Being able to retire at an early age doesn’t just happen, it involves commitment, planning and maintaining realistic expectations. The following early retirement guide will specifically exclude extreme methods because for most of the population this simply is not realistic. Instead we will concentrate on the more prosaic issues including money management, how to get free money, proper retirement planning, and more. Therefore, starting with the basics and moving on…
What is financial independence?
Imagine for a moment that you have sufficient wealth to maintain your desired lifestyle without ever being concerned about any monetary matters again in the future. As such, you could continue to go to restaurants, go on holidays, and enjoy your hobbies without being burdened by any concerns surrounding payment. Going to work, if you so chose to, would never be down to receiving a salary or payment. If this scenario applies to you then you have reached financial independence!
Why financial independence matters for retirement
Retirement is the event of no longer working. Since this can be forced upon you through uncontrollable circumstances, including both ill health and your age preventing you from finding suitable employment, retirement does not mean that you are entitled to, or will receive the ability to continue with, your desired lifestyle. In such circumstances all your basic living expenses will still have to be covered such as food, housing (maintenance costs if you own your property or rent if you don’t), and utility bills (gas, electricity, water etc). This means that you will have to choose what luxuries you forego to make ends meet and may result in you foregoing or reducing what you spend on holidays, hobbies or your family.
Attaining financial independence ensures that you do not have to sacrifice any of these luxuries when you retire.
How old do you have to be to take early retirement?
This is a fluid concept and depends upon your circumstances. It can, however, be defined as achieving sufficient financial independence before the normal retirement age for your occupation. Therefore, one person’s age for early retirement could be classed as retiring late for another. For example, a civil servant retiring at 51 is a legitimate case of early retirement whereas a footballer retiring at the same age would classify them as one of the latest retirees ever recorded for their profession.
The default retirement age in the UK was previously 65 so an early retirement may typically be classed as any age less than this. Although the default retirement age has since been phased out this is still a good barometer for the upper range of an early retirement age.
Create a financial plan
This is the most important aspect to get right. Creating a bespoke retirement plan will help you establish your objectives and prioritise accordingly. From this you will have a target amount which will enable you to achieve financial independence along with a route, via knowing how much has to be regularly saved & the annual investment returns required, to achieve your goal.
Money management tips
Having the best financial plan ever devised is not worth one iota if you cannot save any money. Even if you do there may still be ways to streamline your finances. The following generalised tips on money management are a few routes that may help make your money work harder.
Pay back credit efficiently – Loans can be beneficial for your wealth if used correctly. A good example is using property financing (mortgages) to purchase homes. Buying a house, due to the financial commitment involved, would be unattainable to a lot of even the most prudent people if it wasn’t possible to borrow money. It therefore can make sense not to pay off loans quickly and is all dependant upon the terms offered, the returns available via saving the money instead, and the level of risk a person is comfortable taking. To help guide you, here are generalised ways of paying back debt based on the following loan types;
Standard credit cards or store cards which can carry very high interest rates commonly exceeding 10% p.a. – Thes should be paid back as quickly as possible. Ideally credit cards should be paid off monthly which will improve your credit rating whilst not costing you any additional money in terms of interest payments.
Interest free loans – These should be paid off over the allocated timeframe. There is little benefit in paying these off early so any additional payments that you are intending to make should be used to pay off other interest baring debt or placed into savings.
Front loaded loans – This is where all the interest is applied at the start of the loan term. These terms should be avoided if possible since they doesn’t allow you to really benefit from paying off the loan early. Due to the penalties attached to such loan terms it is usually best to pay these over the allocated timeframe.
Normal loans/ property finance – Where interest is accrued on a regular basis then any debt with the highest interest rate should be paid off first and working down from there.
Further to the above it is important to fully understand the conditions of any loans so that certain terms, including penalties for paying off debt early, can be accounted for when calculating whether it will be beneficial to do so. Sometimes it may be better to keep debt when the terms are not particularly onerous. For example, if your investments are yielding 7% per annum and your debt is costing 3% p.a. then, assuming you are comfortable with the risk involved in holding your investments, it may be more beneficial to not pay extra into your loan. This could also prevent you from paying additional fees. For example, overpaying a loan to then withdraw funds in the future could result in the payment of avoidable charges. If the terms were particularly favourable then you may decide against paying the loan off early under any circumstances.
Prioritise spending – By considering your priorities without regard to timing, it will ensure that any income you receive is put to best use. Most people are fixated on the present when accounting for spending which limits their ability to make efficient use of it. Also, the majority of people cannot afford to do everything within their earning constraints which is why spending should be prioritised. Whether a conscious decision or an unconsciously intentional one, purchasing one item which reduces your income to below the level required to achieve another goal within the original timescale is prioritising it. For example, if a person states, when asked, that it is more important to save for a deposit towards a property than going on holiday and they then purchase a holiday which results in them having insufficient income to save for a house deposit in the timescale originally stated then their priority is not the house.
The difficulty of prioritising is with instant gratification. Longer term objectives, such as achieving a comfortable lifestyle in retirement, can lose their priority if it means foregoing purchases which can be benefited from immediately such as replacing a car, buying a new TV etc. Therefore, be truthful with yourself when setting goals.
