This is the digital nomad quest podcast with Sharon Tseung. teaching people how to build passive income, become financially free
and design the best lives.
Hey guys, Sharon from digital nomad quest, and today we’re gonna talk about how to retire by 40. So I’m sure a lot of you guys are interested in retiring early retirement before 65, when most people usually retire. And of course, you guys know with this channel, I talk about financial freedom and passive income a lot. And I’m really encouraging you guys to design your best lives, I want people to not have to follow that norm of retiring in their late 60s, if they don’t want to. For me, I feel like I have essentially hit that point of financial freedom. But money isn’t what I’m after. For me. It’s about doing cool stuff with my life. And that’s why I’m all about creating that freedom for yourself, because that’s what can help you truly live your life to your full potential. So when I started learning more about financial freedom, I really learned about the fire movement. So if you don’t know already, fire stands for financial independence retire early. It’s basically a movement of people who are devoted to retiring early and accomplishing financial freedom by saving a lot and investing a lot. Most of these people follow an extreme saving lifestyle and save up to 70% of their income. Now, with the fire movement, a lot of people follow the 4% rule, it’s basically a way to understand how much you need to save and invest and how much you’re allowed to withdraw when you’re retired. So theoretically, your investments should increase around 7% per year average. And then inflation will account for 3% of that. That means if you subtract the two, you can theoretically pull out 4% every year and the principal will not dwindle for about 30 years, the rule was created using data on stock and bond returns over the 50 year period from 1926 to 1976. When this rule was created, they were basically thinking a balanced portfolio of 50% stocks and 50% bonds. But financial experts now recommend different allocations. So back in the day, I actually interviewed this girl who retired with $700,000, at the age of 32. She decided that was enough with the 4% rule, she said she was going to spend about $28,000 per year, she put the majority of her savings in BTSA x, which is the Vanguard Total Stock market index fund. And it’s a pretty safe index fund that pays you out in dividends. So if she’s spending $28,000, per the 4% rule, theoretically, the principle of $700,000 is not going to dwindle. So that 4% rule is going to help you understand your retirement number as well as your withdrawal number. And the 25x rule actually comes from the 4% rule based off that 4% rule. Essentially, if you figure out your annual spend, and you multiply that by 25, you’ll get that number that would be your retirement number in that scenario of that girl saving $700,000. Basically $28,000 times 25 is $700,000. And by the way, if you want to be more conservative, you might use a 3.5% rule or a 3% rule. For example, right now inflation is at all time highs. So to be safe, you might want to save more. The 4% rule is just a rule of thumb a guideline to help you figure out your retirement number. But it’s not a hard rule. So basically what this you achieve fire if you hit that 25x rule, but aside from fire, there’s also things like lean fire, barista, fire, coast fire and fat fire. So let’s talk about those different ones. So usually people say an annual budget of $40,000 per year or less is lean fire. And I think they did that because that number is really easy to calculate it’s a million dollars for your net worth if you want that 40,000 Because 4% of a million is 40,000. If you check out financial samurais article he believes that lean fire is one your investments can generate $20,000 per person in your household. So for example, if you have a family of three, the number would be $60,000 instead of $20,000. And also usually per definition, lean fire is less than the average annual spend for American So in 2018, that number was $61,224. So for that definition, if you spent under that every year then you would be doing Lean fire. So barista fire means you’ll have enough money to retire early. But you’ll still need a part time job for additional income and health insurance, you basically could work a part time barista job to cover your additional expenses to for example, instead of saving 1 million with Lean fire, you could save essentially $250,000 and pull $10,000 a year per the 4% rule, then you get a part time job that would cover the remaining $30,000 of your expenses as well as helps you with covering health insurance. Next, let’s talk about Coast fire Coast fires like a different way to think about it. Essentially, you’ll have enough money saved for retirement but you’re still gonna need income to cover expenses. So based off this Business Insider article, essentially if your goal was to retire at age 65 with $1 million and you have $200,000 saved up at age 30 You would have reached Coast fire because you’re basically