Published September 17th, 2015
The average retirement age in the United States is 62. The average expected retirement age is 66.
Both the real and expected retirement age has slowly trended upwards, as the image below shows:
This is the opposite of what should be happening in an investment-savvy and productive first-world country.
You’d think that the retirement age would trend down as we become more productive… But that has not occurred.
The truth is, some people retire much earlier than their 60’s. Many people are retiring in their 50’s, 40’s, and even 30’s in some cases. The reality is you don’t have to be rich to retire early – you must be disciplined and invest wisely, however.
What makes me hopeful is that both discipline and wise investing is teachable. I would love to see the average retirement age in the United States (and everywhere else for that matter) to fall far lower than 62.
What Does Retirement Mean?
First off, lets define retirement. It doesn’t mean sitting on the couch all day every day. Retirement means you are financially free to live the life you’ve chosen. Simply put, retirement means you don’t have to work.
Retirement does not mean you won’t work at all. Those who retire early often work – doing the things they want to do, rather than what they have to do.
You may be compensated monetarily for your passions; that’s not bad at all. You can be retired and get paid – if it is on your terms.
Early retirees often want to enjoy things when they are younger rather than older – it’s much easier to do a 12 mile hike when you are in your 30’s, 40’s, or even 50’s rather than 75.
Money, Time, Life, & Freedom
“If you’ve got the money, honey, I’ve got the time”
– Willie Nelson
Time is the ultimate currency of life. We only get so much of it, and then it’s gone. Of course, we aren’t free to do most things without money.
Money is a store of value. The value you create with your time is stored as money. We use time to create value and store it as money. Then we use money to spend our time in ways we couldn’t before.
One of the tenants of finance is that money in the future is worth less than money today. This has been known since at least 620 B.C., when Aesop wrote:
“A bird in the hand is worth two in the bush”
Time is valuable. I argue that someone who spends 1 hour a week making $75,000 a year will likely be happier (all other things being equal) than someone who spends 80 hours a week to make $75,000 a year.
One needs a balance, however. If you spend all your time providing value and saving money, you will have no time to enjoy the fruits of your work. On the other hand, if you don’t provide any value and make no money, you will not be able to do much with your time.
A balance between money, time, and life is critical. Passive income is the short-cut through the work-life balance conundrum. Passive income is money you make without having to spend additional time to make the money.
You are truly free when your passive income covers your expenses.
The Secret: Covering Your Expenses with Passive Income
The secret to early retirement is covering your expenses with passive income. There are three sides to this equation:
- Current Income
- Passive Income
Current Income – Expenses = Savings
Savings x Yield = Passive Income
The more money you can save, the quicker you can build your passive income. It really is that simple. The only way to save more is to either:
- Reduce expenses
- Increase income
Controlling expenses is critical to retiring early. The more you cut down on expenses, the sooner you can retire.
As an extreme example – Jacob Fisker of Early Retirement Extreme lives on just $7,000 a year… With expenses that low, you would be able to save virtually all your income and retire very early.
Of course, cutting expenses that low significantly and seriously changes your lifestyle. Small cuts here and there coupled with examining what you really need – and what you don’t – go a long way toward reducing budgets.
The 4 biggest expenses in most people’s lives are:
- Medical & Health
Buying a used car with no monthly payments (or downsizing to 1 car), getting a cheaper apartment (or living in a paid off home), and planning out meals and not eating out can all help to significantly reduce your expenses.
Medical and health bills are more difficult. They can easily add up to more than the other three big categories for some people. There is no simple fix or easy answer with medical expenses.
Lowering expenses is the single fastest way to retirement. That’s because you get a dual benefit from lowering expenses.
First, you have more money to invest every month. That means more money to build your retirement portfolio.
Second, the amount of passive income you need every month to cover your expenses is reduced. Lower expenses simply means an earlier retirement.
There are nearly infinite ways to raise your income, but they are beyond the scope of this article. They all boil down to the same thing; the more value you provide, the greater your income will be. The more efficient you are with your time, the greater value you can provide per hour worked, and the higher your income will be.
The passive income aspect of early retirement involves investing wisely. This will be discussed in detail below.
Dividend Stocks for Passive Income
Passive income is scalable; investing $1,000,000 in Coca-Cola (KO) stock and receiving $34,000 a year in dividends takes just as much time as investing $100 in Coca-Cola stock and receiving $3.40 a year in dividends. Click here to see 12 high quality dividend stocks for retirement.
Passive income does not take up your time. Once you are invested in a dividend stock, you don’t have to do anything else to receive your dividend payments.
This is the opposite of being paid for your time – how most people generate income.
There are a nearly infinite amount of different styles of investing. I believe dividend investing in general – and investing in high quality dividend growth stocks specifically – to be the best fit for individual investors; especially individual investors looking for growing passive income streams.
