How to Retire at 50 (Or Sooner!)
When I tell people that I hope to retire at 40, people give me funny looks. The ‘classic’ early retirement target is retiring at 50.
I then go on to explain that I won’t be bringing in an impressive salary, nor will I be buying lottery tickets, and they begin to worry for my sanity.
While I appreciate that this is a somewhat extreme goal, it is clearly backed by a simple personal finance principle. This principle is so incredibly simple that most UK consumers have almost forgotten it.
The Key Principle that Slashes Your Working Years
- Your Spending/Income ratio is Crucial to Retirement Success.
Your spending to income ratio is the key driver of your retirement age. Get it wrong, and you will struggle financially for the rest of your life. Get it right, and you will be able to ride a wave of wealth past all of your peers.
The ratio has a very pronounced effect that reaches far beyond what you might first suppose. Simple logic and maths actually reveals that the positive benefits of lowering the ratio have a vast and disproportionate effect on your retirement age.
An Example: The Standard UK Consumer
Imagine you are a typical UK consumer. You earn an after-tax salary of £20k per year (This is not too far from the national average wage). I’m going to be kind here, and ignore those who spend more than they earn, by supposing that you spend 90% of your salary (£18k). 5% of your salary goes into your pension, and 5% ends up in your savings account, but to all intents and purposes this simply amounts to £2k added to savings each year.
Modern families struggle to curb their spending
Now lets calculate how much capital (savings & investments) you will need to be able to live off the interest at your current level of spending. Assuming that you can get a return of 5% per year on your investments, you will need to accumulate £18k/0.05 = £360k in your tax-free investments, to be able to live the same lifestyle you enjoy presently.
We have instantly encountered the elephant in the room. If the average Joe is only saving £2k per year, it would take 47 years for their savings pot (growing at 5% annually, with £2k annual contributions) to reach the required level. In other words, you failed in providing enough income for your retirement.
The Accelerator Effect
Now suppose you are a bit more savvy with your money, and you choose to save twice as much. Many would expect this to half the time period. So let’s do the calculation.
If you save £4k/£20k then you now only spend £16k per year. Therefore you will require £16k/0.05 = £320k in your savings pot. If you are saving £4k per year, you will need 33 years to reach your target.
If you save £6k/£20k then you now only spend £14k per year. Therefore you will require £14k/0.05 = £280k in your savings pot. If you are saving £6k per year, you will need 25 years to reach your target.
If you save £8k/£20k then you now only spend £12k per year. Therefore you will require £12k/0.05 = £240k in your savings post. If you are saving £8k per year, you will need just 19 years to reach your target.
See the graph below to see the relationship between your ratio and number of saving years required.
As you can see, rather than a simple straight-line relationship occurring, there is rapid accelaration at the beginning of the reduction in the ratio, with further gains becoming more difficult, as the effect of compounding becomes weaker when very early retirement ages are involved.
Where Are You On The Curve?
The benefits of retaining your income are demonstrated very clearly in the graph. Someone who spends 65% of their income, as apposed to 95% of their income, can retire 3 times faster! The difference in their retirement plan is dramatic, although the spending cuts are not, as they have only given up a third of their income. This is a win for the ‘learn to live with less’ camp. Are you the type of person who sees money as a ‘permission to spend’, or do you instead only spend on the important things in life, and save all the rest? The latter approach to consuming will pay enormous dividends following these principles.
How Wealthy Would I Be If I Worked to 65?
Perhaps retiring extremely early isn’t your goal. Instead you wish to work until 65 but use your enhanced savings to fund a lavish and exciting lifestyle. The Spending/Income ratio continues to dominate your success at achieving this goal.
Now look at the size of those possible numbers involved! Indeed, the numbers do not lie. You can become a multi-millionaire on a £25,000 salary if you cut your outgoings to a half of your ingoings. Whilst this graph holds so much possibility, so much potential for young savers, it is also a sad reminder of the current finances of the majority of the general public. Someone who saved 35% of their income would be sitting on a cool £million, but where would our ‘typical UK consumer’ be? A 10% saver would only have about £300k to fund their retirement (£1,250 p/m). If only they could cut a 10% slice out of their expenses, they would have retired on double the income – £2,500 per month. They could have lived out their retired years spending many months abroad, giving financial support to their family, and having the freedom to live where they wanted. Instead, they have to live off a salary lower than their original ingoings during their working lives.
With just a relatively small change to your lifestyle and spending habits, you can enormously change the financial prosperity of your retirement.
The Massive Problem: Spend Swell
If my graphs are to be believed – someone who saves a quarter of their income can retire by the age of 50, but so few individuals manage to do so. So what is the problem? Is something wrong with the model?
There’s no denying it – my model is based on solid reasoning. The problem that axes the chances of retiring early is what I’ll call ‘spending swell’ – the natural tendency for us to spend more on things as we grow older. When we start our career and own a cheap run around car, we are fairly content. However after half a decade of blood sweat and tears in order to progress ones career, people feel the nature urge to increase their spending in line with their salary. As they get promoted to manager, we buy a larger car, move into a larger house and go on more lavish holidays. Simply put, rather than keeping expenditure constant and funnelling ever larger amounts into savings – people tend to keep their spending as a fixed % of their salary. This wouldn’t be too bad if their tendencies were to spend 75% of their salary, but we all know that on average people tend to spend almost everything they receive. The real dilemma here is that as the spending swell advances, the amount of capital required to fund it in retirement becomes unfathomable and impossible to fund. Imagine that by the age of 50 you have risen to an after tax salary of £42k. If still spend 90% of this amount, your target pension fund has grown to £750,000, whereas your annual savings contributions are a relatively paltry £4,200. This lifestyle will enevitably lead to a massive drop in quality of life upon retirement!