assuming an annual growth of 5%. Your $200,000 at age 30 is going to grow to one point 1 million at age 65. That’s why it’s basically saying that if you don’t touch that amount, you’re going to be good for retirement, but you’re still going to need a job to cover your expenses. And then lastly, let’s talk about fat fire. As I mentioned, the average US household spends about $61,000 per year fat fire is different from lean fire, because it’s basically saying that you’d be spending more than that annual spend, most people consider a fat fire about $200,000 per year of annual spend. While there’s this medium, that’s called chubby fire, which is between 100,000 to $200,000. So if you’re fat fire, you are living extravagantly and just enjoying life and retiring with a huge nest egg. But let me talk about one problem with the 4% rule that 4% rule was based off of a 30 year horizon is basically saying that at 65, if you needed another 30 years, you’d be covered. But if you’re a fire investor, maybe you’re retiring at 3040, or even 50, you might be looking at retirement, that would be over 50 years, possibly, but at the same time, the 4% rule doesn’t account for passive income, you might have money collected from Social Security inheritance. But back to the previous point. According to this Vanguard article, they mentioned the 4% rule gives an investor with a 30 year retirement horizon about an 82% chance of success, but a fire investor with a 50 year retirement horizon with only a 36% chance of success. But to help with that they do mention certain things that can help with your success rate to up to 90%. You can do things like minimize cost by investing in funds with low expense ratios having a diversified portfolio of not just stocks in the US, but maybe international assets. But in my opinion, you could even diversify with real estate or even passive income side hustles. And lastly, you can have a dynamic spending strategy, which basically entails that if the market goes bad, you would spend less money and if the market goes well, you could spend more money. So again, if you do those things, you can help your success rate to 90%. And if we want to follow that 4x rule, let’s talk about some examples. So basically, if you want to retire by 40, you need to know how much you are saving and investing and how much you normally spend every year, if you spent $25,000 A year based on the 4% rule or 25x rule, you are looking at $625,000 You need saved and invested Have you spent $40,000, you’re looking at $1 million. And if you spent $75,000 a year, you’re looking at $1.875 million saved and invested. And then if you spent a whopping $100,000 A year you’re looking at $2.5 million, you need saving invested. Now let’s put age into these examples. Let’s say you’re 30 years old, you have $300,000 Saved invested and you spend about $25,000 per year. That means if you want to retire by 40, you’ll have about 10 years to save about $325,000 to hit that $625,000 that would follow the 4% rule. Or let’s say you are 25 years old and have about $100,000 and you spend about $40,000 a year, that means you’ll have 15 years to save $900,000 to hit that 1 million mark to essentially meet that 4% rule. I just want to add to that if you’re 39 I don’t want you to feel upset by this video. Or if you are over 40 Don’t be upset by this video, right everyone is on their own journeys. And on their own timeline. I just wanted to make this episode for people who did want to try to retire by 40 and how to look at it. But essentially a lot of these things apply at different ages, right? If you started watching this video at 18 years old, or you started watching it at 50 years old, essentially, you can still apply that 4% rule or 25x rule to kind of decide what your retirement number might be. And again, if you want to be conservative, make it a 3% rule, for example, and just use this as kind of a benchmark or guideline but not a hard rule. So if you want to be more risk averse, save more than the 25x rule make it a 30x rule or you can think about retirement in a different way. Another way to think about it is figuring out your savings rate. And this is based off of Mister Money Mustache his findings. So these two graphics are from Mister Money Mustache. And with this chart, you are assuming a net worth of zero. And this is also assuming you can earn 5% investment returns after inflation and you’re saving yours and then you’ll live off of that 4% rule after retirement. So obviously, if you look at this chart, if you spend 0% of your income, you can retire now, right? If you spend 100% of your income, you are never going to retire you could be making a million dollars. But if you spent a million dollars a year, you’re never going to retire. For example, if you are actively making a million dollars a year and then spending a million dollars a year you are never going to retire. Now looking at this chart. If your savings rate is 70% your working years for retirement is 8.5 years. So that’s actually really crazy to think about. Obviously, the more you save and reduce