Many people are at a point in their lives where they have a steady income, but they’re not necessarily swimming in cash. They may have some money saved up, but they’re not sure what to do with it besides let it sit in a bank account earning almost no interest. They may even have a 401(k), but they’re not sure exactly what it is or how it works.
If this sounds familiar, you’re not alone. The world of investing is downright intimidating. Who wants to worry about losing all of their money in the stock market? Who wants to worry about retirement when that won’t happen for decades? It can wait for later, right?
Wrong! As they say: the best time to plant a tree is 10 years ago, but the second best time is now. Just like a tree, investments grow over time, so the sooner you start, the sooner you’ll begin accumulating wealth. That’s wealth you can use to send your kids to college, buy a home, and eventually retire! And heck, if you do it well enough, you may even be able to retire early.
Luckily, the basics actually aren’t that bad! There are plenty of resources out there to help you. For the most part, it just takes a little effort to get started, and after that, you can largely just set it and forget it. You’ll come back in a couple decades and be astounded at the numbers in your account! So if that sounds good to you, let’s get started. Here’s a table of contents too if you’d like to see where this article is going.
Note: This guide is aimed at people who live in the US.
Retirement
First off, let’s zoom to the end goal. Eventually, you’re gonna want to retire, right? So where does the money come from?
For one, you’ll probably get social security payments. If you take the median individual income of about $46,000 and plug it into a quick social security benefit calculator, you’ll see about $22,000 in yearly benefits (assuming you are born in the year 2000 and retire at age 67). That’s in 2023 dollars, for reference, so while the precise numbers on your checks will be higher, it will all be canceled out by inflation. It will feel like you’re living on $22k. And that doesn’t sound like a lot!
So you’ll definitely want to save up some extra money. What seems like a decent standard of living? $50k perhaps? Note that your money may go farther if your house is paid off, you don’t have kids to take care of, and you no longer have a job that requires you to commute and/or live in an expensive city. But on the other hand, your healthcare expenses may be higher, and you may want to have some extra money for things like travel. $50k seems like a good starting point though. So that means we want to have an extra $28k per year.
If we suppose that you’ll live for 20 years after retiring, i.e. from 67 to 87, then the simplest math says you would simply need $28k x 20 = $560,000 saved up. It’s actually a bit more complicated than that, but let’s try to keep it simple. And to keep things extra conservative, let’s just round up to $600,000.
Ok, $600,000 is a whole lot of money! That would require saving $15,000 every year for 40 years, right? Who can afford that?
Luckily, here comes compound interest to the rescue! Compound interest is the concept of how invested money can grow exponentially over time.
Rabbits
Think about how quickly rabbits can reproduce. A couple of rabbits might produce 6 babies every month. So after 10 years, you might say that you have 6 x 12 x 10 = 720 rabbits. Sounds like a lot, but we forgot that the babies can make babies too! After a few months, they’ll be reproducing on their own. Those first 6 baby rabbits can each make hundreds of their own rabbits. And their babies will make more rabbits too, and so on and so on. After 10 years, you could have millions of rabbits. Yes, millions!
With compound interest, investments do the same thing. Every time you earn interest, that interest starts earning interest too. It’s truly a wonderful cycle! To help visualize this growth, here’s a graph showing the growth of a $1,000 investment over time, depending on whether it’s in a bank account or invested in the stock market.
As you can see, that money barely grows at all if left in a bank account, even if it’s a relatively high-interest account (many common bank accounts give more like 0.01% instead of 2%).
In contrast, the money invested in the stock market not only grows like mad, but the speed at which it grows gets faster over time! In fact, the investment is roughly doubling every 10 years. This is the magic of compound interest!
From this, you can see that if you invest just $1000 at age 18, you could have $53,900 by age 68. And this scales up to bigger numbers too! You can try out these calculations for yourself using a compound interest calculator[2]. It’s easy!
