Updated May 25th, 2017

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.

This article includes tips on how to retire early, as well as a real-world example from Early Retiree Reality. The real-world example is near the end of this article.

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:

Expenses

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:

Food

Housing

Transportation

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 10 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.

Here’s why…

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. At Sure Dividend, we maintain a select spreadsheet of true blue chip stocks with 100+ year operating histories and 3%+ dividend yields.

Click here to download my free blue chip stock Excel Spreadsheet now, including metrics that matter like dividend yield and the price-to-earnings ratio.

You can learn more about how to generate rising passive income through dividend investing by watching the webinar replay video below.

The Wealth Eating Cancer of Inflation

Additionally, it’s important that your passive income rises every year to combat inflation. Keep reading this article to learn more about the wealth destroying effects 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 a list of nearly 300 established 5%+ yielding stocks.

Early Retirement Calculator Spreadsheet

Click the link below to download your copy of the early retirement calculator spreadsheet.

Download Early Retirement Calculator

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%.

Real-World Example: Early Retiree Reality’s Story

Little did I know when I wrote my first ever article for Seeking Alpha – How I Retired At 45 – that it would generate so much discussion. As of this writing, it has 1,253 comments…

One thing is clear based on the comments: each person has his or her own idea about how much money is needed for retirement.

I’m not a financial planner, so I can’t give you retirement planning advice. However, what I can do is show you, by example, why you might need less than you think to retire early, if that’s your goal. Here’s how to know when you can retire.

The idea is not tell you step by step what to do, but rather show you the principles that are applicable to everyone. Extreme measures are not involved.

Early retirement shouldn’t be all that difficult if you have a decent middle class household income. The first and most important principle is this:

It’s not how much you make, but how much you have left at the end of the month.

This simple concept escapes some people for some reason.

A seemingly well-to-do couple who lives in a nice big house and buys a luxury car every few years may very well be ill prepared for retirement. After paying the mortgage, car loans, daycare, credit card bills, and private school tuition, they may be left with little to no savings at the end of each month.

It not only affects every day middle class working folks, but “rich” people as well. A Sports Illustrated article reported that 78% of NFL players are in financial dire straits within just two years of leaving the game, and 60% of NBA players face the same result within five years. Some of these athletes made tens of millions of dollars during their professional careers. It’s a safe bet to say the top reason is bad spending habits.

Wants Versus Needs

To prepare for early retirement, it’s therefore imperative that you live below your means. That means having a lifestyle that costs significantly less than your disposable income. The sooner you start, the better off you’ll be.

Each person has his or her own idea of happiness. Some can’t do without the material things in life, but some can.

The key is figure out yours.

If you have expensive tastes, it doesn’t mean you can’t retire early. It just means you have to have a bigger income and/or retire later in life. There are “needs” and then there are “wants”; don’t get them mixed up.

“Needs” include food and shelter, but “wants” are things like eating out in expensive restaurants multiple times a week, and living in a McMansion. Therefore cutting your “wants” to as low a level as possible and still feeling happy is the best way to save for early retirement.

Source: Obama Pacman

See the people above lining up outside an Apple store to shell out $800 for the latest iPhone? Most of them “want” one, not “need” one.

My Personal Story

I’ve never had expensive tastes even when I was single and making a pretty good salary as a software engineer. My wife, who is a stay-at-home mom, is an even more careful with money than me. That’s the reason my family of four can live on around $20,000 per year, not including unexpected expenses such as medical care.

By the way, this is possible because we live in a lower cost state (Texas), and not in an expensive one such as California, New York, or Massachusetts.

Some might think we live in a crummy house and eat nothing but ramen noodles with that budget. We don’t. Our 2,200 sq. ft. house is new construction, and situated in the best school district in the metro area. We don’t shop at Whole Foods, but we eat well. Everyone in our family has their own iPad and laptop. It’s just that we don’t have a mortgage or car payment (both are paid for), daycare expenses, and other spending we find frivolous.

For some, it might help to draw up a monthly budget and track all expenses. I certainly don’t go that far. I do keep a spreadsheet to estimate our living expenses, but have never kept track of expenses. To me, it’s bothersome since we don’t have a problem with overspending.

What does our budget look like?