Improve investment returns with no risk
The holy grail to investing is getting something for nothing. The general rule is that to achieve a higher return a greater level of risk is required. Although there are ways to mitigate certain forms of risk none of these improve the investment returns on offer.
The main route to achieve higher returns with no risk is by utilising tax efficient structures. This ensures you do not pay all the taxes that would be otherwise due in a completely legal and transparent manner. They are, in fact, actively encouraged by governments.
The most well known version is a pension. Assuming that you are happy with the downsides then pensions provide a way of legally reducing the amount of tax you would otherwise pay. This, using the UK system works on three fronts: a pension commencement lump sum is available, up to 25%, which avoids paying tax in its entirety; income of retirees is typically lower which can reduce a person’s tax rate and thus the tax ultimately due; and finally, income can be withdrawn according to requirement enabling higher levels of tax to be avoidable.
Further to this, UK expatriates who have built up sizeable British pensions but who now reside abroad can be bound by more lenient regulations regarding their pensionable assets. This can provide a way to further reduce the tax liability otherwise due whilst increasing both flexibility and choice. These schemes are collectively known as Qualifying Recognised Overseas Pension Schemes or QROPS for short and there is a wide variety of providers and countries which host these schemes.
The process of achieving decent returns over the long term is as much about mindset as picking the correct investments. It is no use selecting a great investment and selling it too early because it transpires to be more volatile than you were expecting. To capitalise we will go through some of the key points to consider and/or be aware of when you invest;
Returns are linked to risk – This is fundamental to investing though it only works one way. If you are happy to target a lower return you can take less risk. However, taking more risk does not, in itself, necessarily lead to higher returns.
Know your risk personality and invest accordingly – If you are adverse to risk and place money in volatile investments there is a strong likelihood that you will withdraw money at the wrong time i.e. when your investment has dropped in value due to overall market conditions. By contrast, if you have a higher capacity towards taking risk than the investments chosen you could be limiting your overall potential returns.
Invest according to timescale – Risk is a combination of volatility and time. The longer the investment timeframe the higher the volatility one can accept for the same risk level. This is why having money in cash over very short periods (days, weeks & months) is extremely low risk whereas holding it for substantial timeframes (10+ years) makes it risky due to the likelihood of you receiving very poor returns over the period in question.
Know your target – Linking back to creating a financial plan, it is important to review your objectives periodically and invest accordingly. This will highlight your progress towards achieving your goals along with reaffirming your investment selection if required. For example, if your investment holdings have fallen sharply due to overall market conditions then taking a step back, reviewing your longer term objectives, returns achieved and progress since you’ve begun may confirm your investment strategy is working for you. This can prevent panic selling and may, if you are in a position to, allow you to capitalise from short term low prices thereby further boosting longer term performance.
Capitalise from market drops – Due to the concept of pound cost averaging if money is not invested as one single lump sum amount but, instead, on a continual basis then falling markets work in your favour. This is because subsequent investments are bought at a lower price than may have otherwise been the case. The only critical point when it is beneficial for high prices is when you sell.
Falling markets cause people to panic and sell thereby losing money when they should, in fact, continue to buy. After all, buying regularly will give you the average price and the lower that is the greater the likelihood that a higher price will be available in the future.
Don’t try to time the market – In an ideal scenario one would always buy low and sell high. The problem is knowing when each point occurs. Just because an investment has halved in value does not mean it will not halve again and the reverse is also true. Also, trying to time the market may mean that you miss out. It is common for people to lose out when investments start to rise because they can fixate on earlier lower prices and convince themselves to buy on a dip that never materialises. If you are investing rather than trading the easiest route is to continually invest when you have the proceeds to do so. This way you will always invest at a fair price over the longer term because purchases made at high points will be offset by those purchased cheaply.
Sell in favourable conditions – Although it’s difficult to time the market when purchasing investments is concerned the opposite is not the case especially when a long term goal is involved. Markets rise over the longer term and go through cycles when they are both expensive and cheap. By setting out long term objectives the exit point can be timed successfully assuming there is flexibility involved. For example, if a target amount is reached one year earlier because markets are performing well then it is best to take money out at that point rather than leave it until it’s required since the investments could fall in the interim. This is one way to sell high.
Be aware that the riskiness of an investment can change – Not only should you invest according to timescale but it is important to be aware that the risk associated with investments can change depending upon market conditions. This is because price can also affect risk. It can lead to investments in a typically lower risk category becoming more risky than those usually classified as higher risk. This can be exasperated during periods of political interference. For example, Quantitative Easing (QE), a form of money printing, has resulted in governments, via central banks, purchasing huge quantities of their own bonds. Importantly, this has been done in a price insensitive manner thereby increasing their prices and reducing the yields (annual income returns) offered. This filters through to other investments because prices are interlinked on a grand scheme. As soon as one investment becomes relatively more expensive then others, which appear to offer better value, this results in money flowing into the latter. Should inflation expectations cause interest rates to rise, potentially substantially, then certain government bonds, which are regarded as very low risk, could suffer high losses. This could be unexpected by those who do not account for the changing nature of risk within investments.
Early retirement is achieved via sacrifice though this does not have to have a large baring on your lifestyle. The key to ensuring that you have the most efficient lifestyle is by thoroughly planning and prioritising which of your objectives are truly important to you with no regard to timescale.