Many people seek freedom from the need to clock on and clock off. To not be answerable to a boss. To not having to devote time and energy to things that they’re not passionate about, just for the pay.
The dream therefore becomes to retire early, and the sooner the better. In Australia superannuation is the primary vehicle with which to save for retirement, and access to superannuation is available from age 60. Therefore when we’re talking about early retirement, we’re referring to retiring earlier than age 60.
And what do we mean by being able to retire early? Does that mean sitting at home all day looking at the TV? I certainly hope not. Of the people I talk to with the ambition to retire early, I believe their goal is to have choice and freedom. To be able to say no to things they don’t want to do in a work sense. Early retirement links very strongly with financial independence, and that is where we will be focusing the attention of this article. So your dream of early retirement might be leaving the normal full time paid work force at age 40 and working as a fishing guide 6 months of the year in Northern Australia. Perhaps it’s leaving the paid workforce to help your daughter care for your grandkids. Or you want to become an independent film maker. The point is early retirement isn’t about retiring from life, rather it’s escaping the captivity of the workforce and spending your time as you wish to. It’s recognising that we don’t have a limitless life span, and so the sooner we can pursue the things that make us happy, the better.
You may have heard of the book The Millionaire Next Door. It’s quite US focused, but it has some interesting insights none the less. The two authors studied households whose net-worth (ie. assets minus debts) exceeded one million US dollars. One really interesting finding was that millionaire households were disproportionately clustered in blue collar and middle class suburbs, and not in the higher income, white collar, more affluent suburbs that you would assume. Digging into why this was the case, the authors found that the higher income earners devoted more of their income to luxury items and status symbols, often funded with debt. These people tended to neglect savings and investment.
I think this gives us a good pointer as to how you might be able to retire early. Don’t lease the expensive car, don’t buy the $1,000 hand bag or the $300 pair of jeans. A fulfilling life means different things to different people, but if you want to be financially independent, then feeling the need to keep up with the Jones is going to need to be jettisoned.
Let’s look at 5 things you could do to gain the financial independence necessary to be able to retire early.
1. Understand your livings costs.
Is all of your spending really necessary? You need a budget. For you to be in a position to quit your job, you need to know how much money you need to live. Is it $30,000 per year of $80,000 per year? Here’s some overly simplistic maths for you, just to illustrate:
If you wanted to build up a portfolio of investments that would generate $30,000 per year for you to live off, rising with inflation, and with a high level of confidence that it wont run out in your life time, you would need investments worth approximately $750,000. If you needed $40,000 per year, that would rise to $1million. So to have just an extra $10,000 per year, you need to save an extra $250,000. (Note that I haven’t allowed for tax here, this is just a really simple illustration). So to flip that, if you could reduce your living expenses by $10,000 per year, then the amount you need to save to be financially independent and retire early is reduced by $250,000. How much sooner would that mean you could escape your current employment captivity?
It’s one of the most simple financial rules around yet one so many of us struggle with – you must, must, must, spend less than you earn. Know how much you have coming in, after tax. Check that against your expenses as identified in your budget. What is the surplus? Savings could involve extra payments on your home loan, regularly investing in a managed fund, or building up cash in a bank account and then buying some shares whenever it gets to a certain sum. Strategies differ, but if you are to become financially independent, you need to save, and that means you need to spend less than you earn.
First you save, but then what to do with those savings? Sure you could leave it in the bank, but with minimal interest, and tax on that interest too, you’re going to have to do a lot of heavy lifting to get yourself to the point of financial independence and early retirement. Typically you would look to invest in assets that will grow in value over time, which usually means shares or property. There are all sorts of considerations here around investment time frame, the use of debt, and diversification, and so it is really important that you seek out professional impartial advice.
But a key concept to grasp is that risk and reward are always linked. You can take no risk and leave your money in the bank. But if you had the capacity to save $2,000 a month and you wanted to build up $500,000 in savings to become financially independent, that would take you about 21 years. If instead you invested in a share portfolio that earned 7% per year on average, it would take less than 14 years to reach the same goal. So you are achieving your goal to retire early 7 years sooner by taking some risk. Or to flip it, if you want to take no risk, the price you pay is 7 years of your life.
4. Minimise/avoid debt
To clarify straight up, not all debt is bad. Most of use could never buy a house in Australia without borrowing. And because any gains made on the increase in value of your home are tax free, usually borrowing to buy a home is a financially wise thing to do. Similarly some times debt to help fund good quality investments can make sense. But the debt to avoid is debt to fund consumption. Credit card debt to by clothes or a holiday. A loan for a new car when maybe something a few years old would have done. As highlighted in the the points covered earlier, if you are to retire early, you need to get your expenses down and your savings up. Loan repayments push against this objective.
5. Downsize/tree change
I know of several people who have achieved financial independence by selling their inner city home and moving to a rural area or just a smaller home. In some cases such a move resulted in them becoming debt free, which reduced their living costs and granted them considerably more freedom. Or perhaps there is some money left over following the change which can be invested and provide some income to reduce the need to generate a wage.
As a final thought, consider what you will be doing in this early retirement of yours. Is there any chance that what you want to spend your time doing could earn you some money? Even if it’s a small amount.
As shown in the example earlier, $10,000 of income needs something like $250,000 of investments to produce it on a sustainable long term basis. So if you can earn $10,000 in your early retirement, that’s $250,000 that you don’t have to save. That early retirement could be that bit earlier!
We love to help people plan financially for significant transitions in life such as retirement. Book an appointment here, so we can explore how we can help you achieve your goals and dreams.
Also, our podcast Financial Autonomy explores these themes in all sorts of ways, so visit http://financialautonomy.com.au/index.php/audio-blog/
This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives. While every effort has been made to ensure the accuracy of the information, it is not guaranteed. You should obtain professional advice before acting on the information contained in this publication.