The blueprint for retiring early – Part 1

I achieved financial independence at age 38. This is the blueprint I followed to do it.

Step #1 – Fix your spending

First, you have to fix your spending. I don’t mean ‘fix’ like it’s broken, I mean fix it as in only spend a constant, known amount of money. You might adjust this up or down over time, but for any given year you need to set a target spending budget and stick to it.

The key to fixing your spending is NOT by using a traditional ‘budget’, which no one does or sticks to, but with your employer’s direct deposit. Most companies will let you choose at least two or three different accounts to split your direct deposit into.

Let’s say you get paid monthly and have penciled out your budget at $3,000/month for everything: essentials + discretionary. You allocate $3,000 of your direct deposit to go to the checking account that you pay all of your bills and credit cards out of, and then deposit the ‘balance’ (rest of your paycheck) to a savings account which will ONLY be used for transferring money one way to your investment accounts ( = Roth IRA + taxable accounts.)

Having one single tub of money in your checking tempts you to spend everything most months, and then have nothing for unexpected or irregular expenses that only come around a few times a year. To avoid this problem, you should also having at least one other savings account that gets a fixed amount of money too, and use that as your ‘buffer’ fund for discretionary things that you can save up for and only buy once that fund has sufficient money in it.

I actually use multiple sub-savings accounts: one for travel, one for miscellaneous stuff I want like backpacking gear or household items, one for a future new (used) car when mine dies, etc, but do what is easiest to manage for you. If you sent $1,000 to your subsavings account(s) for occasional expenses and $2,000 to your checking for regular monthly bills, your early retirement financial picture would look like this so far:

Screen Shot 2020-05-07 at 10.38.36 PM

I’ve detailed exactly how to set this up, including what bank to use, here. For more on how to figure out what you’re spending in order to estimate your direct deposit needs, read this.

Once you have this banking system of accounts + automated transfers (including your all-important direct deposit) set up, there are only two points of failure:

1) you forget to transfer money from your sub-savings accounts back to your checking to pay for once-in-a-while expenses. Avoid this by using your bank’s app and making transfers as soon as you spend money that comes from a sub-savings account. Say you buy plane tickets for $1,500. As soon as you buy them, transfer that same amount from your Travel savings account to checking so that the money is there when your credit card payment comes due. (I recommend setting all your bills up to auto-pay for simplicity and to avoid late fees.)

2) The second point of failure is outspending the amount you’ve budgeted for. If you’ve correctly computed your recurring expenses that come from checking, you’re ok there. If you haven’t, either adjust your monthly deposits upward, or if it’s just a temporary blip, ‘steal’ money from your subsavings accounts to pay for a higher-than-usual monthly bill. For your discretionary expenses that you’re accounting for in your sub-savings accounts, you must wait to spend that money until you have enough in your sub-savings account to pay for it. For example, if you have a Travel fund, do not book your next vacation until you have enough in that sub-savings account to pay for it. This develops the simple-yet-essential habit of not spending money you don’t have.

Your goal in all of this is to steadily increase your rate of saving as your income increases over time. People with steady employment that fail to build wealth are increasing their spending to match their income increases. Thus they never ‘get ahead’, and with credit cards and debt, they can even spend enough to fall further behind despite worker harder and earning more over time.

For people that are serious about accelerating the date at which they can work for fun versus money, you want to eventually save 50% or more of your annual income. This is hardest when you’re just starting your career and your income is low, or if you’re just starting to get a handle on your expenses. Don’t be discouraged: any increase in savings is a big step in the right direction! I saved barely anything straight out of college (but I did save something), and now, 15 years later, I’m saving well over 50% of my take-home pay as my income has increased by keeping my expenses at the same level they were for the past ~10 years.

The rich get richer

Once you fix your spending, you’re now banking every windfall that comes your way. Bonus at work? You get to keep all that. RSUs vest? Bank it. Annual raise? More and more yearly savings moving you closer and closer to financial independence.

In Part 2 we’ll discuss Steps 2 and 3: maxing out tax-free savings and what investments to choose for maximum growth with minimal long-term risk.

Author: Ward Williams

Ward is an independent financial advisor at Better Tomorrow Financial. He started working as an independent investment advisor in 2009.

Leave a Reply