Note that the only income line that matters (for predictable living expenses) is the estimated dividends. Currently I can generate $50,000 per year in income without incurring federal income tax, so I achieve it in the other ways listed, depending on year-to-year variances in dividend income and capital gains.

This is our current budget. The budget prior to my retirement didn’t look much different than this. The only significant differences are there was a mortgage and the auto insurance bill was almost twice as high because we had two cars to insure.

We have cash on hand to cover unexpected medical emergencies, fully accounting for the deductibles and maximum out-of-pocket costs in our health insurance plan.

How To Cut Costs Wisely

As you can see, not having a mortgage lowers the cost of living significantly. Since I’m retired, we need only one car now, resulting in low transportation costs.

Other things you may notice “missing” from my budget are cell phone bills and dining out. We use a combination of T-Mobile prepaid (legacy plan, Gold status) and FreedomPop cell phones, so our cell phone cost is around $40 per year. We give out our Google Voice number, and program it to ring our home phone (legacy Ooma plan, which is free from all monthly charges) and all the cell phones when someone calls. That way, when we’re home, we can pick up the home phone instead of a cell phone. As for dining out, we eat out probably less than ten times a year. Home cooking is healthier and cheaper, and many times, tastes better.

The point is, get your budget as low as possible. What are some of the ways we save?

I do most repairs myself, including things like repairing faucet and toilet leaks, replacing carpet with wood flooring, replacing sprinkler heads, changing car oil, replacing brake pads, etc. In fact, the only people we hired to do anything in the last 15 years were house painters and a roofer. Part of the reason is we have bought only new construction homes, so maintenance costs were minimal. We also buy new cars, and take good care of them, so we haven’t spent any car repair money for as long as I can remember except for oil changes, air filters, batteries, tires, brake pads, wiper blades, and windshield washer.

Several other saving tips are below:

We don’t hire house cleaners or lawn keepers, stuff we could easily do ourselves.

Take “staycations” most of the time.

Wait to buy tech gadgets (never “version 1”, which are always expensive and quickly become outdated). For example, our first iPad was the fourth generation one, whose price was reduced after the iPad Air was announced. Today, we have two iPad 4s and two iPad Airs using the strategy of buying the previous generation product after a new one is announced. All of the iPads were purchased for less than $300 brand new during sales events.

Use the air conditioner less than most people during the summer (plus our new house is quite a bit more energy efficient.)

Shopped around for the best rate for electricity based on our low usage.

Shopped around for the lowest auto and home insurance companies from well-known national companies.

We don’t subscribe to cable, opting instead for free over-the-air TV. We don’t watch TV much at all anyway.

We buy discounted gift cards from com and eBay for stores we shop at the most (Lowe’s, Home Depot, TJ Maxx, Marshalls), familiarizing ourselves with the terms and conditions regarding fraud protection.

We hunt for the best deals when we shop online, utilizing sites such as SlickDeals, RetailMeNot, CamelCamelCamel, eBay, etc.

For the vast majority of grocery items, we buy the store brand instead of national brands, unless they are on sale and close enough in price. We regularly buy brand names for only a handful of products (e.g., toilet paper and toothpaste).

We buy in bulk at Costco, but only for things we know we can consume in full before they go bad.

We buy quality products (at discounts of course) for stuff that needs to last a long time, such as appliances and power tools.

I also use my cash-back rewards credit cards whenever I can, and pay them in full every month. Every little bit counts, and adds up over time. Take people with a Starbucks habit for example. If that person spends $20 a week at Starbucks instead of drinking the free coffee at the office, he’d be spending around $86 a month. If instead he invested that amount each month into the S&P 500 index fund, he would have $380,077 after 40 years at a CAGR of 9%. That’s one expensive habit.

Admittedly, saving can be tougher to do if you live in more expensive areas of the country. Housing costs in areas like San Francisco, Boston, and New York can eat up a big chunk of one’s budget. If you can and are willing to move, then do so!

If you cannot or unwilling to, then realize that you are paying a premium to stay where you are. As someone who is no longer tied to a job, we are free to move anywhere in the country as we please, as long as it fits our budget.