[2] This is also all in 2023 dollars. The US stock market historically returns about 10% per year, so I’m using the 8% assumption here to roughly cancel out an estimated inflation rate of 2%. If you like, you can increase the interest rate from 8% to 10% and the inflation rate from 0% to 2%, and this will show about the same number under the “Inflation Adjusted Balance”. Either way works!
All right, so that calculator shows how much we end up with based on how much we contribute. But we want the opposite here: we know we need $600k, but how much should we contribute every month to achieve that? Luckily, there’s another calculator just for that purpose! Here are a few examples to check out:
- If you invest $82 per month from age 18, you could have $600k by age 67.
- If you invest $171 per month from age 27, you could have $600k by age 67.
- If you invest $24,720 one time at age 27 and do nothing else, you could have $600k by age 67.
Are those numbers starting to seem a little more achievable? Now factor in that many people are also eligible for a 401(k) or 403(b) through their job. This is a retirement account that you can use to save money, and when you do, the company will often also match some of your contributions dollar-for-dollar! So for example, if you contribute $100, they will contribute $100 too. This can potentially cut the amount of saving you need to do in half. And you might even get a tax credit or deduction on top of that!
Add all this together, and you might only need to save an average of $40 per month for retirement, if you start early enough. We’ll talk more about the details of 401(k)s, matching, and tax benefits later, but suffice it to say, saving for retirement is actually pretty attainable for most middle-class Americans. It just requires a little knowledge, effort, and time!
How to get that compound interest
You invest in stocks! A stock is essentially a small piece of a company, and by owning one, you can get a share of the profits! These are high-risk, but can also offer high rewards.
But which companies should you buy stock in? Generally, it’s almost impossible to tell which ones are great investments, and which ones are going to be worthless. But as a whole, the US stock market does actually trend upward over the long term. So all you have to do is simply invest in all of the stocks, and you’ll usually end up with an average return of about 8% per year (after inflation).
But how do you invest in all of the stocks? Well, you can simply purchase a low-cost index fund which automatically buys stock in most of the companies in the US. Good options here are a “total stock market” fund or an “S&P 500” fund (which tracks the 500 largest companies.
It’s also usually a good idea to invest in bonds as well. When you buy a bond, you’re essentially loaning a company or government a small amount of money, and in exchange, they’ll pay you back later with interest. It’s good to have some of these as well, because even though they usually have a smaller return, they are also considered lower-risk. That way, you don’t lose everything in case of a market downturn.
For beginner investors, I usually recommend purchasing a “target retirement date” fund that’s labeled with the year you plan to retire in, e.g. a “2060” fund. These include both stocks and bonds, and automatically adjust the ratio between them over time for you. Easy!
The most important rule
Do NOT sell off your investments if the market crashes! Don’t even look at your portfolio. Just keep buying investments every month. Why? Because some of the best investors are the ones who either forgot about their account… or are dead.
When the stock market tanks, people get worried and sell off their investments since they’re afraid of losing all of their money. But they never know when the bottom of the market is, so they just keep waiting… until eventually, the market is recovered and they finally have the courage to invest again. But by then, it’s too late—they sold low and bought high. Their own actions caused them to lock in their losses. Whereas if they had just held on to their investments, they probably would have been just fine! You don’t lose money until you sell.
Want proof? Even if you had bought the S&P 500 right at the market peak in 2007, you would still have doubled your money in 10 years just by continuing to hold it instead of selling. And that’s not even counting how much money you could have made by continuing to invest the whole time (since you would have been buying at the bottom, even without knowing it at the time).
But what if the stock market doesn’t recover?
It’s true that historical gains don’t guarantee future gains… buuut it’s generally a safe assumption, short of an apocalypse. And if that happens, you might be better off investing in canned beans.
