How to retire early - 5 things you could do to gain financial independence - Episode 7

Many people that I speak to 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 that we use to save for retirement, and access to superannuation is available from age 60.  So, when we’re talking about early retirement, we’re referring to retiring earlier than age 60. But what does being retired before the age of 60 actually mean?  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 today’s podcast. 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.   If you are to retire early, you need to develop a plan to support yourself.  I’ve come up with 5 things you could do to gain the financial independence that you need.  They are:

Understand your livings costs. Save Invest Minimise/avoid debt Downsize/tree change

Let’s take a look at each in a bit of detail:  

Understand your livings costs.

Is all of your spending really necessary?  You need a budget and a cash flow management plan.  For you to be in a position to quit your job, you need to know how much money you require to live.  Is it $30,000 per year or $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 won’t run out in your life time, you would need investments worth approximately $750,000. If, instead of $30,000, 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? 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. In order to retire early you are going to need to build some wealth.  It may not need to be millions, that depends on your goals, but owning a roof over your head is probably a minimum starting point. The authors of the The Millionaire Next Door to me missed the point about the purpose of money, which in my mind is to give you freedom and happiness.   I’ve certainly met people who never spend a cent, and as a result would meet the criteria of having considerable net wealth. But they don’t seem to me to have lived happy lives.  The beneficiaries of their estate are likely to be the happy ones! So I want to be quite clear that I don’t see the building up of a large pool of wealth as being the marker of a successful life.  That may happen, and it’s no bad thing, but money is a tool which allows you to do the things that make you happy. So, with that caveat established, it is undeniable that if your goal is to retire early, you will need to build some wealth. And the findings of these authors does highlight the difference between those who do successfully build wealth and those that don’t.  Very interestingly, having a high income is not a pre-requisite to building wealth and becoming financially independent. The lesson from TMND would seem to be, don’t lease the expensive car, don’t buy the $1,000 hand bag or the $300 pair of jeans.  Avoid the status symbols and the debts often linked to them.  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. 2  Save It’s one of the simplest financial rules around yet one so many of us struggle with it – 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?  Now put this to work.  This is cash flow management. 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. Many people put off doing a budget because it seems too daunting, or they worry that then working to a budget will impinge too much on their life. In truth, you could sit in front of your computer one night for an hour max, glass of wine, beer, or chai latte in hand as is your preference, and between your online bank statements, and the budgeting tool we have provided, you could have a budget done. Even if you go no further than that, the insight you will gain as to where your money is going will be valuable.  Hopefully though you do take things a bit further and think about whether the way you are using your money is really as you want it.  Could you be happier if in fact you made some changes?  Perhaps there is some spending that you could cut down on, which would enable you to save, so that you can start to see some real progress in achieving your goals. 3  Invest 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. In the downloadable toolkit that accompanies this episode we’ve done some modeling on the impact of investment risk and return on the achievement of your goals, so be sure to check that out.  It shows how long it would take to save $100,000 assuming different rates of return, so it should be really helpful for you.  Just go to this post on our website, financialautonomy.com.au and you’ll see the button to download it.  4  Minimise/avoid debt To clarify straight up, not all debt is bad.  Most of us 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 sometimes debt to help fund good quality investments can make sense. But the debt to avoid is debt to fund consumption.  Credit card debt to buy clothes or a holiday.  A loan for a new car when maybe something a few years old would have done. As touched on 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.  As the NBN rolls out, there should be more and more scope for people to work outside of the big cities.  I know I use Skype a lot for meetings, and with the Screen Share functionality, I’ve found you can have a really good meeting with someone that is far superior to a phone meeting and not miles away from meeting in the flesh. 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’s some money left over following the change which can be invested and provide some income to reduce the need to generate a wage. If you haven’t already done so, have a listen to episode 6, where an element of Nish’s success was this type of change, Mortgage repayments or rent tend to take up a large part of peoples budgets.  And as highlighted in the first point earlier, the lower you can get your living costs, the easier it will be for you to get to the point where you can retire early. It follows then that if you can downsize or make a tree change, and get your housing costs down through the reduction or elimination of debt, or just lower rent, your goal of early retirement will be that much more attainable.   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!   As always, we have a downloadable toolkit for this episode.  It’s really important to me that the content we provide to you is actionable.  The toolkit contains checklists and templates to get you moving on your journey to financial automomy, so be sure to grab your free download. As I hope you can tell, I love to help people plan financially for significant transitions in life such as early retirement.  While you’re at our website check out the Work with me page to learn how we can work together on a one on one basis to help you achieve your goals and dreams.   Important Information: 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.