that number, there would be a huge weight lifted off your shoulder because from that point on, you can annually withdraw 4% of your money (indexed to increase with inflation) for 30 years or more with a very low chance of running out.

After you have identified your amount, look at your current net worth and how far you are. That is your target for additional wealth building before you retire.

A key thing is to keep your current expenses as low as you reasonably can to help save money for investment. Cut out luxuries like new car purchases if your current car is good enough, huge wedding expenses, fancy jewelry, boats, McMansions etc

It is not easy to cut expenses, I know. With our consumerist culture and wish to impress our friends and neighbours or guilt (can I really deny my son a new PS5 on the first day it comes out? ). But these traps keep us anchored to a lifetime of financial anxiety (will I ever have enough to retire? How do I pay off those monster loans and mortgages? Will my family be on streets if I lose my job?). They will also keep you working late into your old age.

What should I invest in?

A good retirement portfolio consists of diversified stock and bond index funds eg: VTI and BND.

Ok, let’s say you have identified how to minimize your expenses and save say 25, 35 or 50% of your income. What do you invest it in? Which stocks should I buy to make the fastest way to riches? When should I buy, when should I sell?

Well, hold on there, tiger! You cannot get rich quick. Building wealth is a slow and steady effort. It takes a minimum of 10-15 years once you get started on the right path and you can’t rush it by going and speculating on bitcoin or day trading like your life depends on it.

First identify an asset allocation i.e. how much % stocks and how much % fixed income (govt savings schemes, debt bonds, bank CDs etc). A good rule of thumb for people 80% stock index funds and 20% fixed income investments. The more conservative you are (and the older you get), the higher the fixed income investments (60/40). The younger you are, the more aggressive you can afford to be (eg: 90/10).

For the stock portion of your investment: How to choose? Should I buy Apple? Facebook? Shell oil? Which bluecap stocks? Options, derivatives?

Fortunately, there is an easy way. For the long term, individual stocks are risky. You need to invest in a broad basket of stocks across all sectors and geographies. A good way to do that is with index funds.

US investors have been lucky in their ability to get really low cost, efficient investment vehicles. You can choose a combination of US total stock market index fund (eg: VTSAX/VTI in Vanguard or FZROX in Fidelity) And International excluding US index fund (eg: VXUS or FZILX)

Typically one tends to have some bias for the currency in which your retirement spending will be. If you are confident that you will retire in the US, choose 80% US total index and 20% intl ex US index.

If you think you will choose geographical arbitrage (more on that later) choose a bigger international component eg: 60/40 US/world.

Ok, now we have identified investments. That leads us to the next question

How much percent of your income to save for retirement?

 Save as much as you can!

How much you need to save depends on how soon you want to retire. Religiously contribute the maximum you can every month. Pay yourself (your investments) first and only then see what is left over to spend and what choices you need to make to stick within your leftover budget. It is important to track how your net worth is doing. There are free services like personalcapital.com and mint.com that help you do that. If you are a stickler for keeping financial details strictly under your own control, you could build an excel or google sheets model.

 

How many years you will have to work for a range of possible savings rates, starting from a net worth of zero

 

 

 See this chart on effect of different savings rates on time to retirement. For example, if you start with 0 right now and save 50% of your income and can live with the remaining 50%, then you can retire in 17 years. Even lesser time if your salary increases during this time, but your expenses stay the same in terms of dollar amount (i.e. your savings rate goes up as you earn more). 

   If you are a high wage earner, 50% or more of your income would be a good choice. This will get easier as you get raises if you avoid the temptation to let lifestyle growth affect your expenses too much! If you are a low wage earner, try 15% to start with (yes it will be painful, but the journey is worth it). Again, over your career as your income increases, it will be easier to increase your savings rate.

Geographical arbitrage to reduce the target

            I mentioned before you need 25X your annual expenses to retire. What if you are living in a HCOL (High cost of living) area? Your expenses seem so high! How are you ever going to be able to save enough to be 25X that number?!!!! Well the good news is the HCOL area is giving you a high income right now, and while your expenses are high now, you don’t have to live there forever. There are so many places in the world that are so much cheaper that, if you have an open mind to accept new experiences and new culture, you can move there instead. Perhaps instead Boston, you can go live in Tampa, Florida or Penang, Malaysia or Lisbon, Portugal or Chiang Mai, Thailand or Bali, Indonesia (all awesome places I have been to myself and would not mind living in myself). Some of these places are easy to move to especially if they are in the same country. Some require advance planning to set up the proper residence visas.

            How does this play out with an actual example? Let’s say after your best efforts you can barely fit into annual expenses of $60K living in the Boston, USA. At this expense envelope, you need a $1.5M net worth before you can afford to retire. However, let’s say you are willing to move from Boston to Florida and can bring that down to $40K/year. Now your retirement number went down to $1M. Let’s say if you move to Portugal, $30K is more than enough to live a super comfortable life. Now your requirement went down to $750K.

Sites like Nomadlist.com or Numbeo.com give you cost of living comparisons for different parts of the world. Feel free to dream!

Summary

It looks intimidating at  the start of your journey, but the sooner you start, the easier it gets to see growth in your retirement assets. You should shoot for 25x your anticipated living expenses as your retirement goal (considering also moving to a low cost of living area). Invest in index funds without trying to time the market and save as much as you can. When you hit 25X or 30X your target, you are financially independent. At that point, continue working if it’s a career you love, switch to a career that is more interesting to you but potentially low paying or risky or completely switch to hobbies to keep you busy and spend more time with your family!

 In all cases, it is your choice and your days of working to somebody else’s dictats are over!