Joking aside, there are things you can do to reduce your risk. For example, you could diversify your portfolio by investing in real estate or bonds, or even more specifically, US bonds (which are considered one of the safest investments in the world). You could even just keep all of your money in a high-yield savings account (2-3% or higher) or CDs. But just remember, if your average growth rate isn’t higher than inflation (often about 2-3%), then your investments aren’t really growing over time, and it will take a LOT longer to retire. If you want the rewards, you have to take on some risk!
Generally, it’s recommended to take on more risk when you’re young. The reason is twofold:
- When you’re young, retirement is 30-40 years away. At that time scale, the chances of the stock market going down and staying down for so long is practically zero, judging by the historical US stock returns over the past 100 or so years. Again, it’s not a guarantee, but it’s a pretty safe bet.
- Even if you lose all of your money, you have time to make up for it with future earnings.
The corollary is that you should take on less and less risk as you get older. Not only do you have less time to make up for any losses, but so does the stock market. Wouldn’t it suck if all of your money was in stocks, and they all went down by 90% the day before you retired? You might never be able to retire, then!
So to manage that risk, we transition over time from mostly high-risk high-reward stocks to mostly low-risk low-reward bonds. In fact, that’s exactly what target retirement date funds do, which is why I recommended them earlier!
Early Retirement
Ok, now that we’ve talked about risk, let’s forget about it and just assume average stock market returns of about 8% after inflation. Time to talk about saving again!
If you’re barely scraping by, even that $40 a month we mentioned earlier might not seem feasible. But for many, $40 sounds quite easy! In fact, you may start to wonder what you could do if you really put your mind to it… Here are a few more examples for you:
- If you invest $403 per month from age 20, you could have $600k by age 50.
- If you invest $630 per month from age 20, you could have $600k by age 45.
- If you invest $1019 per month from age 20, you could have $600k by age 40.
That’s right, if you make even a fairly modest middle-class salary and are simply good at saving, it’s possible to build up some serious wealth. You might even see these numbers and wonder if you could retire in your 40s… or even your 30s! After all, just because most people retire in their 50s or 60s, doesn’t mean that you have to. If you’re lucky enough to have a well-paying job and relatively low expenses, early retirement is a real possibility. The thing is that most people simply don’t realize just how possible it really is.
If you are interested in personal finance at all, you may have already read the famous Mr. Money Mustache article The Shockingly Simple Math Behind Early Retirement. One of the biggest takeaways is the relationship between how much you save to how soon you can retire. If you don’t care to read that article, I’ll summarize it here:
- If you save 10% of your income, you can retire in about 51 years.
- If you save 25% of your income, you can retire in about 32 years.
- If you save 50% of your income, you can retire in about 17 years.
Note that this is all ignoring social security benefits.
You may notice that there are no hard numbers here, just percentages. That’s because early retirement changes things a bit—$600,000 actually won’t cut it for early retirement, since that was our “late retirement” number (we planned to supplement it with social security). So you actually need more money to retire early! But how much? Again, it’s all proportional to your savings rate.
For most people, post-retirement spending habits are likely to be similar to pre-retirement ones. That means that the less you spend during pre-retirement, the less money you need to save in order to hit your retirement goal. And there’s a double benefit here, because every dollar you don’t spend builds up your savings instead! So for every portion of your income that you reallocate from spending to saving, you’re shortening your retirement time horizon twice.
Here’s another way to think about it. Let’s ignore all investments and inflation for a moment. If you saved half of your income for 30 years, then that means you have saved up an extra 30 years of living expenses. So that means you can then retire for 30 years. Simple, right? Now add back in all of the growth from investments. That shifts the balance. Now you only need to work for 17 years, and you still get to retire.
That is how retiring in just 17 years is possible. If you are saving 50% of your income, then you are not only saving a lot, but you are also very good at not spending a lot, a habit which should allow your savings to carry you for decades.