your annual expenses, the faster you can retire. So as you can see, it’s a lot of work to achieve financial freedom and an early age. Usually people in this movement are saving up to 70% of their income which is a lot. So let’s talk about how you’re going to achieve these goals right after you figured out your retirement number. That number can look really daunting but things I recommend to do too. To help you achieve this is actually to reduce your living expenses. First of all, one way to do that is to house hack I talk about this a lot. If you guys haven’t seen my previous video on it, make sure to check out how to house hack. Essentially, with House hacking, you’re purchasing a property possibly with an FHA loan that requires a small downpayment of 3.5%. And then you’re renting out rooms or renting out units. For example, if you buy a four Plex, you can rent out the other three units and live in one unit. And that rental income could make up for your mortgage and maybe other expenses. And that makes your living expenses a lot lower majority of people are spending most of their money to rent or to their mortgage. So why not reduce those living expenses, as you buy one house hack, you can move into another house hack and then route the entire property and just keep growing your rental portfolio that way. And then that kind of goes into my next point that instead of just investing in ETFs, stocks index funds, you could potentially look into real estate real estate actually dramatically increase my net worth. For example, I purchased a property at $240,000. And now it’s worth $650,000. Because I held it for so long. It’s increased a lot in value, and it’s been cash flowing for me. And that’s what’s so great about it real estate includes so many benefits, including cashflow, appreciation, leverage tax benefits, and more. So if you do it right, it can be amazing, you should definitely check out my video on the benefits of investing in real estate. Another tip I have is I would highly recommend increasing your passive income through side hustles. Imagine having passive income that covers your living expenses and more that way you can achieve a 0% savings rate and potentially retire now, I would say that a lot of the passive income online side hustles that I talk about do require some maintenance, but it doesn’t take as much time to maintain it does take a lot of effort and time to build up though. So for example, you can start an Etsy shop and sell digital products, you can start a merch by Amazon account and sell custom merch. And both of these methods require zero to low capital, you could even start a YouTube channel or blog because those methods actually do make me passive income as well through ad revenue through affiliate marketing, selling my own products and more. So think about ways you can make passive income online. So not just real estate, having cash flowing rental properties, but also kind of starting these different little businesses. If you are interested in making passive income and you don’t know where to start or you have zero to low capital, check out my video on five ways to make passive income with zero to low capital. The last tip I have is diversifying, I already talked about it earlier. But essentially I diversify a lot. I really believe in it. I am quite risk averse. So I don’t solely depend on the 4% rule and multiple income streams working for me to make things a lot safer because I invest in other asset types. While the market hasn’t been doing as well lately, my net worth hasn’t been fluctuating like crazy, like maybe other investors, right? Because I have a diversified portfolio. For me with this retirement thing. Just make sure you’re thinking about the worst case scenario and accounting for it, things can happen and you want to make sure that you are going to be okay and financially stable, no matter what happens. Actually, I do have one more tip for you that when you are trying to retire earlier is you might want to look into building high income skills as well as looking into commission based roles. For example, you can make a lot as a real estate agent, but it requires a lot of time and effort you can start making a lot more money every month. Whereas if you’re taking a nine to five and there are no commissions, you are essentially putting a ceiling on how much you can earn you can make money through other side hustles. But with your day job, it’s basically cat so it could make sense to maybe become a real estate agent or someone in sales being a loan officer. These are just some rules that you might consider or you might just go with going into high income skills like coding and maybe getting a high six figure role. So ultimately, with all these tips, it’s all about increasing your income reducing your expenses investing as much as you can possibly starting passive income side hustles
so I hope you guys enjoyed this episode, please make sure to rate review and subscribe. It really helps our podcast grow. And thanks again. I’ll see you guys in the next one.Transcribed by https://otter.ai