In the not too distant past, people used to be stuck in the same job for 40-50 years. They'd retire, and enjoy their last few years at home, (or the Costa del Sol, usually on a small monthly state pension.
But in the past 2 decades, there has been a big shift in how people want to live and retire.
The FIRE (Financial Independence/Retire Early) movement, originally created in the US in the 90s, has been growing in popularity in recent years, especially here in the UK. And from our own surveys, we know it’s one of the top 3 financial goals of Millennials and Gen. Z.
And honestly, who wouldn’t love to retire early, sit in the sun and drink cocktails, or travel the world, without having to worry about income (ideally, before we're too old to move)?! And with increasing retirement age and shrinking pensions, this will definitely be an attractive lifestyle choice for many.
But how do you do it? That's what we'll be looking at in this post.
The first question you have to ask yourself is: what does financial independence, or "early" mean to you?
For most of us, retirement means not having to work ever again. But that doesn’t necessarily mean that you now have to be stuck with tending your garden, or feeding the ducks at the pond for the rest of your life!
And maybe you still want to work in some way, just not as you did before. Take every other year off, or work on the side. It’s all about having choice, and living life without restrictions and away from social pressure.
“Early” will have a different meaning for different people. The average state retirement age is somewhere in the region of 60-65. For some, it'll be their 40s, for others their 50s.
A lot will depend on how much money you'll need, and for how long you'll have to save and invest.
The good news is that it’s a lot easier than you think. And you don’t have to be wealthy to enjoy a life of financial independence. But it will require frugal spending and smart investing to get there.
The normal route to retirement, if you start at 20, is usually saving around 15% of your income for 40 years, which will provide you with a retirement fund of 50% of your income per year.
Of course, this doesn’t work for early retirement. So, let’s figure out how much you really need: First of all, you need to think about where you want to retire, what kind of lifestyle you’ll be living, and how much you’ll need every month to cover your basic necessities: rent, food, bills.
Next, you have to consider other expenses: restaurants, travel funds, fun money. When you have your number, it’s time to think about where that money will come from. There are 2 ways to achieve financial independence:
You can also do a combination of both.
The go-to formula in the FIRE movement is the 4% rule, which says that if you can safely withdraw 4% from your savings each year over a period of 30 years, you are at no risk of running out of money.
As an example, let’s say someone retires with £1.5 million in assets. They could safely withdraw £60k per year over the next 30 years, and were more than 98% likely not to run out.
Forget gambling or trying to time the stock market. The easiest way to grow your money is to invest into long term assets, like Exchange Traded Funds (ETFs). These are managed “invest and forget” investment funds that track stock traded companies. An example is the S&P 500, which tracks the 500 biggest US companies.
This fund, created in the 80s, has delivered an average 10 year growth rate of 13.6%. Considering there have been several economic crises, and a yearly inflation rate of 3%, that’s a very healthy growth for your investment. But the real power comes from compound interest.
Let’s say, in the first year you invest £20k. By the end of that year, you’ll have £22,720 in your investment portfolio. By the end of the second year, you’ll have £48,530, and by the third £77,850. That’s £17,850 in compound interest in just 3 years!
As an example, let's assume you’re 20 years old and have an annual income of £50k. You can put aside 25% of this income each year. If you want to keep your standard of living at £5ok, your retirement sum is £1,250,000.
If you invest your funds into the S&P 500 at 13% average yearly return, your estimated retirement age is 49.
Obviously, if you can save more, or get pay raises, bonuses, and other benefits and sources of income, the sooner you can retire (or increase your retirement pot).
There are lots of handy calculators online
- Review your spending habits
The quickest way to financial independence is to review your income and spending. The less you spend on unnecessary expenses, the more you can put away, and the sooner you'll reach financial independence.
- Pay off your debt
This should be your priority before you start anything else on the list. Start with high interest loans, and work your way down.
- Pay off any mortgage
Getting rid of debt also means paying off your mortgage. This will move the property from being a liability to becoming an asset, which can generate passive income for you.
- Save up an emergency cash fund
Aim for around 6 months worth of your salary. This will cover any emergencies that life might throw at you.
- Try to invest at least 25% of your income into a long term high return asset, like an ETF
While these are usually save, long term assets, please make sure to talk to a financial advisor, as your capital might be at risk.
- Increase your savings and investments until you can withdraw 4% over at least 30 years.
You also need to consider inflation (at an average of around 3% per year) and possible taxation when withdrawing funds. The ultimate FI goal would be to increase your pot to a size, where the gains are larger than your annual withdrawals.
Make sure to take advantage of tax benefits, like an ISA investment account, which will allow you to save £20,000 tax free every year.
Header image credit: Liubov Dronova
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