Many young people (like, in their 20’s and 30’s) do not have a plan for their financial future — they’re too busy having fun! I was exactly the same! It seems that most people who plan for retirement do so in their 40’s or later, if at all.
So, today I felt inspired to write this short piece explaining a very basic strategy for how you can retire early, with financially independence. It’s important to understand that only 1% of people achieve this. Most people will become dependent on the government or their children to some degree after they retire, and/or be forced to live very frugal lives. However, if you are like me, you want to travel a lot after you retire, stay in nice hotels, and always be able to afford whatever things, food, experiences, medical care, etc., that you want or need.
Of course, there are millions of ways to make more money, and you can do that, but this is a very basic strategy to get you thinking. It assumes a very conventional career path: get a degree, work at a salaried job until retirement (as early as possible). You can use this as inspiration or a starting point.
- Get a degree and put everything into getting the best grades possible. Commit to earning honours and/or masters if you can.
- As soon as you start earning money, learn to live on 80–90% of your gross income.
- Purchase your own house and pay it off as soon as you can.
- Set up a simple and reliable investment portfolio that will provide your retirement money, and pay into it every month.
If you’re an entrepreneur, just start your company now; this message doesn’t apply to you!
If you still have the option to do so, getting a good degree is a really good plan, because it determines your starting salary. The higher this is, the fewer years you’ll need to work for.
Avoid working during these years if you can, and put all efforts into getting the best grades possible. If you can get honours or a masters degree, do it.
Most students won’t be able to save or invest much money while studying. If you can, then you should, but otherwise just commit wholeheartedly to getting good grades. You can focus on financial independence when you’re getting paid.
After your degree, continue studying and learning more all the time, and always try to be as good at your job as possible, because then your salary will keep going up during your working years and you can retire much sooner. Your income is determined by the value you bring to the market.
Once you start working, get into your own property as soon as you can. Start with something cheap. This is your first home, not your last/dream home.
Let’s say it will cost $300,000 for an example. Your deposit will be about 10%, or $30,000. If you can get a first home owners grant, this will reduce the amount you need to save by about $15,000.
Read at least 5–10 articles online about buying your first home in your state or country. Then go to 5–10 banks and speak to their loans officers to talk about how much you’ll need to save. They’ll be helpful because it’s their job to lend money.
This will tell you most of what you need to know about how much money you need to save, and it will really inspire and motivate you. You can always go back any time to the loan officers you like and ask them more questions — they’ll be happy to help you get into your own home. Banks have the whole process streamlined.
From then, put 10–20% of your salary into a savings account to save up however much you need. Use the highest interest rate savings account you can find. At the moment in Australia this is about 2.85% (ME Bank Online Savings).
Even living on 80–90% of your salary you’ll still have more money than when you were a student. It’s just a matter of discipline.
If your starting salary is, say, $60,000, then you’ll get about $3,750/month after tax (estimated about 25%). If you put 10% or $375/month of this into a savings account, with compound interest it will take about 3 years and 2 months to save your $15,000. If you put 20% or $750/month in, it will take about 1 year and 8 months.
If you start on a higher salary, or your income goes up during this time, or you can do this with a partner, then obviously you can achieve this goal more quickly.
Once you have your first property, the money that you used to spend on rent is now going to your mortgage repayment. This remains your money. You are now paying rent to yourself. The money stays with you, in the form of equity in the property. So you are already way better off. A house is like a savings account in this regard. Sure, some money is going to the bank to cover interest, but the property will probably also go up in value over time. (You can increase the amount that your property goes up in value by purchasing in an area that is likely to soon be gentrified, and by improving the property.)
From here, about every couple of years, get your property valued, and calculate how much equity you have. You can use this as a deposit on a new place. Every few years, upgrade to something better, in line with your salary, which will determine the mortgage repayment you can afford. Talk to the bank and they will tell you what you can afford. Expect to upgrade your primary dwelling a few times during your working years, until you can buy or build what you actually want.
When you are finally living in your last/dream house, pay it off as fast as you can. You want to have it all paid off before you retire.
A common strategy is:
- Start with a one or two bedroom apartment to live in while single.
- Get a bigger place when you get married or have your first kid.
- Get a bigger place when you have 2–3 kids.
- When the kids are all grown up and moved out, move into a smaller place for you and your partner to live out your retirement in. Selling the family home and downsizing can be a good way to free up $100,000 or more to invest.
Before you bought your first place you were paying rent and saving 10–20% of your gross income for your house deposit. Once you have your first home, that 10–20% can now be invested. This is your retirement money.
As a rule of thumb, ordinary low-risk investments will grow about 5% per year. Once you retire, you’ll live on this 5% annual growth. Before you retire, this money will be reinvested, to take advantage of the “magic of compound interest”.
Let’s say you want a retirement salary of $100,000, which is 5% of $2 million. This is how much you’ll need invested in order to live on $100,000 indefinitely.
Don’t be intimidated by the amount. With compound interest, it’s quite achievable.
Let’s assume you start investing $375/month. Let’s also assume that every year your salary goes up by about 10%, so you increase the investment amount by 10% as well. At a steady 5% growth rate, compounding, you’ll have your $2 million in 34.5 years.
Making the same assumptions, if you start with $750/month, it will take 28 years.
So, if you start university at 18, start work at 22, buy your own home at 25, and invest for 28 years, you’ll be able to retire financially independent at 53. That’s more than 10 years earlier than most people, and you’ll have a really good, cruisey, fun life for the next 30–50 years, without ever needing financial assistance.
How to invest? Perhaps the simplest and best approach is probably to follow the “All Weather Strategy” created by Ray Dalio, one of the world’s most successful investors.
- 30% in domestic stocks (e.g. index fund)
- 40% in long-term bonds
- 15% in intermediate-term bonds
- 7.5% in gold
- 7.5% in commodities
This portfolio is designed to perform well through all kinds of economic ups and downs. You rebalance the portfolio every year, which means moving money from higher-performing assets to lower-performing ones, to make the percentages the same as above.
There are simpler investment strategies, but this is believed to be one of the best ones for people who aren’t professional investors. It might seem a difficult thing to set up an investment portfolio like this, but it’s not. Just read articles and books and ask questions until you know what to do.
After 65, you can use an annuity to provide you a regular income for rest of your life. So you would basically cash in all your investments at this point, and hand over most or all of it to an annuity provider.
There are lots of different options for how you want to set it up. As a simple example, if you invest $2 million in a lifetime annuity with Challenger, and waive the option to withdraw the funds, you’ll get paid about $110,000 per year (increasing with inflation), for the rest of your life.
This is a really low-stress way to set up your retirement.
Take good care of your health (vegan whole foods diet, no drugs, exercise every day, it’s not rocket science) and you’ll live a long time, and if you set up this strategy you won’t have to work for most of that time!
It may seem like 30 years is a long time to work for, and it is. But remember, most people work for longer than this, and they still don’t retire financially independent.
Besides, there are lots of things you can do to shorten the timeline.
- Learn to live well on less money, so you can save and invest more. Lower your expenses using a variety of strategies.
- Bring in extra money with an online business that you can work on in the evenings, or rent out rooms in your house, etc.
- Be really good at your job and get promoted, so your income goes up more than 10% per year.
- Become an entrepreneur or property investor or developer.
Make sure you understand compound interest. $100 invested for 30 years at 5% growth is worth almost $450. Every dollar you invest now is worth much more later on. Investments normally grow more than twice as fast as inflation.
Don’t get overwhelmed. There are plenty of free articles and cheap books that teach all this stuff 🙂