Welcome to our second reader case study. This is where I encourage you, the readers, to write in with your situation that you want looked at.
I do my best to answer your questions and provide recommendations for your situation. I also encourage you to post your thoughts in the comments sections to help out our subject.
Today, we have Stu (not his real name) wanting to know if he can reach financial independence before the age of 55 (7 years).
Stu’s email in bold.
My financial goal is to be able to stop working (if I so choose) by the age of 55. I'm turning 48 next week.
I live in my own freehold house, worth around 380k-400k.
I've got 300k invested, one half in Kiwisaver (growth fund), the other half in managed funds (medium/high risk). I know that this 300k will most likely turn into over 1 million by the time I reach 65.
I'm drip saving $1,000 a month at the moment. I'm currently earning about $40k gross a year, and looking for ways to increase this.
I'm self-employed, my income varies. Let's work with a post-tax income of $37K.
My annual expenses are:
Rates (incl. water): $2000
House 400k (freehold)
Kiwisaver 142k (Milford KiwiSaver Active Growth 100%)
Investments 163k (Milford Dynamic Fund 39.75%, Milford Trans-Tasman Equity Fund 30.31%, Milford Balanced Fund 17.28%, Milford Diversified Income Fund 12.66%)
I’m single with no kids. My ideal retirement would be a 12 month summer. Travelling the world in chase of the sun. Half a year in Europe and half in New Zealand. I would rent out my house for approximately $15K a year after costs. I would get a campervan and explore NZ. I would still be able to do some work now and then, earning $1000 a month, all I need for that is power, a laptop and internet.
What action should I take, starting today, to work on my goal of retiring 10 years before my superannuation starts?
Monthly income (after tax)
Investments or savings
Mutual funds: $163,000
Total assets - $695,000
Net worth - $695,000
Monthly surplus - $4,589
Another Your Money Blueprint reader that is doing very well for themselves. A paid off home and a good investment base. Looks pretty good on the surface, but lets dig a little deeper.
Stu said “I know my $300K invested will most likely turn into over 1 million by the time I’m 65”.
Before proceeding I just need to dispel this belief. Remember, Stu wants to have the choice to stop working at age 55, should he want to. This will mean no more contributions to any accounts. In fact, it will mean withdrawing from his accounts.
This will result in an amount at age 55 that is no where near 1 million dollars.
The other side of this assumption is that Stu is what you would call a “growth based investor”. He is invested in investments that carry significant risk, especially over the short term. He is planning to start tapping into this money in 7 years, and it is very possible that stock markets can lose money over this short of a time period.
Will I have enough to retire in 7 years?
A rough guideline to determine your retirement readiness from a financial perspective, is the 4% rule of thumb. Where we multiply your annual spend (expenses minus income) by 25.
In Stu’s case this is $25,000 (current annual expenses) minus $15,000 (projected rental income) = $10,000. You need to find a source of investments that can fund $10,000 a year for the remainder of your life. Using the rule of 25 or 4%, then you will need at least $250,000 in accessible investments.
There is one problem with this equation though. Your current annual expenses are quite low. You don’t have a mortgage, so your cost of living in New Zealand is low. Your retirement plan where you spend half a year in Europe and half a year in New Zealand looks to me that it will cost substantially more than your current lifestyle.
When calculating your retirement readiness, it is imperative to base it on your retirement spending. Not your current levels of spending.
There is some unknown here, but Stu predicts new annual expenses of $40K.
Assuming an annual spend of $40K and rental income of $15K, Stu will need $25K x 25 = $625,000. This is on top of your house.
In order to get this portfolio with a conservative 4% return over the long term and your current annual savings, it should take:
About 9 years to reach your target of $625,000 based on $40,000 a year expenses in retirement. Age 57. A little bit longer than you may have hoped, but note I have not included NZ Superranuation or any work related post retirement income. This is supposed to be an analysis of true financial independence after all.
If you can survive on $35,000 a year expenses in retirement, then you will need $500,000 which is only 6 years away. Age 54
I have used a conservative 4% portfolio return because you should start thinking about restructuring your portfolio allocation.
