Death & Taxes - 3 steps to an early retirement
I was recently interviewed about my life all the way back to when I was born. The goal was to find out anything that could have influenced my success as an independent financial advisor (IFA) helping thousands over the last forty odd years to aim for well-funded "want for nothing" retirements, early or otherwise
When you come from a small industrial town where most folks just scrape by – and where your granny single-handedly brought up a family of seven in a house of two rooms lit only by gas mantles and with an outside toilet shared by neighbours – I reckon there was ample early motivation within me to "get on" in life. To be much better off. And to help others achieve as well.
Maybe that's why I read avidly at an early age about setting goals and visualising results. I remember it being said that to turn goals into reality you also need to turn bad habits
into good ones – and keep these good habits constantly refreshed. Not easy! But that's probably why I got stuck in at my lessons at school, went to university and started my own business at the age of 28. And from then I committed to invest a quarter of my income in case the eggs in my business basket didn't hatch as expected.
My main initial goal was to be able to afford to retire early, perhaps at 55. I watched my dad work seven days a week in all-weather as a bricklayer until well into his sixties: enough motivation to make me stick to my plan. It worked. I could have retired at 55 but didn't. But it's having the freedom to choose that surely matters. Ask those who have no choice.
So my "Mission Possible" this month is to suggest three steps to take if you'd like the possibility of early retirement. Despite my comments above I'm not sure I'm the right person to extol the virtues of early retirement, seeing as I'm 70 now and still "working." My Board suggested I work a TWAT week – Tuesday, Wednesday and Thursday. Mondays and Fridays are supposed to extend my weekend to do what I fancy.
So far, however, I've chosen to come to work. That's if you count reading, thinking, writing and having fun as work. (And it keeps me out of the Scottish rain). So that's what I do for most of the week. As daft as it seems to others, I love what I do. No wonder my grandchildren think I'm not all there!
When I'm asked to speak to local business groups about investment, there's usually at least one cynic in the audience who asks "If you're so bloody clever at this why aren't you retired?" Good question. The sad thing is many of them don't believe my answer. It seems too few these days recognise passion or purpose. (Nor, for the record, do I play golf or spend my day obsessed by social media.)
Back in late 2008 in the Great Financial Crisis, I bumped into and old neighbour at our local opticians when we were having our eyes tested. He asked if I'd retired like him. I said I'd only consider it once our clients had recovered any recent investment losses, once the next bull market came along. He replied sarcastically that it was more than my eyes that needed testing – and followed up with his confident prediction there wouldn't be another bull market in our lifetimes. He was half right. He died before 6th March 2009.
To be honest, I don't like the words "early retirement." Never have. If I'm pushed I'll agree it's slightly better than "retirement" for obvious mathematical reasons. But both terms share an attraction quotient roughly the same as a Party Political Broadcast. Mention anything to do with retiring or pensions and most folks' eyes glaze over. Plenty of time to worry about that sort of thing eh?
Bad news and perspective
Well here's the bad news. Ask old timers what they regret most in life and many of them will say that they wished they'd started investing for their later years much earlier. Trust me, time flies by far too quickly. Older Baby Boomers will remember comedienne Hilda Baker, who was quoted as saying "When I was 40 I went into the kitchen to make a cup of tea. When I came out, to my horror I discovered I was 65." Judging by the various surveys reported by the media over the last few years it's obvious that far too many reach retirement financially unprepared. Umpteen surveys suggest the average private pension pot on top of the State Pension is no more than £50,000. Use that to buy a guaranteed inflation proofed income with protection for your partner should you pop your clogs too soon, and you'll be lucky to receive £150 a month before tax.
With only another £600 a month or so from your State pension it doesn't sound like it's going to be much fun in retirement for most of us, does it? And with savers still relying on deposits for income and "growth," despite almost zero interest rates for eight years, you can safely predict further financial misery looming for millions.
Yet a survey conducted by Prudential found that nine out of ten over-55s have bucket lists, citing things like cruises, living abroad and safaris, among other goals. Another survey found that 60% of workers hate their jobs so much they wish they could pack it in to begin ticking off their bucket lists. So what's stopping all these unhappy people? Not enough money saved up – that's what. Simples.
When I first started giving advice on investment 44 years ago, I thought all I had to do was pack my brain with enough knowledge on investments, pensions small print and tax reliefs, then improve the circumstances of those I came across and walk away happy. But it wasn't enough. Clients said they were grateful but wished they could more easily see what all this meant in real terms when they stopped earning. Most of them said they wanted to be sure they'd have enough to have the opportunity to retire early and be free. But where should they start?
