A lot of people know that the earlier they invest the better – however – many are unaware of how much money they actually need to be able to retire.
When retiring, you’ll want to have achieved financial freedom – where the income from your investments covers your living expenses.
One thing to note is that the amount you need to retire will entirely depend on your expenses. So, if you want to retire early, then you could consider lowering your expenses. A more lavish retirement will obviously cost you a lot more.
In this blog, I’ll talk you through exactly how much that figure will be for you.
Retirement Expenses
For this blog to be of more use – you may wish to calculate what you want to spend in retirement. Let’s break this down for what I think I’d spend as an example:
· Housing - £12,000 a year
· Utilities - £2,500 a year
· Food - £4,000 a year
· Car insurance + tax - £1,500 a year
I’d consider this a no-frills retirement – totalling £20,000 a year. If you were to add some meals out, expensive gifts and multiple holidays a year – this may then total £30,000 a year. And in my opinion, a very comfortable retirement, perhaps with a bigger house, would total £40,000 a year. These are the expense scenarios I’ll use from here on in.
The 4% Rule
The 4% Rule is something pretty well known in the financial world. The idea is that if you have a sum invested – you should be able to live off of that sum for the rest of your retirement, so long as your yearly expenses equate to 4% of it.
We can use this to work backwards – finding out how much money we need for different types of retirements:
· A £20,000 a year retirement requires £500,000 invested
· A £30,000 a year retirement requires £750,000 invested
· A £40,000 a year retirement requires £1,000,000 invested
How this came about
The 4% Rule was created using historical stocks and bonds data from 1926-1976. Prior to this, experts believed that it should be a 5% rule – meaning you need less to retire.
A further study was conducted by a financial advisor named William Bengen in 1994, due to his skepticism. He used the worst performing times in the market, such as the early 1930s and 1970s to stress test this rule.
His findings were that even in the worst possible market conditions, this rule was sufficient and provided enough funds for a 33-year retirement as a minimum. Even if you had the worst possible market timing.
The general rule of thumb is to have a portfolio that comprises of 60% stocks and 40% bonds when using this method.
Added Safety
When talking about retirement – we want to ensure that we’re completely safe. There’s nothing worse than having to go back to work in your old age. Not only this, I, and many of you reading, may want to aim for a longer retirement than 33 years. Therefore, we may wish to opt for a 3% rule.
If we were to use a 3% rule, this is how much we’d need to retire:
· A £20,000 a year retirement requires £666,667
· A £30,000 a year retirement requires £1,000,000
· A £40,000 a year retirement requires £1,333,333
How to get there
It’s all well and good saying you need a £1,000,000 to retire and live nicely – however, how can you get there?
Well historically the markets have returned around 7% a year after adjusting for inflation. So, based on this assumption – this is how long it will take to hit that £1,000,000 mark:
· Investing £1,000 a month – 28 years
· Investing £1,500 a month – 23 years
· Investing £2,000 a month – 20 years
Therefore, if you’re frugal with your money and earn a decent wage, there’s no reason why you can’t retire early!
However, one thing to consider is the power of compounding. If you were to take the last scenario, investing £2,000 a month for 20 years, you’d end up with £1,041,853 as your lump sum invested. If you were to continue for another 5 years, you’d have a staggering £1,620,143 – enough money to support a retirement costing £48,604 a year!
This shows us how important it is to invest as early as possible and let that money work for you! When it comes to investing – it’s important to take advantage of any incentives available. Account churning is a good way to do this – see my blog on it here if you’re interested.
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