Early Retirement Requires You To Build Assets Faster
Traditional retirement planning emphasizes traditional financial concepts like saving and passive investment strategies – otherwise known as the slow and secure path to wealth.
It’s the same old stuff you’ve heard repeated ad nauseam: max out your 401(k), and invest the savings in a properly diversified portfolio using buy-and-hold.
This works okay when applied judiciously over a 40 year career to finance a 30+ year retirement, but early retirees have shorter careers and longer retirements. That means they have less time to save and need more money to spend once retired. The traditional approach will only work if you pursue extreme frugality to reduce the savings and retirement income required.
The problem is passive investment portfolios only grow so fast – not nearly fast enough for those seeking early retirement at regular spending levels. Depending on the data and time period analyzed, long-term returns vary from low to middle single digits net of inflation – hardly a rate to grow wealth fast enough for most early retirements.
Additionally, contained within this long-term data are 15 year periods where real returns are actually negative for a diversified, passive portfolio. That’s a mathematical disaster for someone seeking early retirement. (See the buy and hold myth section of this web site for more information on passive investment limitations or here for investment alternatives.)
In other words, if you want to save and passively invest your way to an early retirement at current spending levels, then think again, because there won’t be enough time to compound the growth of the assets in a meaningful way. It’s just math.
Losing compound growth as a wealth building tool due to the shorter time-frame of early retirement requires you to add a non-conventional dimension to your plans. You must apply one or more of the following three principles:
- Extreme Frugality: This is defined as being an extraordinary saver with low expenses relative to income. Some people have been known to save more than 70% of their earned income to retire in 7-10 years. It’s possible, but it’s not everyone’s first preference, so let’s look at two other alternatives.
- Active Investing: This is defined as adding a skill component to your investment strategies, which creates an additional return stream above and beyond passive returns. The higher investment return amplifies and accelerates the compound return. You can learn more about active investing here.
- Leverage: This is defined as expanding your resource base beyond your own limitations. Leverage allows you to replace less time with more resources, thus multiplying what you can achieve in the same amount of time.
“Give me a lever long enough and a place to stand and I will move the entire earth.”– Archimedes
For example, I retired early at age 35 the hard way. I saved the bulk of my earnings (frugality), which I then leveraged with specialized knowledge in investing (see Step 5 – Expectancy Investing), to increase the returns beyond passive buy and hold returns.
This is a rare and difficult path to early retirement that few succeed with. It requires both personal finance and investment skills – something few people with regular careers choose to develop.
A more common path to early retirement is real estate, because it offers financial leverage, business leverage, and tax advantages. The learning curve is also very reasonable. There are many specialized strategies in real estate that shorten the time to build wealth by offering returns greatly in excess of passive investing.
The common formula for these strategies is to find unusual value and/or add value using skill, while magnifying the returns using the financial leverage inherent in mortgage financing.
“When a man tells you that he got rich through hard work, ask him: “Whose?””– Don Marquis
Another common path to early retirement is leveraging other people’s time through business ownership.
Again, business ownership offers several forms of leverage and tax advantages not available to the passive investor. You can either follow your passion by building your own business, or you can become an owner of the company you work for through option and stock bonuses.
In summary, there are three paths to wealth – paper assets, real estate, and business – but only two of these paths offer leverage (real estate and business) suitable to early retirement without extreme frugality.
The conventional retirement planning approach uses the only non-leveraged asset category – paper assets. That’s why it is the slow path. It is also why it is the most popular path – the financial institutions can profit by selling it to you.
If your objective is to build wealth for a secure and prosperous early retirement, then the message is clear: the mathematics of saving and passive investing through paper assets is too slow.
The traditional path requires more time than someone seeking early retirement can afford (unless extreme frugality is your thing). That means you need an accelerated path to financial security using active and leveraged asset accumulation strategies to reach your early retirement goals faster.
And if you are really in a rush, then try combining all three tools – extreme frugality, active investing, and leverage – to really put your early retirement plans into hyper-drive.
