Current FI target: £667,000. Workings provided below.
Welcome to the first proper blog post. Your best bet is to start over at the “About Us” page if you haven’t already read it, to give you a broad idea of what our intentions are. When you’re happy, let’s being at the beginning by working out our baseline.
How much do we have to start with?
Alright, so the basic goal is to be self-sustaining such that we have the freedom to do what we like with our lives. Pretty straight forwards so far. However, before we can get too embroiled in the intricacies of investing, compound interest, safe withdrawal rates and all the rest, it would be salient to first establish what Ground Zero looks like. I sense a spreadsheet in the making!
Having spent the last several years trying to eek out student loans from one instalment to the next, I have already been running a relatively crude spreadsheet keeping a track of my income and expenditure. Initially it worked just fine – I was only looking after one student bank account and one cash ISA, but over the last couple of months I have been steadily dipping my toe into the likes of P2P lending, matched betting and the like in order to get my money doing something for me. 0.95% interest on the cash ISA just wasn’t cutting it anymore.
What I need to do first of all, therefore, is to establish our baseline by collating all of both mine and my partners accounts into an easily readable table. Perhaps something a little bit like this:
As I mention in the “About Us” section, we both have a pretty frugal nature. The numbers in the table show the product of 20+ years of saving up all that birthday money, Saturday job income, spare student loans etc and the result is both surprising and pleasing. Future articles will delve into the details of Lifetime ISAs, Ratesetter* and the rest, but for now we are happy with just having a figure that we can quote and track as it changes month on month.
Knowing what we have to begin with is a good start, but that’s not all we need to know. The next question to answer is: how much money does one need to live off the interest indefinitely?
How much do we need?
In my head, I’ve broken it down into two large chunks:
1. Buying a house and paying off the mortgage
It makes sense for me, at this stage of my life, to first of all save up for a house deposit and then subsequently savings will be split one way or another between paying off the mortgage ASAP and building up what will be the pension pot. Saving up for the deposit is straight forward: we will squirrel as much money as we can before the time comes to put it all down on red… err… I mean the house of our dreams. Owing to the relatively rigid and predictable structure of the remaining time on our degree and the training pathway for our profession immediately after graduating, I can say with some confidence that it will be approximately 5 years starting this process until we can make the switch from rental accommodation to buying a home. That will be the first time in our training that we will have the opportunity to settle in one location for longer than two years. It also gives us a good amount of time to work on building up that deposit.
2. Building up a “retirement fund” yielding enough interest to live off
This is phase 2 of the grand plan. Once we are firmly on the property ladder, we can start directing our energy towards the ultimate goal securing a satisfactory ‘freedom fund’.
Initially, I thought this would be the hardest calculation, but as it turns out, the formula for working out the necessary size of said fund is simple enough for even me to comprehend. The key number you need to work it out first of all is your annual income requirement that you are happy to live on. Remember, this number excludes rent/mortgage payments as the idea is to own your house outright by this stage, but it does include everything else that you need to live on a daily basis. You can also scratch off costs directly related to employment – commuting would be an example of that.
For us, I can look back at previous years’ figures in my budget spreadsheet to see exactly how much money I spend each year (excluding rent, for this calculation).
So, this table shows that my most expensive year in the last three years was just shy of £5,000 – we can double that to allow for my partners expenses, bringing our annual income requirement to £10,000. However, we don’t truly plan on living like students forever, so it would be reasonable to increase the number to account for things like running a car, maintenance on the house, funding hobbies, travel etc. I don’t think it’s unreasonable to now suggest a ballpark figure of £20,000 per annum as a comfortable amount with a bit of headroom.
Brilliant! Now what?
Conventional wisdom on t’internet seems to suggest that withdrawing no more than 4% of your retirement fund per year is a sustainable rate in order to protect your capital (the so-called “safe withdrawal rate” [SWR]). Since we intend to withdraw from this fund over a longer time period than most would and after having done some intense research on where this 4% figure comes from, it seems sensible to lower this number to 3%, just for the sake of a bit more security. Better to have and not need, than to need and not have – particularly in the context of financing the rest of your life.
Now we’re ready for the equation:
Desired Annual Income x (1 divided by SWR) = Retirement Fund
Plugging in our figures:
£20,000 x (1 divided by 3%) = £667,000
There we go. A retirement fund of £667,000 with a real (post-inflation) rate of return of 3% – below the historical average, hence the extra buffer of security – will afford us a perpetual, inflation-linked annual income of £20,000. Easy peasy.
Let us assume for one moment that a nice house out in the countryside will cost £350,000, add that to the retirement fund of £667,000 and all we need is… ah… a cool £1mil.
Better start saving up…
Thoughts or comments? Let us know in the comment section below!