The problem is therefore discipline. Could you keep living the same lifestyle as your income increases, or is the urge to climb up the materialistic edge of the social ladder too strong to resist? Let’s not forget, your partner will probably be clamouring to improve some aspects of spending when they hear about a promotion, so it’s not only yourself that needs convincing. Occasionally a couple completely agree on this matter, and support each other in ‘aggressively saving’. A nod of the hat here should go to the owner of Extreme Early Retirement, who took the Spend/Income ratio to the absolute extreme by living on 20% of his income, and retired from fulltime work in fewer years than you could count on both hands. Read his story and find out how he did it, it may inspire you as it once did me.
Let’s Aim Higher
In the case above, I’ve played it safe and used conservative figures (5% is very easy to get from a savvy portfolio), and I’ve also assumed that you will earn roughly the national average salary in the UK. But now I want to change the cards a little to really get you excited about your retirement prospects. In the real world, 8% is often given as the standard average return from a portfolio heavy in stocks and shares. I also notice you’re reading material about early retirement on the web, which actually suggests you earn higher than the national average. Also, your proactivity in reading about financial topics tells me that you will work towards higher earnings than the average Joe, because it is clearly a priority for you. So I will now assume you earn £35k for each year throughout your career. This changes the game completely. See for yourself:
The ultimate irony of the early retirement ‘spend swell’ dilemma is that those who refuse to swell their spending during their career, will live out the rest of their long retirement with more money than they know what to do with! Conversely those who show the greatest desire for material possessions will be unable to fund a desirable lifestyle. I’ll leave you to drool and leave a comment below.
Notes:
1. I appreciate that ‘averaging out’ a salary across whole career is cheating a little bit, as this throws more of the investment into the early years, allowing for greater compounding effects, but I can assure you that even when this is taken into account, the overall effect is still just as pleasing!
2. A 5% yielding portfolio is ‘easy’ to attain. Use the simple science of diversification through splitting a portfolio in equal parts across long term deposits, stocks with dividend yields, and corporate bonds. This can be enacted by simply purchasing 3 different funds.
3. An 8% yielding portfolio will look more like 70% Stocks, 20% Corporate Bonds and 10% Cash. This is only a rough guide, and one possibility from hundreds, but shows that an 8% portfolio will require a higher risk tolerance and may not be suitable for conservative investors. For an efficient portfolio design, you may want to ask yourself “Do I need a financial advisor“, don’t fall victim to the common mistakes of investors.
14 Responses to “How to Retire at 50 (Or Sooner!)”
Leave a Reply
Powered by WordPress | Please Read Our Disclaimer and Privacy Policy | © Simon Oates. All rights reserved
[...] My personal views on saving are made very clear on Financial Expert. In my article ‘How to Retire at 50‘ I explain that our ability to save will dramatically affect our future lives. First and [...]
Yep, its all about that residual passive income!
Hi there Really enjoyed what you had written about, It\’s presented us a purpose to take into consideration just a bit more regarding the path I\’ll need. Thank you for writing on it.
Have found this very informative.Hope to invest for a realistic Annual Return within the next couple of months.If I can work less fantastic.
Good idea and well thought out in principle.
HOWEVER there is no room in the equations for inflation. While wages have been more or less frozen for many years, prices have increased dramatically over the past few especially those of Travel, Fuel Electricity Gas Food and Water.
If saving can not be stepped up the plan falls over.
Tax changes like Value Added Tax and Council Tax augment difficulty in saving/spending gap without increase on income.
Problems also exist in interest rates or dividends from shares. The rates of interest have been very low for some time and share prices very volatile. Thus there is no sure place to ensure a sufficient income of any kind.
From this we can gather most people will live a frugal standard especially when pension funds are plundered by businesses and government.
The effect of inflation is certainly not to be dismissed, and will have a significant ‘dampening’ effect on the figures I quote above.
However, let’s be careful we don’t take the last 3 years figures and extrapolate over the next 50 years. VAT increases may have added inflationary pressure recently, but this impact will be restricted in the coming decades.
However, this being said, I still believe the overall message of the article is on target!
Thanks for sharing superb informations. Your web-site is so cool. I’m impressed by the details that you have on this blog. It reveals how nicely you perceive this subject. Bookmarked this website page, will come back for more articles. You, my friend, ROCK! I found simply the info I already searched everywhere and simply couldn’t come across. What an ideal web site.
The article is technical in a financial manner, but “to all intensive purposes”?
It’s to “all intents and purposes.”
A common mistake, but shouln’t be made here.
Thanks for spotting that grammatical mistake! More eyes the merrier!
Brilliant information and had convinced me to change my ways, greatly increased my motivation. My father achieved exactly this and retired at 52.
This combined with increasing your income is the way to achieve early retirement. They say live within your means because the advice is to those who don’t, but really the advice is to live within MUCH LESS than your means.
Thanks for the most excellent resource
Normally I don’t read article on blogs, but I would like to say that this write-up very pressured me to check out and do it! Your writing style has been amazed me. Thanks, quite great post.
Thank you a bunch for sharing this with all folks you really understand what you are speaking about! Bookmarked. Kindly additionally consult with my site =). We may have a link trade arrangement among us
this
Individuals who dwell in glass homes should not toss stones
Good article but you can retire even earlier than this if you invest in passive income streams
In this world nothing can be stated to ensure, except death and taxes.
There is absolutely no time for cut-and-dried monotony. There exists time for work. And time for love. That leaves no other time!