How to Invest to Retire Early

Who says you have to wait until you are 65 years old to retire? Younger generations entering today's workforce are challenging the traditional notion of retirement. The good news is that it's never too soon to plan for your retirement. Even if your retirement is decades away, you can learn how to invest to retire early.

Before Investing Define Your Goals

Your lifestyle and financial goals influence your retirement strategy. You may aim to retire by age 50. Perhaps you plan to travel the world or buy a house on the beach. Defining your financial goals is the first step to building an investment strategy regardless of your retirement plans.  

Understanding Your Financial Independence, Retire Early (FIRE) Number

If you want to retire early, the Financial Independence Retire Early (FIRE) movement may be for you. Under the FIRE method, your retirement strategy prioritizes saving and investing at least half of your earnings. The goal of your investment portfolio is 60% stock and 40% bonds. Since the FIRE movement emphasizes extreme saving, be prepared to drastically cut back your living expenses or pick up a side hustle.

FIRE retirees often follow two benchmarks when setting their retirement strategy: the 25x rule and the 4% rule.

Under the 25x rule, you must save at least 25 times your annual expenses to retire. If you expect your monthly living expenses to run you $5,000 per month, you multiply this by 12 for your yearly expenses. Then multiply your annual cost estimate by 25 to reveal your FIRE number, which is the amount you need to retire. Under this example, the FIRE number is $60,000 x 25, or $1,500,000.

While the 25x rule focuses on retirement savings, the 4% rule guides you on how much retirement funds to withdraw. Under this strategy, you plan to spend 4% of your savings in your first year of retirement. You still withdraw the same amount each year, but it's adjusted for inflation.

Using the example above, you would withdraw $1,500,000 x 4%, or $60,000, for your retirement budget in your first year. For each year afterward, you withdraw the same amount adjusted for inflation. 

6 Best Investments to Retire Early

If your retirement strategy is based solely on your employer-sponsored 401(k) or IRA account, you may be limiting yourself. Supplement your retirement savings with the following investments.  

High Yield Savings Accounts

You usually earn a higher savings rate with a high-yield savings account than putting funds into a traditional bank account. Unlike some savings accounts that pay interest only on what you have deposited, you earn interest on the entire balance with a high-yield savings account. Your earnings generate their own return.

A high-yield savings account gives you easy access to your funds, making it a good fit for an emergency fund. High-yield savings accounts have no contribution limits, and you don’t need to worry about early withdrawal penalties if you need access to your money. 

Standard Brokerage Account

A brokerage account lets you diversify your investments. You can choose short-term or long-term investments or a combination of both. Depending on your retirement goals, investing in diverse types of securities, such as stocks, bonds, mutual funds and exchange-traded funds (ETFs), can help mitigate investment risk and generate a steady cash flow.

You may invest in dividend stocks to help provide a monthly stream of income. Or choose an ETF that invests in a pool of securities from different companies and industries. While ETFs may provide a lower return than if you were to invest in individual stocks, there is less investment risk, and your returns can be more consistent. 

You may also add bonds to your investment portfolio. You may not realize high returns with bonds, but you’ll get a safe investment that produces a steady cash flow.

Incorporating a brokerage account into your retirement strategy is helpful when you have maxed out contributions to your 401(k) or IRA accounts but still want to save for retirement. Like a high-yield savings account, there are no contribution limits, nor are you penalized when taking money out. However, you do pay tax on any interest or dividends earned. You also pay capital gains tax if you realize a gain in the year you sell investments. 

Roth IRA

A Roth IRA is a tax-advantaged retirement account where you make after-tax contributions. The funds you invest go into various securities you've chosen. You pay no tax on interest or dividends earned in your Roth IRA as you would in a traditional brokerage account. Unlike a traditional 401(k) or IRA, you pay no tax when you withdraw funds in retirement.

If you expect to be in a higher tax bracket when you retire than the one you are in now, a Roth IRA may be a good option for you. While you don’t get the tax break when contributing to a Roth IRA, you could pay less overall tax when you take out funds upon retirement. 

Municipal Bonds

When you buy a municipal bond, you loan money to a state or local government. Often referred to as munis, the funds raised are typically used to pay for operating expenses or to finance a large public project. Since investors receive interest or coupon payments during the bond's term, munis are popular for their constant cash flow. You get the principal returned to you at the end of the term.

Municipal bonds are attractive to some investors because they have minimal risk and are exempt from federal income tax. However, you may be subject to state or local tax on the interest earned. While munis offer lower risk, their returns are often lower than other investments. 

Real Estate

If you have the financial means and ability to manage property, investing in rental real estate can effectively generate passive income. Not only are you investing in property that typically grows in value over time, but the money you earn from renters can help cover the property's expenses and supplement your monthly income.

Keep in mind that rental property requires maintenance and upkeep. You may end up paying a property management company if you can’t maintain the property on your own.

Alternatively, you can invest in real estate through publicly or privately traded investment vehicles.

Index Funds

Index funds carry a wide range of securities from different industries. While most funds aim to exceed market returns, an index fund matches the overall performance of a specific market index, such as the S&P 500. You likely won’t beat market expectations with an index fund, but you will pay less in fees. While index funds can ebb and flow with the market, they can generate a reliable return over time, making them a worthwhile investment to help you retire early. 

Start Investing for Retirement with the Best Brokerage Accounts

Below are some of the best brokerage accounts to consider when building your retirement strategy. 

Stick to Your Investment Goals and Retire Early

Does retiring early top your list of financial goals? The good news is you might be able to retire early if you stick to a sound investment strategy. The relaxation and freedom of retiring early will be well worth your sacrifice to get there.

Frequently Asked Questions