Last Updated on July 20, 2022 at 8:06 am
In this article, we discuss some common mistakes that should be avoided while planning for early retirement.
What is early retirement? This typically means quitting a salaried job to do what a person loves (for free or otherwise). Today 55 is the normal retirement age. So early retirement is approximately 45 years or earlier. See; How to prepare for the new normal; in retirement planning.
- Have a clear plan of what you would do with your time at least 1-2 years before you resign. As they say, the idle mind is the devil’s workshop. When the pressure of the job gets to you, all you want to do is relax and do nothing. When you actually have nothing to do, life can be quite dreary. Freelancing or other forms of gainful employment involving productive use of time is crucial for health and wealth (in this context, ensuring the person does not run out of money).
- It would be better to have a dry run by taking a few months’ break (without pay) from your employer (if possible) to see how you cope mentally.
- Ensure your spouse/partner and children fully appreciate your decision.
- For most early retirees an irregular source of income from freelancing would be essential. However, in many cases, estimating this income before retirement will be hard. Therefore we recommend not to depend on this retirement while planning for early retirement. If you depend on this income then it is not really early retirement.
- Do not assume you will be frugal in future! You have no control over your expenses!
- You must assume your expenses after retirement will increase each year by at least 6% – 8% would be much better!
- Expect lower returns from equity and fixed income than what we get today. Your retired life could span 2-4 decades. Over this time, returns are expected to fall. See: Ten-year Nifty SIP returns have reduced by almost 50%
- Review your retirement plan (inputs and assumptions) each year before and after retirement.
- Never assume your portfolio will be able to beat inflation in retirement. That is, do not set a real return higher than 0%! A poor sequence of returns (such as the one in play) can deplete your corpus fast. See: Want to be financially free? Do not count on frugality! Worry about sequence of returns risk!
- The above implies that you should not have significant equity allocation regardless of when you retire! For a person retiring at 40, the freefincal robo advisory tool recommends an overall 37% equity allocation to be distributed among three buckets – see example below.
- Do not think of early retirement unless you have enough resources to live off a safe fixed-income instrument with withdrawals increasing 6% a year for the first 15 years in retirement. Additional resources are necessary to beat 6% inflation for the remaining years of retirement and these can be invested in different buckets. See: Retirement plan review: Am I on track to retire by 50? This is a reasonably robust way to handle bear markets in the initial phase of retirement.
- If you are not going to work for money after early retirement then do not be in a hurry to quit your job. Ensure you have enough corpus to implement an annuity ladder or at least a single annuity (aka income flooring). That is you guarantee a certain amount of your expenses via a pension plan. See how to compute this here: How to use income laddering with annuities to plan for retirement.
- Do not take multiples of annual expenses seriously! Members of the FIRE community talk about 30X or 40X as a good enough corpus to retire with. Here X refers to current annual expenses. While these multiples are good enough to relish a sense of accomplishment, they cannot be relied on to actually quit your job! You need to create a detailed plan capable of withstanding at least one decade of recession or bear markets (pt. 11 refers to 15 such years).
To reiterate, by quitting your job, you are giving up a stable (albeit stressful) job and a reliable income stream capable of supporting you for years. Such a decision is not to be taken lightly. No matter how big a corpus you have, the most productive alternative is some form of gainful employment that may not pay as much or as often. Do not think about early retirement without this alternative firmly in place.