Want to retire early? The good news is that your goal is a simple one: you need to save up a pot of money that’s big enough to pay for the lifestyle you desire until the day you die (and you may also need to ensure enough is left in the pot to support any dependants you leave behind).
The bad news, of course, is that this is a lot easier said than done.
Today’s near-record low interest rates and relatively high stock valuations mean that you can’t bank on markets providing you either with rapid growth or a large income.
As David C Stevenson points out, a £100,000 pot won’t take you very far these days if you’re hoping for more than the most basic lifestyle. But don’t get discouraged – there are several things that you can do to help you in your quest.
By adopting the right mind set and following a few simple strategies, it is not only possible to retire comfortably, but you might be able to do it sooner than you think, or opt for a life of semi-retirement. Here are six tips to help you on your way.
1. Spend (a lot) less than you earn
This sounds like stating the obvious, but it’s amazing how many people ignore this basic fact. If you want to retire or semi-retire early, you’ll need to build up a significant pot of savings.
And while making the right investment decisions is a key aspect of getting you to this goal, you can only have the money to invest in the first place if you live below your means and spend a lot less than you earn.
Yet for many people this seems to be very difficult to do. Even when people manage to get themselves into well-paid jobs, or achieve rapid promotions, they make the mistake of gearing up their lifestyles to match their higher income, and often exceed it.
There’s nothing wrong with enjoying the fruits of your labour. However, getting obsessed with keeping up with the Joneses is one of the best ways to blow huge amounts of money over the years – money that could be saved and invested instead, so that you don’t have to spend years flogging yourself at work.
If you are serious about getting out of the rat race, then you have to live your life in a different way. It’s not about being miserable and counting every penny, it’s about prioritising and being realistic.
If your pay rises by more than inflation, try to save the excess rather than spend it – if you can manage to get into the habit of inflating your pay without inflating your lifestyle by the same amount or more, you’ll be able to achieve your savings goals a lot faster than you might expect.
2. Make a budget and stick to it
Set up a spreadsheet and draw up a detailed plan of your outgoings. Make sure that it’s conservative (in other words, err on the side of overstating your outgoings rather than planning for an ‘ideal’ that you never quite hit).
Build in amounts for things that are often overlooked, such as holidays, wear and tear, emergencies and depreciation on the family car. Then track what you spend so that you don’t exceed this amount.
If you have other major pre-retirement spending goals – such as private schooling for your children, or moving to a bigger house – you need to think about how this slots in with your early retirement goal. Can you achieve both? If not, are you happy to push back your target retirement date? Or can you compromise on your other goals in some way?
3. Overpay your mortgage
Without doubt this is one of the best things to do if you want to retire early. Paying off your mortgage means you can effectively live rent free, meaning you need less money to live on.
For example, say you bought a £300,000 property with a 25-year, 90% mortgage (£270,000) at an interest rate of 4%. Overpaying by £300 a month would pay off the mortgage six and a half years early and save you £45,000.
An aggressive strategy – which wouldn’t be right for everyone – would be for a couple to pay their Individual Savings Account (Isa) allowance (currently just over £23,000 in total) to their mortgage instead. It could be paid in just seven years and ten months, saving £113,696 in interest.
4. Buy cheap trackers and diversify
When building your savings, the golden rule is to keep your costs low – you can’t predict the future, but you can control what you pay to invest. Most professional money managers can’t beat the market over the long haul, but still charge a lot for trying.
Using cheap index trackers or exchange-traded funds (ETFs) – which give you the return on the market, rather than trying to beat it – you can build a diversified portfolio of shares, bonds, property, cash and gold for about 0.5% a year.
Professional managers might cost you 2% or even more for the same thing. Over a long period these cost differences can have a big impact on the value of your savings and what you have to live on.
Splitting your portfolio between different investments spreads your risks. You should also rebalance from time to time (by selling assets that have done well and so take up a bigger chunk of your fund, and buying those that have done badly). This can boost your savings over time.
5. Work part-time or freelance
Many of us dream of retirement, but the reality doesn’t always live up to our hopes. Having something to do is very important for both your mind and your finances. You may already have big plans for how you’ll fill your time – but if not, then working part-time and being semi-retired can be a good lifestyle choice.
If you are a skilled professional, companies might not be able to afford to employ you full-time, but might be happy to employ you on a part-time or consultancy basis.
6. Don’t spend it all at once
Once you’ve built your nest egg, you need to make sure you don’t run out of money. If you are working part-time, then you can afford to withdraw a bit more from your portfolio than someone who isn’t. A 4% annual withdrawal rate is probably safe, assuming nominal (including inflation) long-term investment returns of 5%-6%.