Podcast | Digging Deeper - How to attain freedom to retire at 40

In the independence week specials on Moneycontrol we have been exploring ways that individuals can experience financial freedom by planning their investments, tacking their loans and EMIs, saving to travel the world etc. Today, we’re looking at one of the most prized life goals of our times. One that most people would love to do, but few achieve - retirement at age 40.

Retirement at 40? Isn’t 40 the new 30? Why would one want to retire at 40? Well, because once you have your finances in place, I suppose experiencing the wide world and seeing all it has to offer over the next 30 years of your life isn’t such a terrible thing. Or maybe that’s just my opinion.

David Cox, who runs a blog titled I Retired Young, told Time magazine “Start saving as early as possible. Even if it is not a big amount to start with, it gets you into the saving habit, and then as your career develops and your earnings grow, the amount you can save will increase as well.”

Cox retired at 47. However, as the magazine notes, unless you’re in the top 5 percent of earners, merely saving enough to retire by age 40 will be difficult. That’s an understatement, of course. You’ll end up sacrificing nearly everything fun, save for necessities and any inexpensive leisure activity. Say hello to long walks.

Okay, at this point, I kind of share your scepticism. Retirement at 40 seems a pipe dream. We don’t all have big inheritances, we’re not all tech or business tycoons, and we’re not all celebrities. So should we even consider this?

Well, yes. But the thing to keep in mind is, you have to make your money work for you. That old fundamental doesn’t change. As Robert Kiyosaki put it in his book Retire Young Retire Rich, “If you want to retire young and retire rich, it is very important that your money be like a bird dog, going out every day and bringing home more and more assets.”

So let’s get to the math and the numbers we need to know for an early retirement. It is, of course, a given that you need huge savings to even consider retiring. Besides the savings, you’d also need a steady income stream so you don’t deplete said savings. A 2012 study by Aon Hewitt found that in order to retire comfortably, an average employee required savings 11 times that of his or her career pay. They also needed to replace a massive 85 percent of the annual salary.

However, this doesn’t stop the determined early retirer. Paul Schrodt noted in the article in Time that the general rule is saving so you can replace 80 percent of your pre-retirement income with investments or other sources of income. This means you’re likely to put away much more than people who exit the workforce at an older age. Because if you retire at 40, you’ll likely be retired for 40 to 50 years, as against the usual 20 to 30 years. Therefore, depending on how much you earn, you will need to, no prizes for guessing this, save half of each paycheck to retire early.

So it might just be time to get another job that pays more or to ask for a raise. Maximizing your earnings early means it’ll be easier to retire sooner.

Cox says he took a bit of a risk on this. He writes, “For me, it was working overseas that boosted my earnings, it was a risk and it hasn't always been easy, but it definitely moved my retire early date forward.”

Entrepreneur.com noted that those planning an early-retirement share a common trait: ‘They typically adopt a contrarian mindset that produces a fascinating lifestyle, spending, and retirement planning insights.’ They also noted that young retirees discovered something-  the magic number is not income, it’s actually their savings rate as a percentage of their take-home pay. When we keep that in mind, early retirement suddenly looks a lot more attainable.

Peter Adeney of popular blog Mr Money Mustache explains it like this: “If you are spending 100 percent of your income, you will never be prepared to retire . . . If you are spending zero percent of your income [meaning that somehow you're managing to live] and can maintain this after retirement, you can retire right now.”

Thanks, Peter. But how does that help me? Well, a few people in America crunched the numbers and found that he wasn’t off the mark. Well, for Americans. Here’s what they found. If you can save 50 percent of your take-home pay, you can retire in 16.6 years. If you save 75 percent, you can retire in just 7.1 years. While a higher income makes it easier to save a large chunk of your pay, maximizing the savings percentage might be the actual key to early retirement.

Investment advisory firm Futureadvisor.com noted that if one is able to save 40 percent of one’s income from age 20 onwards, then retirement at 40 could be on the horizon. If you start later, the amount you have to save increases.

