Step by Step approach for an Early Retirement
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What is Early Retirement?
Everyone wants to retire early and sit on a pile of cash that will help them sustain for as long as they live. Firstly, individuals have to decide the target retirement age. It is all a back-calculation then to ascertain the right time to start investing, amount of investments, rate of return, and finally selecting the asset class providing such return. However, the unique catch here is that early retirement is all about time, i.e. less time to build wealth, and more time to enjoy it.
If you wish to retire early, you should think of starting early too. Starting early has always been beneficial to most of the marquee successful investors. Mr Warren Buffet made his first investment when he was just eleven. However, not everyone has the foresight, ability and knowledge as he did, at such a young age. The average age to start investing could be just as soon as the individual is out of college, i.e. the early 20s. Investing early in your life teaches you a pattern of financial independence and discipline in addition to the following advantages.
- Improves Risk-Taking Ability: Risk-taking abilities increases with lesser responsibility.
- Save more: Investors tend to save more by cutting on unnecessary expenses and divert such saved money towards investment.
- More Recovery Time: In case of a wrong choice of investment, you always have a better chance to recover the losses in your long investment career.
- Time Value of Money: Compounding generates multifold returns and has a larger impact with a longer time frame. The investment gets more time to grow in value.
- Secured Future: The investments made at an early life can always be handy during tough times as well as during any emergency.
- Support your Retirement Plans: Early age investments increase the probability of reaching financial stability and achieving financial independence at a young age.
The traditional retirement approach has a 30-35 years old career savings to finance the 30+ years of retirement. However, passive investment strategies do not grow fast enough to support early retirement. These are lower return passive portfolio strategies like savings in bank fixed deposit etc.
Modern portfolio management strategies offer riskier highly rewarding asset classes such as equity. Being a part of a successful business venture has a potential of multi-bagger return. Further, these investments have a benefit of compounding, which can multiply exponentially with time. Shifting to active investment strategy calls for appropriate asset allocation, risk management tools, as well as the use of leverage to an extent.
How to plan an early retirement?
- Determine the target retirement age.
- Determine the amount of corpus required at the time of retirement.
- Make plans to get out of debt at the earliest.
- Take stock of the current investments and review the asset classes.
- Calculate the periodical investment amount, i.e. Target investment per month. Such calculation would involve a budgeting exercise to ascertain the expense and income levels.
- Calculate the required rate of return to achieve the goal within the stipulated time.
- Identify the asset classes that offer such returns considering the overall portfolio risk.
- Define an asset allocation in the selected asset classes.
- Review and revisit the portfolio at regular intervals.
Alternatively, investors generally have a choice or a preference for the asset classes. In such a case, they may first consider the average rate of return and then decide a particular amount to invest each month regularly and consistently.
What are the asset class in this retirement planning process?
There are broadly three routes to wealth creation namely paper assets, real estate, and investments in businesses. However, only two of these paths offer leverage benefits as mentioned in the modern retirement planning theory, i.e. (real estate and business) leading to quicker wealth creation process which is suitable to early retirement without extreme frugality.
The traditional retirement planning approach uses the only non-leveraged asset category, i.e. paper assets. That is why it is the slower path of the available options.
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