Posted by Tim Stobbs on March 26, 2010
Early retirement is suppose to be this great thing. Do what you want when you want. Yet doing it does have some pitfalls that you need to watch out for and hopefully avoid a few of these.
1) Underestimating expenses. It’s amazing how during your working life you get use to your lifestyle that you tend to forget about certain items like health benefits, replacing your car, your water heater, roof … you get the idea. When your planning for an additional 20 years of retirement you better make sure you check your expense list twice. One way to plan for this is to make sure when you go into retirement that everything is new and/or that you have planned for an extra replacement money. At a minimum I suggest a $1000/year for each car and home you own.
2) Not having any margin of safety on your calculations. It’s nice to hope that things turn out just the way you plan, but let’s face it, life doesn’t work that way. So you better leave some wiggle room when doing the math. In my case I drop my expected rate of return by an extra 1%. Some people like to boost their expenses by an additional 10%. Either way works out fine, but you do want to have some cushion there.
3) Not enough diversification in your investments. In order to avoid having your retirement savings go up in smoke you need to make sure you can suffer some serious damage to your savings. The solution is to avoid putting all your nest eggs in one basket. You most likely want a conservative mix once you get near retirement, but not too conservative that inflation takes you down in twenty years. So you most likely want a high interest savings account, bonds/CD’s, perhaps a REIT and a mix of other equities in Canada, US and the world.
4) Forgetting about taxes. Knowing your Canada or US tax law is required to build a good portfolio as much as diversification. For Canadians you need to know about the three types of investment income (capital gains, interest, dividend) and how each is taxed.
5) Unrealistic expectations. You can’t travel the world and live in five star resorts and leave work at 30. Ok, perhaps one in 15 million can, but I know that isn’t me and most likely not you. So keep your dreams reasonable.
6) Cut off peak earning years. By leaving your working life earlier you cut off your peak earning years. So the earlier you leave the harder it becomes to pull off since you are losing more of your high income years.
7) Emotional considerations. Some people do all the math and planning but forget one thing. What are you going to do with all that time? So they end up bored and go back to work. My question is what’s the point of saving if you don’t have a plan for your activities in retirement! Early on in your planning you want to start considering this. After all you don’t want to forget about enjoying your life now and you also want to ensure you will continue to enjoy your life in early retirement.
So what pitfall are you most at risk of falling into? Or did you have another pitfall to add?