Save half your income, retire in 17 years
For example, suppose that you make $80,000 per year. You’re able to get your expenses down such that you’re saving 50% of your money, or $40,000 per year. If we plug that into the same compound interest calculator we used earlier, and assume a conservative 5% annual stock market growth (after inflation), then you can see that you accumulate over 1 million dollars in just 17 years. (And if you use the less conservative 8% growth number I mentioned earlier, it would only take you 14 years.)
Now zoom to the future. Suppose you finally get that million dollars. That sounds like a lot, but how do you know that that’s enough to retire on? Especially if you’re retiring early! After all, you might retire at 35 and live to the ripe age of 95. It seems like you might start stretching that million pretty thin after 60 years, right? Sure, you’ll start getting social security at some point, but that could be decades away. Wouldn’t it be great if there was a way to plan things so that you never run out of money?
Turns out, it’s possible.
Living off the interest: The 4% Rule
In the personal finance world, there’s a commonly referenced idea called the 4% rule, which states that, given average investment returns, you can withdraw 4% of your money every year… forever. And chances are very good that you will never run out of money. That means if you have $1,000,000, then you can withdraw $40,000 per year (since 4% of $1m is $40k).
Yes, you heard (read?) me right: if you have a million dollars, you can withdraw $40,000 every year, and you will still have $1,000,000 (or more!) left in your account. If you have even just average investments, then the growth will almost always cancel out the withdrawals, and so you never run out of money.
If you’ve ever heard the phrase “living off the interest”, this is what that is.
So there we go! You were living off of $40k per year before retirement (i.e. half of your $80k income), and now you can continue living off of $40k per year after retirement as well. Your standard of life hasn’t changed, and you never have to work again!
The 4% Rule states that if you have a million dollars, you can withdraw $40,000 every year, forever, and chances are that you will never run out of money.
Skeptical? Check out this calculator! It performs an investment simulation of every 30-year retirement period from 1928 to 2022, and you can see that with a 4% withdrawal rate, you won’t run out of money in 99% of cases. Obviously, the future is impossible to predict, but checking against the past 100 years of history can give us a pretty good idea of what might happen.
But wait, I only entered 30 years, but I said you might retire at 35 and live to 95! Well once you get to around 65, you can just start taking social security payments, and between that and whatever savings you still have, you have nearly a 100% chance of, again, never running out of money!
So yeah, that sounds great… except that we totally glossed over how it was possible to save 50% of your income. I understand that you may be skeptical, so I’ll prove to you that it’s possible on a middle-class salary. How? Because I know people who are doing it.
How can you save half of your income?
Take Alice for example. Alice is in her late 20s. She has a middle-class job in a high-cost-of-living city, making $60,000 per year. She lives in a house with 3 other roommates, bringing the cost of housing down significantly. She commutes to her job via public transit since it’s much cheaper than owning a car. She cooks most of her own food at home. She gets her books from the public library. She doesn’t even really try to save money, it just happens. And yet, she feels like she has an excellent quality of life.
Here is Alice’s monthly budget:
- Income: $5000
- Taxes: $1000
- Rent: $750 ($3000 house split 4 ways)
- Groceries: $300
- Transportation: $150 (for transit passes and occasional taxi rides)
- Utilities: $125
- Health/dental insurance: $50 (mostly covered by work)
- Phone plan: $25
- Left over: $2600
And there you go. Less than half of her income is dedicated to necessary monthly expenses. She spends another few hundred per month on restaurants, clothing, incidentals, travel, streaming services, etc., which leaves a little bit less than 50% for savings. But then consider that contributing to certain retirement accounts (like 401(k)s and IRAs) can actually reduce your taxes and even give you a tax credit—all to the tune of thousands of dollars per year. So between the reduced taxes, as well as some 401(k) matches (a couple thousand dollars per year), she is indeed actually saving about half of her income (i.e. $30,000 per year).