Dividend growth stocks grow their dividend payments over time. Take PepsiCo as an example. In year 2005, the company paid shareholders $1.01 per share in dividends. Now, the company pays its shareholders $2.81 a year in dividends. In 2005, PepsiCo shares traded around $55. Investors who purchased PepsiCo shares in 2005 are now enjoying a yield-on-cost of over 5%.
You didn’t have to be some sort of genius to buy PepsiCo stock in 2005. The company has been a well-known blue-chip stock for decades. PepsiCo wasn’t extremely cheap in 2005 either – it was trading for a price-to-earnings ratio around 20. This is the type of ‘average’ performance one can expect from investing in high quality dividend growth stocks.
PepsiCo is a member of a select group of stocks called Dividend Aristocrats. These are the ‘gold standard’ of dividend stocks. To be a Dividend Aristocrat, a stock must pay increasing dividends for 25 or more consecutive years.
Dividend Aristocrats are by definition high quality businesses… How else could they raise their dividends for 25+ years in a row? They are also very shareholder friendly; again, as evidenced by their 25+ years of rising dividend payments.
Common sense says that owning a business with a strong competitive advantage will produce excellent long-term results. Common sense is not wrong on this matter. The image below shows how Dividend Aristocrats have significantly outperformed the S&P 500 by over 2 percentage points a year over the last decade.
Investors who stick to purchasing Dividend Aristocrat stocks and other blue-chip dividend growth stocks will very, very likely see rising dividend income over time. Click here to see 11 Blue Chip dividend stocks trading at bargain prices.
It’s important that your passive income rises every year to combat inflation.
The Wealth Eating Cancer of Inflation
Inflation has averaged about 3% a year over the last several decades. Inflation is a hidden wealth tax brought about through money creation by the Federal Reserve. Every year (on average) money that is not invested loses 3% of its real value.
This means one must invest in investments that pay growing income streams to counteract the wealth-cancer of inflation. High quality dividend growth stocks should grow their dividend payments faster than the rate of inflation. This allows dividend growth investors to maintain or increase their standard of living after retirement.
Compound Interest & Dividend Stocks
“The Most Powerful Force in the Universe is Compound Interest”
– Albert Einstein (quote author disputed)
Time cannot be saved. You can’t add time to your bank account. We all only get so much of it, and then it’s gone.
Investing is different, however. The return from your investment can be reinvested. This reinvested portion then grows… This process is called compounding. Money compounds. Time does not compound. This means that money saved today and allowed to grow for 20 years will be worth much more than money saved 20 years from now.
With dividend growth stocks, the dividends paid can be reinvested into other dividend stocks. The dividends from each company tend to grow year-after-year as well. You get multiple layers of compounding.
A good analogy is a small snowball rolling downhill and picking up more and more snow until it turns into a massive snow-boulder:
Don’t wait to build your dividend snowball. Every day you wait to start is costing you money in the future.
High Dividend Stocks
Don’t be tempted to invest only in the dividend stocks with the highest dividend yields.
Always look for quality. A dividend stock with a 10% yield likely has serious issues that are widely known in the investing world – that’s why the yield is so high; to ‘compensate’ investors for the above average risk.
What good is a high yield if you can’t rely on the dividend? Only invest in businesses that you are very certain will continue to pay steady or (preferably) increasing dividends far into the future. Click here to see 12 quality 5%+ yield stocks analyzed.
Early Retirement Calculator Spreadsheet
Click the link below to download your copy of the early retirement calculator spreadsheet.
The early retirement calculator can be used to calculate how many years you have until retirement, given your current income, expenses, expected dividend yield at retirement, and expected inflation rate and total returns.
As a side note, most financial advisors and retirement planners have a ‘4% rule’. This rule says that you can safely withdraw 4% of your account value every year to live on during retirement without ever running out of money. If you plan on implementing the 4% rule, just change the expected dividend yield in the spreadsheet to 4%.
Additional Information: Forums and Blogs
The early retirement and personal finance communities are very active online. Several quality sites and forums are listed below:
Early Retirement Extreme: This is perhaps the best resource on radical, early retirement. The entire site is excellent and gives you a completely different way of looking at money, life, and what we spend. Do not miss the site’s lively forum.
The Retire Early Home Page: This site features several calculators to help plan for early retirement. The site also features articles on th3 ‘4% rule’, social security, retirement books to read, and more.
Early Retirement Forums: These forums have a wealth of information on early retirement and retirement investing.
Dividend Mantra: Dividend Mantra follows one man’s journey to early retirement at 40 using frugality and dividend stocks.
Money Ning: A personal finance blog where we share insights on carefully saving money, investing, frugal living, coupons, promo codes.
The Simple Dollar: The Simple Dollar is for people looking to fight debt and bad spending habits and build a financial future – all while enjoying a few luxuries here and there.