A lot of people would like nothing better than to be able to retire early. But early retirement presents special challenges. When preparing for early retirement it’s important to do some contingency planning. There are at least four threats to your early retirement plans – but more important – is knowing what to do about them.
Outliving Your Money
This may be the single biggest threat to early retirement planning. In recent decades, as life spans have increased, people retiring at 65 have had to deal with the prospect of providing for themselves for the next 20, 25, or even 30 years. If you plan to retire at 55 or 50, you’ll need to add an extra 10 to 15 years on top of all of those numbers. It is not inconceivable that you will need to provide for 40 years or more if you retire at age 50. That will be more years than you spend working to prepare for retirement.
What can you do to avoid outliving your money?
- Plan to save even more money than you originally planned. Depending upon how early you plan to retire, what your expected longevity is, and how much you plan to rely on your retirement portfolio, you may need to save anywhere from 50% to 100% more than you would need had you delayed retirement until 65 or later.
- Develop one or more passive income sources so that they’ll be available to supplement your investment income.
- Have a backup career, just in case you run into a rough patch that drains more of your portfolio than you feel comfortable with.
- Keep your most basic living expenses as low as possible. This will include housing, your car expense, and certainly any debts that you might carry. The better way of course is to be completely debt-free.
The great, big, giant “X” factor plaguing retirement planning is inflation. No matter how much money you have saved for retirement, inflation can shrink it without you even noticing. This will not only reduce your portfolio size in real terms, but it will also reduce the amount of investment income that you will have available to pay your living expenses.
One of the inherent problems with inflation is that there’s no way to know today how significant it will be in the future. Perhaps the best way is to look at what inflation has done to money over a recent time period. For example, if you want to get a rough idea as to what prices will be 20 years from now, you can check and see what inflation has done in the past 20 years.
The Bureau of Labor Statistics has an inflation calculator tool that will help you to do just that. For example, if you want to make an educated guess about what inflation will do to your money in 20 years, you can simply go to the calculator and put in “1984”. You will see it now takes $1,602 to buy in 2014 what $1,000 bought in 1984. Based on this, we can assume that the rate of inflation is running roughly 3% per year. You can then build that rate into your investment calculations to see how much money you’ll need to have in real terms.
So how can you plan for the effect of inflation on your early retirement?
- Invest for growth. Your return on investment will need to outpace the rate of inflation by a wide margin if you hope to retire early. Try out a free online Personal Capital account to help you manage your investments.
- Invest in assets that tend to perform well with inflation. Energy and real estate are two time-tested asset categories.
- Plan to have multiple income sources, that way you will not completely rely on your investment portfolio. This may be even more important during times when inflation may be particularly high.
A Stock Market Crash
If you are a long-term investor and planning for retirement that is significantly more than a decade away, a stock market crash may not be an issue. But if you’re getting close to that time, particularly if it’s just a few years away, a crash can completely change your plans.
How can you work around a stock market crash in the years leading up to your early retirement date?
- Begin moving your money into more conservative investments as you get close to your retirement date. This might mean shifting from growth type assets, to growth and income vehicles.
- Be prepared to be flexible with your retirement date. A poorly timed market crash could require you to set your back retirement by five years or more to overcome the market decline.
- Have income sources that are not reliant upon the stock market. You may be able to rely on those sources even after retirement, to give your portfolio a chance to recover.
A Personal or Family Crisis
As much as we like to think that everything will be smooth sailing between now and the time of early retirement, life sometimes gets in the way of our best laid plans. You could be hit by a personal crisis, such as a major health event, or a family crisis, such as a divorce, or even problems with your children. These are all part of life, and they don’t go away just because you want to retire early.
How do you plan for an unexpected crisis in conjunction with early retirement?
- In addition to your basic retirement investment planning, you should also build up a substantial emergency fund. This will enable you to deal with a major unexpected crisis without being forced to liquidate your investment portfolio, which may reduce your income after the fact.
- Once again, having additional sources of income can go a long way toward helping you to deal with at least the financial aspects of the crisis. That will be especially important if the crisis is a prolonged one, which is not an infrequent situation as you get older.
- Be prepared to be flexible in all aspects of your early retirement – the timing, your standard of living, and the use of the time that you have available once you are retired. Though you may plan an early retirement on the beach, life may have other plans and you’ll need to be ready to adjust as needed.
It’s worth noting that early retirement can also help you to deal with a personal or family crisis. The fact that you will no longer be weighed down by maintaining a stressful career, can provide you with the time that you need to deal with the problems that you are facing.
None of this is to suggest that early retirement is not doable. It’s just that like everything else in life, there are usually hidden obstacles. If you are ready to deal with those obstacles, you can retire early, and do it in comfort.