During my working years, I took advantage of 401(k) programs as much as I could. All of the companies I worked for had company matching, such as a 50% match up to the first 6% in contributions. So not only did I reduce my income tax, but my money grew quicker because of the company matches. My saving did not stop there; I also contributed to my investment account with any disposable cash I had.

That brings up an important point. If you plan to retire early, then you need to plow money into your taxable (non-tax-deferred) investment account, since you need the money before you can withdraw from retirement accounts without penalties. There are ways to withdraw money from IRAs before your normal retirement age without penalty (72t distribution), but having the substantial portion in your taxable account makes things a lot easier.

Between the retirement accounts and the taxable account, I probably saved at least 20% of my disposable income while I was working. (I didn’t keep a record, so that’s just a rough estimate.) This compares to an average of around 5% for the average US household today:

Source: Y Charts

There are many countries with much higher savings rates. China, for example, is almost at 40%!

The message is clear: if you want to retire early, and don’t make a gigantic salary, then you have to save much more than the average US household.

Spending less and saving more is fine and dandy. However, unless you start off with multiple millions of dollars, you have to make your savings grow substantially.

Not only will inflation make your money worth less in the future, but as you age, healthcare costs rise dramatically. Having a written budget is an important first step, since it lets you know how much you need in retirement.

The other half of the equation is getting your savings to produce a rising income year after year to meet your increasingly larger budget.

It’s been said “the difference between the poor and the rich is that the poor works for money, but money works for the rich.”

find that very enlightening. Even though I don’t consider myself “rich”, the principle applies: Let Money Work for You.

Additional Information: Forums and Blogs

The next several sections of this article are written by Early Retiree Reality and discuss his real-life example of early retirement.

Little did I know when I wrote my first ever article for Seeking Alpha – How I Retired At 45 – that it would generate so much discussion. As of this writing, it has 1,253 comments…

One thing is clear based on the comments: each person has his or her own idea about how much money is needed for retirement.

I’m not a financial planner, so I can’t give you retirement planning advice. However, what I can do is show you, by example, why you might need less than you think to retire early, if that’s your goal. Here’s how to know when you can retire.

The idea is not tell you step by step what to do, but rather show you the principles that are applicable to everyone. Extreme measures are not involved.

Early retirement shouldn’t be all that difficult if you have a decent middle class household income. The first and most important principle is this:

It’s not how much you make, but how much you have left at the end of the month.

This simple concept escapes some people for some reason.

A seemingly well-to-do couple who lives in a nice big house and buys a luxury car every few years may very well be ill prepared for retirement. After paying the mortgage, car loans, daycare, credit card bills, and private school tuition, they may be left with little to no savings at the end of each month.

It not only affects every day middle class working folks, but “rich” people as well. A Sports Illustrated article reported that 78% of NFL players are in financial dire straits within just two years of leaving the game, and 60% of NBA players face the same result within five years. Some of these athletes made tens of millions of dollars during their professional careers. It’s a safe bet to say the top reason is bad spending habits.

Wants Versus Needs

To prepare for early retirement, it’s therefore imperative that you live below your means. That means having a lifestyle that costs significantly less than your disposable income. The sooner you start, the better off you’ll be.

Each person has his or her own idea of happiness. Some can’t do without the material things in life, but some can.

The key is figure out yours.

If you have expensive tastes, it doesn’t mean you can’t retire early. It just means you have to have a bigger income and/or retire later in life. There are “needs” and then there are “wants”; don’t get them mixed up.

“Needs” include food and shelter, but “wants” are things like eating out in expensive restaurants multiple times a week, and living in a McMansion. Therefore cutting your “wants” to as low a level as possible and still feeling happy is the best way to save for early retirement.

Source: Obama Pacman

See the people above lining up outside an Apple store to shell out $800 for the latest iPhone? Most of them “want” one, not “need” one.

My Personal Story

I’ve never had expensive tastes even when I was single and making a pretty good salary as a software engineer. My wife, who is a stay-at-home mom, is an even more careful with money than me. That’s the reason my family of four can live on around $20,000 per year, not including unexpected expenses such as medical care.

By the way, this is possible because we live in a lower cost state (Texas), and not in an expensive one such as California, New York, or Massachusetts.