Remember that Alice is a real person that I know; I just anonymized the name. So yes, saving 50% of your income on a middle-class salary is possible. Though granted, Alice has an easier time of it for many reasons:
- She has no significant health issues or disabilities
- She makes more than the U.S. median income ($60k vs $46k)
- She does not have significant debt
- She does not have or want kids
- She is happy to live with roommates
- She is happy to live without a car
- She is naturally frugal
Many of these things are not voluntary choices, so I will admit that retiring in less than 20 years is not feasible for many people. But for the stuff you can change, such as consumption choices, it’s worth considering the tradeoffs. Yes, there is some sacrifice involved in going car-free and living with roommates. In fact, many people assume that it’s impossible to go car-free, and that’s because it pretty much is… where they currently live. But Alice specifically moved to a place that’s close to transit options. As it turns out, if you put long-term thought and effort into your consumption decisions, you can actually make a pretty big dent in your expenses. That’s what Alice is doing, and now Alice will be able to retire in her late 30s. Again, all on a middle-class salary!
But maybe you’re still not really sold on the idea of early retirement. After all, the idea of retiring at such an early age is pretty weird anyway. Who retires in their 30s or 40s? What does such a retiree even do? And for the people who get so focused on early retirement that they spend decades working overtime and pinching every penny… is it even worth it in the end? Wouldn’t it be better to just try and enjoy your whole life, rather than save all the fun for retirement?
It’s questions like these that make me reluctant to recommend the idea of early retirement. “Retirement” has a lot of connotations that don’t really mesh with what I believe. That’s why I prefer not just a different term, but a different mindset: Financial Independence.
Financial Independence
Financial Independence (or FI) is just a fancy term for “no longer needing to work in order to support yourself”. In other words, you have enough savings/investments to live off of for the rest of your life. This means you can “retire” if you want, regardless of your age.
But retirement is not truly the end goal here. The end goal is freedom, security, and happiness. And yes, it turns out that money actually can buy happiness—at least to a large extent.
What do I mean by this? Well, you may have heard this depressing statistic:
57% of Americans can’t afford a sudden $500 expense.
So then what happens if your car breaks down and you can’t commute to work any more? Or if your landlord raises your rent with no notice, and you can’t afford the increase? Now you’re faced with potentially losing your job or your home. Do you really think you’d be happy being kicked out onto the street? Of course not. And that’s the mechanism by which money buys happiness: it buys you the ability to avoid unhappiness. The ability to avoid stress. The ability to be secure in your life and not worry so much!
Money buys you the ability to avoid unhappiness.
Living paycheck-to-paycheck is stressful. Being in debt is stressful. Constantly worrying about being evicted or having your water shut off is stressful. Simply having money solves all of these problems. It’s no secret that a little bit of savings will help you out in a jam.
So we know that we need a LOT of money for retirement, and that we need a decent amount of money tucked away for a rainy day. But what about everything in between?
Well, there’s the other aspect: money buys you freedom.
Freedom
When you have to work for a living, you are not free. Unless you want to starve on the street, you have to do what your employer tells you to do.
However, once you’re no longer living paycheck-to-paycheck, that means you don’t need a paycheck. At least for a little while. This gives you back a surprising amount of freedom:
- Evil boss? Just quit!
- Long commute? Find somewhere closer!
- Burned out or injured? Recover for as long as you need!
And guess what? Your freedom scales with the amount of money you have saved. For example, here are some options that open up for you based on how wealthy you are:
- $5,000: Keep your bills on autopay so you don’t have to worry about missing payments and ruining your credit score
- $20,000: Quit your job at a moment’s notice and find a new one without time pressure (also called “F you” money, named for what you might say to your boss when you quit)
- $40,000: Take the summer off and travel around Asia
- $80,000: Go back to school and get a degree in mixology
- $200,000: Start a business or nonprofit
- $500,000: Buy a lake house or something, I don’t know
- $1,000,000: Financial independence!
Not only are you building your nest egg for retirement—you’re building your own freedom.
