Posted by Robert on April 4, 2011
This is a guest post by Robert, who lives in Calgary and works as a financial adviser. He is married, has three kids and plans to retire at age 35. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
Financially, it is really simple to work toward retirement. There are only two variables to focus on: spending and investment income. By focusing on these essential variables, a person can track their progress toward retirement quite effectively. Once this part of the plan is on track, there are many other variables that can add complications. But the basic theory is simple.
How much do you regularly spend on your lifestyle? Surprisingly, many people can’t directly answer this question without resorting to a vague qualifier like “all of it.” In order to plan how much income a person will need to support their lifestyle without working, they need to understand how much they spend in a typical month or year. This might require facing some uncomfortable facts. But it should be a simple matter of gathering the last three bank statements and finding out how much money came out of the account each month.
Can you regularly spend less? This step is optional, but for those of us who would like to retire early, it brings the goal closer. The less a person spends in a typical month, the less income they require from other sources in order to meet their financial needs. In this way, it would be helpful to work on reducing lifestyle spending a little each month, not by sacrificing or giving up needs, but by being aware of waste and inefficiencies.
Finally, start to develop another source of income. This is where things can become complicated, because there are many equally valid ways to produce investment income. It could come from rental real estate, stock market profits or dividends, bond or GIC interest, a trust fund or a pension. The key here is that the income should be “passive” in the sense that there isn’t a need to work for it. In the sense that retiring means not working, this passive income can replace your present earned income.
Many people are visual in understanding their progress toward goals. By charting lifestyle spending and investment income each month, a person should be able to see spending fall and income rise until the point where they meet. At that point, retirement becomes a financial possibility. Tim and Dave both plan to reach this point at age 45 by spending reasonably. Some people may be motivated to spend very little in order to reach this point earlier. I have focused on producing high income from stocks in order to reach this point earlier.
There are a number of ways to reach the financial point of being able to retire. These are the simple variables to focus on first. Then, add in the additional variables of an emergency fund, insurance, a safety buffer, a variety of sources of income (diversification), a backup plan, and the possibility of pension income that won’t start for many years in the future.
Do you know how much you spend? How much passive income can you produce? What do you need to do to make those two lines cross?