Some might think we live in a crummy house and eat nothing but ramen noodles with that budget. We don’t. Our 2,200 sq. ft. house is new construction, and situated in the best school district in the metro area. We don’t shop at Whole Foods, but we eat well. Everyone in our family has their own iPad and laptop. It’s just that we don’t have a mortgage or car payment (both are paid for), daycare expenses, and other spending we find frivolous.

For some, it might help to draw up a monthly budget and track all expenses. I certainly don’t go that far. I do keep a spreadsheet to estimate our living expenses, but have never kept track of expenses. To me, it’s bothersome since we don’t have a problem with overspending.

What does our budget look like?

Note that the only income line that matters (for predictable living expenses) is the estimated dividends. Currently I can generate $50,000 per year in income without incurring federal income tax, so I achieve it in the other ways listed, depending on year-to-year variances in dividend income and capital gains.

This is our current budget. The budget prior to my retirement didn’t look much different than this. The only significant differences are there was a mortgage and the auto insurance bill was almost twice as high because we had two cars to insure.

We have cash on hand to cover unexpected medical emergencies, fully accounting for the deductibles and maximum out-of-pocket costs in our health insurance plan.

How To Cut Costs Wisely

As you can see, not having a mortgage lowers the cost of living significantly. Since I’m retired, we need only one car now, resulting in low transportation costs.

Other things you may notice “missing” from my budget are cell phone bills and dining out. We use a combination of T-Mobile prepaid (legacy plan, Gold status) and FreedomPop cell phones, so our cell phone cost is around $40 per year. We give out our Google Voice number, and program it to ring our home phone (legacy Ooma plan, which is free from all monthly charges) and all the cell phones when someone calls. That way, when we’re home, we can pick up the home phone instead of a cell phone. As for dining out, we eat out probably less than ten times a year. Home cooking is healthier and cheaper, and many times, tastes better.

The point is, get your budget as low as possible. What are some of the ways we save?

I do most repairs myself, including things like repairing faucet and toilet leaks, replacing carpet with wood flooring, replacing sprinkler heads, changing car oil, replacing brake pads, etc. In fact, the only people we hired to do anything in the last 15 years were house painters and a roofer. Part of the reason is we have bought only new construction homes, so maintenance costs were minimal. We also buy new cars, and take good care of them, so we haven’t spent any car repair money for as long as I can remember except for oil changes, air filters, batteries, tires, brake pads, wiper blades, and windshield washer.

Several other saving tips are below:

We don’t hire house cleaners or lawn keepers, stuff we could easily do ourselves.

Take “staycations” most of the time.

Wait to buy tech gadgets (never “version 1”, which are always expensive and quickly become outdated). For example, our first iPad was the fourth generation one, whose price was reduced after the iPad Air was announced. Today, we have two iPad 4s and two iPad Airs using the strategy of buying the previous generation product after a new one is announced. All of the iPads were purchased for less than $300 brand new during sales events.

Use the air conditioner less than most people during the summer (plus our new house is quite a bit more energy efficient.)

Shopped around for the best rate for electricity based on our low usage.

Shopped around for the lowest auto and home insurance companies from well-known national companies.

We don’t subscribe to cable, opting instead for free over-the-air TV. We don’t watch TV much at all anyway.

We buy discounted gift cards from com and eBay for stores we shop at the most (Lowe’s, Home Depot, TJ Maxx, Marshalls), familiarizing ourselves with the terms and conditions regarding fraud protection.

We hunt for the best deals when we shop online, utilizing sites such as SlickDeals, RetailMeNot, CamelCamelCamel, eBay, etc.

For the vast majority of grocery items, we buy the store brand instead of national brands, unless they are on sale and close enough in price. We regularly buy brand names for only a handful of products (e.g., toilet paper and toothpaste).

We buy in bulk at Costco, but only for things we know we can consume in full before they go bad.

We buy quality products (at discounts of course) for stuff that needs to last a long time, such as appliances and power tools.

I also use my cash-back rewards credit cards whenever I can, and pay them in full every month. Every little bit counts, and adds up over time. Take people with a Starbucks habit for example. If that person spends $20 a week at Starbucks instead of drinking the free coffee at the office, he’d be spending around $86 a month. If instead he invested that amount each month into the S&P 500 index fund, he would have $380,077 after 40 years at a CAGR of 9%. That’s one expensive habit.