STEP ONE – Don't ignore the Rule of 72
It's not a bad idea to do what I did. Start with a goal. Express it in today's money – otherwise it's as useless as an ashtray on a motorbike. Perspective is crucial. When I did my calculations there were no personal computers or smartphones. There were electronic calculators but they were the size of microwave ovens. Thankfully all you needed was a set of compound interest tables and to grasp "The Rule of 72". And that's still all you need today. Why complicate matters?
Understanding compound interest and the Rule of 72 focusses your attention on why it's crucially important to grasp the impact that inflation and different investment returns make to your quality of life in retirement. Sadly most folk just don't get it. So let's take what's happened from 1950 to 2016 comparing UK inflation, deposits (the Building Society Index with gross interest reinvested) and UK shares (Barclays Equity Index with dividends reinvested).
Starting in 1950 with £100 in each case, inflation averaged 5.25% per annum (yes really!), Building Society Index returns averaged 6.1%, and the UK Equity Index averaged 11.4% total return. If to match inflation you needed to equal £3,314, and to beat the Building Society Index return you needed £5,560, what do you think 11.4% per annum in equities produced? When asked this question, the vast majority of investors are miles out – which goes a long to explain why so few reach carefree, well-funded retirements.
£182,494! Fact. Go check the Rule of 72. Divide your net returns per annum into 72. And learn how long it takes to double your money. One percent per annum in cash deposits? They double every 72 years. Hmmm. That's why you should start as soon as you can and invest in assets for the long term. It's never too late either. Warren Buffet built 99.2% of his invested wealth after he turned 50.
STEP TWO – Apply the "Change Formula"
Once you've decided you need to build a retirement kitty of over £1 million, next up you need to work out where you stand right now. Start with a full money audit, warts and all. How much are your pension funds, property investments, stock portfolios, ISAs and deposits, and any likely inheritances worth?
Add it up. Deduct that from your retirement fund goal you've decided you want expressed in today's terms. Now look at that gap. And how many years you have left to plug it. Ouch.
Now it's time to have a long hard look at what's there and how effective it all is. Not a bad time to introduce our "Change Formula."
I've found that most investors are content with what they have even though it's obvious to others that relying on deposits and Cash ISAs is a guaranteed recipe for failure. The only way to challenge your current way of thinking is to become unsure. And that isn't easy when we all tend to have our own behavioural biases. Why not ask yourself "What do I believe to be true that's actually false?"
The best way for quick results is to apply the change formula: C= D+V+F+E.
Change = Disquiet + Vision + First Steps + Energy
If you don't have disquiet you won't be open to change. Then you need a vision of something measurably better. But that gap is often too wide emotionally. So introducing a first step is always helpful. Such as, "Having asked you these questions, established what may need to be changed etc., why don't I take away all these jargon filled documents and details, analyse them for you, and report back with a plan?" Phew, that sounds nice and uncomplicated. Most folks can cope with that.
So far so good. But what happens to most investors if left to their own devices? Bad habits re-emerge. And that's why most successful savers have advisers – coaches if you prefer – to keep their investor clients on track year after year. To stop them emotionally reacting to Bad News at Ten and other media interference that plays havoc with our brains' amygdalae. That's the panic button that keeps us "safe" in the herd which was probably helpful thousands of years ago – but not now.
STEP THREE – Take advantage of tax breaks
By now you know your goal in today's money. You've established how long you have left to achieve it. You're aware of the gap between where you are now and where you want to be. You've a much better idea about compound interest and the massive difference a few extra percentages can make to your retirement kitty.
Now it's time to stir in the advantages accruing from simple tax planning. Doesn't it make sense to maximise any tax breaks where available? If you could bundle up all your current deposits and investments, then restructure them in order of tax effectiveness, and only then invest in the most effective investments, wouldn't that make more sense?
That's why the majority of investors should concentrate first on private pensions, which are still an unparalleled tax haven. Every contribution is increased by the lovely HMRC before
your money's invested, at between 25% and 81% (depending on your tax rate). And if you're employed and your employer can be persuaded to chip in, that's more money for nothing. Once in the plan all investment gains roll up tax free. And "income" can be removed
later with minimal taxes if you take good advice. It's possible to avoid Inheritance Tax too. No Brainer.
Next up there are a whole range of plans that offer either some tax relief and tax freedom on returns (like VCTs) or simply tax free gains to draw down later as tax free income like investment ISAs. The annual significant Capital Gains Tax exemptions are also seriously underrated by long-term savers despite the fact they offer further tax free "income" opportunities.
We live in increasingly fraught times as investors. We are pounded daily with bad news and one reason after another why we should keep our money "safe." We can be easily pulled into the "safety" of the herd by a popular media who jump from one crisis to another day by day to catch our eye and sell more advertising.
If you want to be one of the few to reach financial freedom in perfect financial nick, recognising the benefits of an experienced independent eye to watch over you along the way, then maybe there's one more step to take: Go ask around and get yourself a coach. Better still, make it an experienced IFA