Not including Kiwisaver, you currently have 85% of your investments in growth assets. Just 7 years away from needing them I would recommend reducing your exposure to growth assets considering this shorter timeframe. A big loss in the markets now could be devastating for your plans, since you have such a high proportion in growth assets.
What if you sold your house, instead of renting? Would that make a difference to how soon you could pull the plug from full time work. Lets assume $380,000 in your hand after the house sale at age 55. You won’t have the $15,000 a year income anymore, but your investments opening balance will be $380,000 more. Your annual expenses of $40,000 would now need a portfolio of $1 million.
Much of the sameness really. At age 57 you will have $1 million. Same as in the rent out the house scenario. If house prices go on a bit of a run over the next 7 years, remember you have this option and could be worth considering. In saying that, real estate passive income adds an extra layer of protection to your diversification.
I am also a fan of having at least a 1-2 year cash buffer, where you hold 1-2 years worth of expenses in a liquid cash account. This will provide me with peace of mind in retirement when the markets are falling, knowing I have that to tap into instead. Just my preference, as I like to stress test my retirement. But worth considering how big a buffer you would like and how much longer you want to work.
The good thing about this analysis is that we haven’t even considered Stu’s potential business in retirement that would return $12,000 a year. We also haven’t included NZ Superannuation payments. I always tend to plan on the conservative side. If those both work out well for Stu though, he will be looking at a very comfortable retirement. Stu will know more about the likelihood of both scenarios as he approaches age 55.
The 4% rule of thumb is not an exact predictor of your retirement success. It is as good a starting point as any though. The key is to be prepared and remain flexible. When markets are down for example, don’t spend as much that year. If there are several bad years in a row, consider some part time income.
If Stu can earn some extra income over the next 7 years he can speed up reaching his goal.
I haven’t calculated inflation. My calculations for the next 7 years were based on the fact that Stu’s income would increase with inflation, balancing each other out. If Stu’s income is not likely to increase with inflation, he will need to recalculate his required savings based on an inflated annual expenses prediction. $40,000 in expenses now, may be $45,000 in 7 years for example.
When retirement planning, there is a need to separate liquid (easily accessed) investments from non liquid (such as locked in Kiwisaver) investments. This is to make sure the early retiree has enough accessible cash to use before they have access to the locked in investments from Kiwisaver. This case study did not have to worry about that since he has enough to carry him through to age 65 if he sticks to the spending plan and is appropriately diversified.
Stu is in pretty good shape. He currently has a great base to achieve his future goals. He really just needs to continue contributing $12,000 a year for the next 6-9 years depending on whether his retirement expenses are $35,000 or $40,000 a year.
It’s important Stu has access to cash when he retires. That being said, he should keep contributions to Kiwisaver to the absolute minimum. Enough to get any employer or government contributions, but no more. His focus should be on his accessible bond and share investments that he will be relying on between ages 55 and 65. Stu has enough in Kiwisaver for compound interest to work its magic without worrying about contributions now.
Such is the importance of this portfolio, Stu may like to consider his portfolio allocation and move from a growth portfolio to a more conservative or balanced portfolio. It is still important though,to keep a good proportion of growth to help the portfolio beat inflationary pressures. The cost of living increases as we age, and its important to have a diversified portfolio that can at least keep pace with inflation, while minimising losses. You can read some tips on how to do so in my investing series.
Stu’s plan involves multiple sources of income which is great for risk minimisation in retirement. He has interest from bonds and savings. Dividends and capital growth from stocks. Rental income. Potentially business income as well. This will serve Stu very well, especially during tough economic periods.
This case study goes to show the impact of diligent savings over time and keeping expenses low. Stu’s income is not the highest going around, and he has shown great discipline. He didn’t buy too much house with too big a mortgage and now he is reaping the rewards.
That’s all for today. If you’d like to be considered for a case study, feel free to flick me an email.
Chime in with your comments or suggestions for Stu below.
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