Want to retire early? Well so does everyone else, but most won’t. But here’s a secret: you don’t need to make a ton of money to retire years before you expected. All you need is time.
That’s not a resource that everyone has a bunch of, but if you do, don’t let it go to waste. Time is simply the best asset in life, which is true for your financial life too.
Time is critical because it lets you take advantage of compound interest. Albert Einstein once called compound interest the most powerful force in the universe. Let’s look at an example.
It’s all about time
Say you save $250 a month for 10 years. In total, you’ll have saved $30,000 in capital, but that money would have grown over that 10-year period. If it had earned an 8% rate of return, that $250 per month contribution would have become roughly $45,000. That’s a $15,000 profit over a decade. Not bad.
But what if you doubled the period to 20 years? In that case, you will invest a total of $60,000 in capital. Will your previous $15,000 also double? Not quite.
If you save $250 per month for 20 years at an 8% interest rate, your money will grow to nearly $150,000! Over 10 years, you turn a $15,000 profit. But over 20 years, you generate a $90,000 profit. That’s the power of compound interest, a force you can only harness with time.
If you want to retire early, all you need is a consistent savings rate and time. It doesn’t matter if you’re 20, 40, or 60 years old — you’re not getting any younger.
Forget whatever your savings habits were in the past. If you want to take advantage of compound interest and the power of time, it all starts right now.
How to figure it out
The most important things to figure out today are your “number” and your “duration.” These are simple concepts, but every investor should know these figures by heart. You’d be amazed how many savers are hoping for an early retirement, yet don’t understand these concepts.
Your “number” is simply how much you need to retire comfortably. There’s an easy calculation for this. First, decide how much you want to accrue each year in passive income during retirement, then multiple that number by 20. If you want $50,000 per year in income, for example, you’ll need $1 million to retire.
Your “duration” is how many years you have left before retirement. If you’re 40 years old and want to retire at age 60, your duration is 20 years. From here, the math is simple.
If you have $0 saved but you want to reach $1 million in savings in 20 years, you’ll need to invest roughly $1,700 per month. That’s a tough task, but you’re starting at zero and only have two decades to play with.
Instead, let’s assume you have $50,000 already saved and want to reach $1 million in savings in 30 years. In this scenario, you’ll only need to save around $350 per month.
There are countless future value calculators available on the internet that make the math surprisingly easy. Simply plug in your number and duration and a few other factors to discover how much you’ll need to stash away each month to get there. If you want to retire 10 years ahead of time, simply subtract a decade from your duration.
Of course you’ll still need to invest in wealth-generating stocks to reach your goals, but leveraging time is your best tool. If you want to leverage time, you need to know exactly how much you’ll need to retire, how many years you have to invest, and how much you’ll need to save each month to get there.
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Fool contributor Ryan Vanzo has no position in any stocks mentioned.