As you can see, financial independence is not simply an on/off switch, but a spectrum. So even if you don’t think you can retire early, your journey to financial independence will be a worthwhile one. Not only are you building your nest egg for retirement, but you’re building up your own freedom. And if you are able to accumulate enough money to reach full financial independence, well congratulations, because that’s when you have the most freedom of all! You can:
- Focus on your hobbies
- Volunteer
- Work part time and donate your extra money
- Be a stay-at-home parent/grandparent
- Travel the world
Basically, you can just do what you love, even if it’s not profitable! The whole idea of financial independence is simply to manage your resources well in order to increase your freedom and happiness. That’s why I dismissed the idea of a “sad, penny-pinching early retiree” earlier. FI is not about sacrifice and depriving yourself. It’s about re-evaluating your priorities in life and living a little more thoughtfully in order to maximize true happiness. The end goal is not to acquire money, but rather to live a life well-lived.
FI Mindset
As part of re-evaluating your priorities, you should question your consumption decisions using both a long-term mindset and whatever data is available to you. For example, suppose you are considering spending $20,000 on a new car.
These are the wrong questions to ask yourself:
- “Will I enjoy it?”
- “Do I deserve it?”
- “Can I afford the monthly payment?”
Rather, compare against the alternatives. These are the right questions:
- “Do I really need this?”
- “Is this purchase worth it in the long run?”
- “What am I giving up in order to buy this?”
- “How many extra years will I have to work in order to afford this?”
Could that $20,000 be better utilized as a financial safety net? Maybe a dream vacation? Perhaps your child’s college fund? Or maybe it could allow you to retire a full 7 years earlier? Remember: do the math! Fire up that compound interest calculator and crunch the numbers. If you invest the money at 8% for 20 years instead of buying a car, your $20,000 could turn into $250,000—a 12x return on investment. You could buy a whole house with that! Is a new car really worth $250,000 to you?
However, there is wiggle room here. If you did the calculations and you still think it’s worth it, then it’s ok to splurge every once in a while. Just make sure you know the tradeoffs you’re making!
You can apply this mindset to purchases big and small. And likewise, you can use this mindset to determine what other factors in your life are worth tweaking. For example, starting a new job might be stressful, but maybe it’s worth it if it accelerates your FI journey.
Just be careful that you don’t swing too far in the “penny-pinching” direction—you must attempt to balance the needs and wants of “current you” with those of “future you”. You should not sacrifice your younger years for the sake of your older ones. After all, life is short, and you don’t know how long you have. Rather, just be thoughtful. Consider what decisions and purchases have the best “return on investment”, but try to spread the returns out over your life. Focus on the things that truly make you happy, rather than on what gives you a “shopping high”. Try to be content with what you have. And keep an eye toward the future.
How to actually save and invest
Ok, enough with the preachy platitudes! Here are the real actionable steps. At the highest level, here is what you need to do:
- Spend less than you make
- Invest the difference (wisely!)
Obviously, it’s easier to do #1 if you make a lot of money. If you’re really stuck in a low-wage job, it’s worth researching options for moving into a higher-paying field. You might be able to go back to school while working, or even pivot to a better-paying job that doesn’t require a college degree. They’re out there, just a web search away!
The other way to do #1 is obviously to spend less money. If you’re barely scraping by, chances are that you don’t have a lot of options for trimming your budget. But for many, there are dozens of ways to reduce spending, many of which actually don’t involve much sacrifice. Again, sometimes it just requires being thoughtful and re-evaluating your priorities!
If you’re looking for some specific money-saving tips, check out our whole article on the topic:
As for #2, figuring out where to invest your money also requires its own article. If wish someone could just tell you where you should put your money, then look no further than here:
The above two articles are a great place to get started, so now you have no excuse to put off retirement planning. Remember, the earlier you start, the more time your investments have to grow! So seriously, it’s time to get started today! And if you have specific questions for me, toss a comment on this article and I’ll give you some customized advice. 🙂 Good luck!
The Readyist 
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