Yahoo Finance 6 ways to guarantee an early retirement
For a growing number of Australians, leaving the world of work earlier than planned is no longer just a pipe dream, but a very imminent reality.
Singles and couples - kids or no kids - ranging in ages from early thirties to late forties across the country are swapping inflated lifestyles, consumer debt and a ‘bigger is better’ mantra for frugal living, safe investments and passive income streams that completely cover their cost of living.
This movement has a name: Financial Independence Retire Early (more commonly shortened to FIRE), and it’s exploding in popularity down under, rendering the traditional notion of work as optional.
The premise is fairly simple.
Eliminate debts as quickly as possible, tame lifestyle costs to free up disposable income, then use a considerable chunk of that newfound cash flow (anywhere from 30-60%) to invest in low-risk, moderate return investment vehicles like shares (particularly exchange-traded funds and listed investment companies), bonds or healthy yield investment properties, among others.
How long it takes to achieve depends on the amount you want to live on, as higher figures require more capital to produce the desired income.
As an example, a passive income of $50,000 per year could be generated from an investment portfolio equalling $1,250,000 (assuming you are only drawing 4% of its conservative annual 7% return, for inflation).
Can’t live on $50,000 per year? Figure out what a comfortable number would be for your situation and apply the same logic (annual expenses x 25 years = your retirement figure, with a conservative 7% annual return).
Of course, your portfolio might return much more than 7%, and inflation may not be as high as 3%. In this case, you can adjust accordingly - enjoying that extra income - but it’s a general rule to follow to ensure you never run of money.
The main outcome is that you simplify your life, and therefore your expenses, to a level that is within your means, making it easier to save and invest hefty sums over a short timeframe. Thousands of Australians already have (or are on the way) to achieving FIRE.
Here are six ways they’re guaranteeing their early retirement, and you can too.
Commit, budget and get started
Firstly, they make the decision to pursue financial independence - and they commit to it, creating a plan for how they’re going to reach their goal.
Whether it’s lean FIRE (retiring with a smaller amount saved up), fat FIRE (retiring with a cushy number) or somewhere in the middle, they start mapping out their process, budgeting their cash flow and learning how to invest.
This can include starting to understand their personal comfort levels and risk profile around owning different investment vehicles. Some people much prefer to carve out their wealth in property, others opt for the liquidity of shares, and others are okay with an equal spread of many asset classes.
They understand how superannuation will come into play later on and plan for that as well. Even if they can’t start investing straightaway, due to debt or other circumstances, they at least begin the research process, raising the bar on their financial knowledge in anticipation of being able to jump when the time is right.
Eliminate toxic debt from their life
Next, they begin to tackle any debt they might have with unprecedented velocity. Whatever debt reduction philosophies they subscribe to, they ramp up their efforts in order to get rid of their number as soon as possible.
With many toxic and personal debts, not only is the interest charged usually much higher than the real return potential on various traditional investments, but it’s a psychological burden that keeps many people inert from taking action. It may even impact them from being able to access the capital required for certain investments, like home or business loans.
Normalise a savings rate of at least 30% of their annual income
A fundamental step in the process of achieving FIRE is normalising a savings rate that might seem completely unachievable at first: at least 30% of annualised income.
This step goes hand-in-hand with reducing expenses so that there’s more to play with, and for some hardcore FIRE followers, saving anywhere from 60%-80% is their norm.
If an average Australian yearly wage sits at $84,968 (2019 ABS data, before tax), that represents at least comparatively $25,000 (before tax) a year being squirreled away.
The more you save, the faster you get to your magic figure for drawing passive income. You may be comfortable bringing your retirement age forward only a decade, or you might want to down tools by 40, or even 30 - remember, this savings rate is going to dictate that.
Build an emergency fund equating to a years salary
One thing that’s for certain: life happens, and sometimes, it’s expensive.
Creating a "life happens" fund equating to one years’ worth of annual expenses means that FIRE followers don’t have to go back to old habits in times of financial strain, like losing a job, falling ill or having to fork out for costly, unexpected repairs on something.
It’s not only about avoiding the debt trap, but also prevents them from selling their hard-earned assets in a time where the market is performing poorly - as it so often does in cycles. In that instance, they’d have to sell at a lower market value, making a loss, or if the gain was minimal, may have to pay a capital gains tax that eats into an already small profit margin.
Saving an emergency buffer of cash (even if it’s sitting in an offset, redraw facility or high-interest savings account) equating to a years’ worth of salary is a tick in the box.
Establish their first passive income stream, then build
Passive income is income that generates while you sleep. In short, you don’t need to do anything in order to acquire it. Australians that follow the FIRE methodology know that their wealth will come from passive income streams, being the diversified asset classes that generate their income.
So, they get to work on building them. Whether it’s share dividends or rental yield, interest from a bond or term deposit, or creating something that pays ongoing royalties or ad revenue, they’ve hit step number five when they’ve established their first passive income stream.
From there, they build. Some investors choose only to focus on one investment type, but most will diversify in order to spread their risk (for example, a property bubble correction can mean major short-term losses in the case of a property-only portfolio).
Transition from a negative to a positive net worth
Finally, after their hard work starts to manifest, they calculate that they have moved from a negative to a positive net worth. Their assets (what they own) now exceed their liabilities (what the owe).
Even if it’s as symbolic as ticking over to owning 51% of their home instead of 49%, they actively track and monitor their net worth to see it grow, and continue to keep an eye on the numbers, watching the compounding effects of their financial decisions grow.
From here, it’s often a straight shot to watching their annual family income come from their investments, without them having to work another day to enjoy that money. However they choose to spend their time from then is completely up to them, and that’s the magic of the movement.
Like the sound of an early retirement? Michelle Ives writes about money, budgeting, investing and her journey to financial independence and retiring by the age of 35 at That Girl On Fire. You can also follow her journey on Instagram at @thatgirl_onfire.
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