This is because brace yourselves for a home truth now - young retirees spend well below their means. Yes, efficient savers who stash away most of their money, manage to retire early. But it is worth noting that many early retirees don’t view spending less money as a sacrifice. In fact, many have developed a mindset that is perfectly content, if not outright proud, of minimizing their consumption. They value frugality. J. Money from BudgetsAreSexy.com says, “Whenever we consider buying stuff, we’re usually fixated on price, but what we’re really after is how much joy this new thing will bring us. I’m just as happy drinking beer at home as I am at a bar.”

Like I said, home truths.

Arielle O’Shea writes in Forbes, “...look at smaller, recurring expenses. The cable goes….The internet speed gets downgraded. Running outside replaces the gym. Any debt that can be refinanced should be. And yes, you will probably never eat avocado toast or drink a latte again.”

One thing to consider when talking about retirement is, what retirement means for you. Are you going to keep things low-key at home and tend to your garden? Or are you going to travel far and wide, eat out every week and live it up?

We spoke about Chris Reining, whom CNN featured as an example of someone who retired at 37. Yep, 37. Of course, Reining had a good start with a well-paying job cyber-security, took out a mortgage and bought a house, and bought his own BMW.  He read the book "Your Money or Your Life" by Joe Dominguez and Vicki Robin in his late 20s. He’s clear that “The people who are most successful at it have compelling reasons for why they want it.” Reining advises three things - earn more, save more, invest more.

Reining is right about investing more. Young retirees have access to the same investing knowhow that you and I are can glean. However, they are not trying to beat the market. They keep things simple. Many use indexing and asset allocation as a steady, long-term investing game-plan that happens over decades, rather than months or years. Yes, decades. They start early. Also, according to a report in Forbes, an analysis by NerdWallet found that, in the US,  avoiding the market could lead to USD 3.3 million in lost retirement savings over 40 years. I expect, adjusted for currency and standards of living, we can assume the same for India.

The most important point is, early retirees started investing earlier than their peers, giving compound interest extra time to work its magic. For instance, assuming 7 percent returns, a person who invests 100 rupees a month from age 20 to 30 would still end up with more money than someone who invested Rs 100 a month from ages 30 to 60.

Say you are now 25 and want to retire by age 45. E R Ashok Kumar, CEO and co-founder of Scripbox explains how to structure your plan for such an outcome. If your salary is Rs 40,000 rupees per month, save Rs 12,000 each month for one year, and invest it in a set of well-diversified equity funds. Equity funds historically provide a long-term average return of 14-16 percent. Let’s go with 14 percent for this plan. The next 12 months, increase your investment by 10 percent to Rs 13,200 per month. Given salary increases of around 10 percent per year, it won’t be too much of a hit.  For the next 18 years, until age 45, do the 10 percent increase in line with your salary hike. Stay invested in good equity funds. You might weather a few market storms when it might seem like things are going bad. Ashok Kumar advises that you stay the course. If everything goes according to plan, Kumar says, in 20 years you would have accumulated over Rs  3 crore. Over that period, you would have contributed only about Rs 90 lakhs. The rest comes from that magical thing called compounded return.

By age 45, your expenses would have gone up. Let’s say about a lakh a month. Kumar suggests that you put five years’ worth of expenses, say about 80 lakhs, into a debt/liquid fund. Draw from it every month for your expenses. The rest remain in equity funds, so compounded return keeps working its magic. At the end of every five years, withdraw five years’ worth of expenses from the equity funds and add to your debt funds. This way, you are all set for the next 50 years.

What we just discussed is called income ladder. It is a brilliant way of generating inflation-protected income when you stop earning.

Retiring at 40 is, as we’ve mentioned earlier, not easy. You can’t have an epiphany at age 35 and hope to have all of this done within just five years. You’ll have to start implementing these practices early in your career. A majority of people don’t believe that they can retire by 40, so they don’t even try. They are prepared for the long haul up to age 65. Perhaps the biggest lesson from the push for early-retirement is that in order to hit ambitious goals, one needs to construct a lifestyle around such a goal.