Retirement. Saying goodbye to emails, meetings and deadlines. Enjoying relaxing days and having the time to spend on life’s passions. You may have heard many friends, colleagues and relatives talking about ‘retiring at 50′ or ’55’ as an ambitious or fool-hardy target. Did you hear someone make this goal maybe 5, 10, 20 years ago and watch them sail right past it? Well I’m actually aiming for 40. Read on to find out how this is possible, as I share my early retirement tips in one of this blogs most popular posts.
My extreme goal certainly grabs attention – but is backed by a simple personal finance principle, and it works. Perhaps the problem is that the principle is so simple that many savers have almost forgotten it entirely.
Slash your working years with these key principle
The secret to success is the ratio between the amount you spend and the amount you save. On Financial Expert I call this the ‘saving ratio’ and measure as a %.
The saving ratio is the key driver of your retirement age. Forget about it and you may struggle financially for the rest of your life. Get it right though, and you can watch yourself ride a wave of wealth past all of your peers.
The ratio has an exaggerated effect which may surprise you. Let me work through the maths below and demonstrate how powerful this simple metric really is.
Example of a typical saver
The average after-tax salary in the UK is £21,000 (£26,500 pre-tax). You save a combined 10% of this income in a bank account or pension, adding £2,100 each year. We can also deduce that you are spending £18,900 (£21,000 – £2,100).
Generously assuming that annuity rates are 5%, you will need a retirement fund of £378,000 (£18,900 / 0.05) to fund your current lifestyle.
Given that you are saving £2,100 per year with a hypothetical 4% interest rate, it would take an eye-watering 53 years to save this amount! In other words you will have failed to fund your retirement even at age 65. And let’s not forget – in this example we were assuming you were saving a responsible-sounding portion of your earnings!
The ratio in action
Before you despair – let me show you how the magic of the saving ratio can bring that early retirement back within reach. I will show you what happens if we save another 10% of income.
If you save 20%, or £4,200 / £21,000, then you are spending a smaller amount per year (£21,000 – £4,200 = £16,800). This will require total retirement fund of £336,000 which will take only 36 years to save.
If you save 30%, or £6,300 / £21,000, then you spend £14,700, requiring a fund of £294,000 which will be reached in 27 years.
If you save 40%, or £8,400 / £21,000, then you spend £12,600, requiring a fund of £252,000 which will be reached in 19 years.
Regardless of the salaries involved, the relationship between your saving ratio and retirement age will always be the same, and is shown in the graph below.
Chart assumes your savings attract an interest rate of 3%, you can obtain annuity income at 4%, and you wish to maintain the same level of spending into retirement.
The graph shows a rapid acceleration at the beginning, then the line starts to flatten out, representing further gains becoming more difficult. This is due to savings not being able to compound and grow over the short time periods involved in very early retirement. Notice that moving the saving ratio from 95% to 70% – a significant but feasible challenge, halves the amount of time needed to work from 60 to 30 years. Someone who could live on a third of their income – that’s £584 a month in the illustration above, would be able to live off their savings after just ten years.
The reason that the change is so dramatic is because increasing your saving ratio has a two-fold impact on your retirement planning:
- Spending less reduces the size of the required retirement fund.
- Saving more means you will reach any fund size at a faster rate.
This double bonus effect pays you a bonus for cutting back on spending.
Where are you on the curve?
It’s time to evaluate your own situation. What is your own saving ratio? For the purposes of this metric, include the capital element of mortgage payments as savings, as these provide an income-of-sorts in the form of ‘free rent’.
You can calculate your own saving ratio and forecast your own retirement date using our calculator:
Calculate your Retirement Age
Let the Financial-Expert.co.uk boffins do the number crunching for you by visiting our very own retirement calculator.Open the Calculator
Common pitfalls for early retirement
Lack of goal setting / monitoring
A common mistake is setting off without a quantifiable goal. Make a very clear target and work backwards to determine what choices / actions must be made to achieve your goal. This logical, strategic planning process will force you to meet and overcome the major challenges and barriers early on.
Here is a sensible series of questions which will form the backbone of a plan:
- How much do I need to save by what date?
- How much do I need to save each month to reach that target?
- Will I try to increase my income or reduce spending, or both?
- Can the target be met through incremental changes to how disposable income is spent, or are fundemental changes to areas such as car ownership & living arrangements required?
Focusing on the wrong costs
Early retirement is a numbers game, so make sure you’re playing the game as tactfully as possible. Which of the following do you think would require least effort, have the largest impact, and be the most likely to be kept up?
A) Saving money on small, daily activities by performing more chores. (Example: Preparing packed lunches).
B) Cutting 20% off a large, monthly bill by making a single decision. (Example: Moving to an area with cheaper housing costs).
Option A) creates a new daily battle of will-power for you to fight everyday. It is only incremental though, and lends itself to short term resolutions. Option B) delivers effortless savings that are guaranteed, but is a big decision that will require another kind of sacrifice.
Surfing the spend thrifty parts of the web will introduce you to a breed of ‘money saving’ that stands in the way of early retirement: bargain hunting for the sake of it.
Achieving a high saving ratio is partially about getting good value for money – but for the most part about being happy with less. Remember that point as it is crucial.
We all want to be happy, but if we also want to retire early – then it is better to be happy whilst spending nothing. Across the globe there exists every combination of spending level & happiness. That this phenonemon occurs proves that happiness is just a state of mind, an attitude, rather than the score we get for owning shoes and cars.
Achieving early retirement in a sustainable way is about becoming one of those lucky people who spend little and yet lead unapologetically happy lives.
From this perspective; the problem with voucher sites, bargain hunting and money saving forums is that they do not fit into that picture above (Being happy with less) as they are no different from brochures, TV adverts and window shopping. They create a want and need for unneccesary, material items in the first place – and then provide a guilt-free way to obtain it. Paying 50% of list price is still a waste of money if you purchase something that you never needed.
Therefore thinking of bargain hunting as a proud hobby is self-sabotage in some respects. It gives a sense of purpose and satisfaction to what others would describe as luxury consumption. The more time you devote towards browsing, shopping and discussing purchases – the more power you give to your consumer identify, rather than saver. Eventually you will give in to temptation.
There is a natural tendency to spend more on things as we grow older. When we start our career and own a cheap little car, we are fairly content. However after half a decade of blood sweat and tears in order to progress, we feel the urge to increase spending in line with salary. As we are promoted, we buy a larger car, move into a larger house and go on more exotic holidays.
Simply put, rather than keeping expenditure constant and funnelling ever larger amounts into savings – we tend to keep our spending as a fixed % of salary. This wouldn’t be too bad if tendencies were to spend only 75% of salary, but we all know that on average people tend to spend almost everything they receive.
The real challenge for early retirement is that as spending swells, the size of the retirement pot required to fund it becomes unreachable. As an example, saving 10% of your £20k salary in your twenties is reasonable. However if by the age of 50 you have risen to an after tax salary of £42k. If you still save 10%, spend 90%, the fund you would need to provide that much income would be £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 Saving 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.