Admittedly, saving can be tougher to do if you live in more expensive areas of the country. Housing costs in areas like San Francisco, Boston, and New York can eat up a big chunk of one’s budget. If you can and are willing to move, then do so!

If you cannot or unwilling to, then realize that you are paying a premium to stay where you are. As someone who is no longer tied to a job, we are free to move anywhere in the country as we please, as long as it fits our budget.

During my working years, I took advantage of 401(k) programs as much as I could. All of the companies I worked for had company matching, such as a 50% match up to the first 6% in contributions. So not only did I reduce my income tax, but my money grew quicker because of the company matches. My saving did not stop there; I also contributed to my investment account with any disposable cash I had.

That brings up an important point. If you plan to retire early, then you need to plow money into your taxable (non-tax-deferred) investment account, since you need the money before you can withdraw from retirement accounts without penalties. There are ways to withdraw money from IRAs before your normal retirement age without penalty (72t distribution), but having the substantial portion in your taxable account makes things a lot easier.

Between the retirement accounts and the taxable account, I probably saved at least 20% of my disposable income while I was working. (I didn’t keep a record, so that’s just a rough estimate.) This compares to an average of around 5% for the average US household today:

Source: Y Charts

There are many countries with much higher savings rates. China, for example, is almost at 40%!

The message is clear: if you want to retire early, and don’t make a gigantic salary, then you have to save much more than the average US household.

Spending less and saving more is fine and dandy. However, unless you start off with multiple millions of dollars, you have to make your savings grow substantially.

Not only will inflation make your money worth less in the future, but as you age, healthcare costs rise dramatically. Having a written budget is an important first step, since it lets you know how much you need in retirement.

The other half of the equation is getting your savings to produce a rising income year after year to meet your increasingly larger budget.

It’s been said “the difference between the poor and the rich is that the poor works for money, but money works for the rich.”

find that very enlightening. Even though I don’t consider myself “rich”, the principle applies: Let Money Work for You.

How I Invest

I’m not going to tell you how to invest your money so it works for you…

People have different risk tolerances and investment skill sets. I am however, going to show you how I am doing it. Maybe you can borrow some ideas, or better yet, come up with your own.

Investing in the stock market is comfortable for me. I have a fairly high risk tolerance level, and I have been doing it for over 22 years. It has been proven over the long term, nothing beats equities. (Some people are more comfortable with real estate, gold, or whatever, and that’s fine with me.)

Ever since I retired a little over two years ago, I have been investing in dividend-paying stocks (after investing in growth only stocks prior to retirement).

From our written budget, I knew I needed to generate at least $20,000 annually to cover our predictable expenses. Inflation runs around 2% annually, plus healthcare costs go higher as we age. Therefore, I targeted a 6% annual growth in dividends to beat inflation and healthcare costs, as well as having something extra to pay for future expenses like home repairs, etc.

For a margin of safety, I add $3,000 to the goal. In summary, our goal (starting last year in 2015) was to generate $23,000 in annual dividends, growing 6% each year. This goal is for the taxable account only, since I don’t plan to withdraw from the retirement accounts until the year 2035.

There are multiple ways to achieve this goal. The way I have chosen mine is via dividend growth investing plus somewhat of a balanced portfolio approach (stocks and bonds). This can be summarized as follows:

In the taxable account, invest for the dividends and dividend growth goals stated above, with a balanced portfolio approach for safety.

In the retirement accounts, invest in dividend-paying companies with excellent prospects of dividend growth.

Let’s discuss the retirement accounts approach first, since that’s relatively straightforward. I categorize investments as follows:

Income: stocks, bonds, or funds that have a flat dividend year after year. These tend to have highest yield and/or highest safety among the categories. An example is Vanguard Long-Term Bond Index ETF (BLV).

Low Dividend Growth Rate: dividend stocks or funds that are expected to grow dividends up to 3% annually. These typically have an above average yield and relatively good safety. An example is AT&T (T).

Medium Dividend Growth Rate: dividend stocks or funds that are expected to grow dividends 3-10% annually. These typically are mature growth companies having an average yield. An example is PepsiCo (PEP).

High Dividend Growth Rate: dividend stocks or funds that are expected to grow dividends above 10% annually. These typically are companies that have a low payout ratio and/or still growing their revenue at a good clip. An example is Microsoft (MSFT).

Growth: stocks or funds comprising of profitable, growing companies that have yet begun to pay a dividend. An example is Google (GOOG).

Speculative: stocks or funds that I believe have potential for price appreciation, either because the price is too depressed and a turnaround is imminent, or the company is in a rapid growth stage. It may or may not pay a dividend, and if it does, it is far too unstable to rely upon. An example is Amazon (AMZN).

In the retirement accounts, I can’t spend the dividends yet, so I don’t care about the current yield. As a result, these accounts hold mostly High Dividend Growth Rate stocks. The idea behind this is if I hold these stocks for a long time, the low yield today may compound into something really significant when I start withdrawing from my retirement accounts 19 years from now. The other benefit is the potential for high capital appreciation. I can partially sell some of these stocks and reinvest them into bonds or safer instruments for income later on.

High DGR stocks I hold in my retirement accounts include: Amgen (AMGN), ARM Holdings (ARMH), CBOE Holdings (CBOE), Costco (COST), Intercontinental Exchange Group (ICE), MasterCard (MA), Moody’s Corp (MCO), Nike (NKE), and Visa (V).

The taxable account of course, is more complex. I have to juggle between safety, income, and dividend growth. “Safety” for me means reducing the “sequence of returns” risk, where multiple years of bear markets in a row can destroy a portfolio in the distribution phase. I have chosen a balanced portfolio as the means to achieve this, by allocating 10-15% of the portfolio value in investment grade bonds. This is a bit aggressive; the typical financial advisor advice is a 60% stocks, 40% bonds mix. For someone with a larger portfolio, say $5 million, a 60/40 allocation makes more sense, but in my case, I need more growth (both capital appreciation and dividend growth) because my portfolio is currently around $1.1M. Should we encounter unexpected expenses and need to withdraw from the portfolio, we have the option to sell stocks or sell bonds, depending on the stock market conditions. (Bonds tend to fare better during bear markets.) Before we do that however, we will use the emergency cash at the bank (18 month’s worth.) In other words, “touching the principal” in the investment accounts is a last resort.

Another aspect of safety is diversification. You don’t want a single stock crash to permanently damage your portfolio. I’m comfortable with holding around 30-35 positions in my portfolio. Everyone has a different comfort level as far as this goes.

Stock picking is an important topic, but out of scope for this article. To cut to the chase though, I like dividend stocks that have a combination of wide economic moat, revenue growth, low payout ratio, lower debt, and a penchant for growing the dividend for at least 3 years.

Let’s take this year as an example and see what my taxable account looks like in my portfolio construction.

How did I come up with this allocation?

Well, it’s just a lot of playing around with spreadsheets after narrowing down the stocks and funds I like. I also wrote my own software application that keeps track of my investments and estimates dividends, so it helps a lot in conjunction with the spreadsheets.

So how does it stack up to the requirements mentioned earlier?

Generate at least $24,301 in dividends this year:

Estimated dividends this year will be $25,031 (should be higher as dividend increases are expected for the remainder of this year.) Note that the $24,087 figure in the table above is based on current positions, so it does not include dividends collected from stocks that have been sold earlier this year.

Dividend growth rate of at least 6%:

Currently the estimated DGR is 5.23%. I arrive at this figure by assigning estimated growth rates for each category, and totaling the annual dividends in each as follows:

I intend to correct this shortfall at the next portfolio rebalance opportunity.

10-15% of portfolio value in investment grade bonds:

Based on a $1.05M portfolio value at the beginning of the year, this means I need at least $105,800 allocated to investment grade bonds. With a current value of $92,743 I am a little shy of the goal. However I intend to correct this issue at the next portfolio rebalance opportunity.

Final Thoughts from Early Retiree Reality



So there you have it.

Living below my means and saving/investing in dividend stocks has allowed me to retire earlier than most Americans, and hopefully an increasing dividend income stream for years to come.

This article gives a real world example of how living below your means and investing in high quality dividend growth stocks can lead to early retirement.

This concludes Early Retiree Reality’s personal story of early retirement.

Additional Resources

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.