As you guys know, the focus of our podcast is to help you gain choice through the achievement of what I’ve called Financial Autonomy. A very close cousin of the idea of financial autonomy is Financial Independence. Financial independence is the concept of owning assets that produce income such that it is not necessary for you to engage in paid employment to produce the money you and your family need to live.
I’m sure most listeners are familiar with the FIRE acronym. As we’ve canvassed in past episodes, whilst this is a cool and catchy acronym, most advocates of this philosophy have come to the realisation that the RE portion, the retire early portion that is, is probably misguided. The financial independent piece though, the first half of the acronym is a valid pursuit, and that’s certainly something that aligns well with us here at Financial Autonomy.
The bulk of the people we work with are in their 40s and 50s, and so that’s why this week I thought I’d share with you the key strategy elements we use to help people like you achieve financial independence. I hope you find it useful.
Why?
The first step in working towards anything is clarity around what it is that you’re trying to achieve and perhaps most importantly, why. The most common reason people give me for pursuing financial independence is to escape a highly stressful work situation. They’ve reached a stage in their career where their skills are in high demand and consequently they are well paid. But the employer very much wants their pound of flesh, and whilst it’s exciting and rewarding to begin with, those with the ability to reflect and perhaps project forward, realise that the work demands are not sustainable long term.
Another “why” we’ve seen a bit of recently are clients wanting to be able to step back their work commitments in order to help care for their ageing parents.
Reflect on why it is that you are pursuing financial independence. If you have a partner, discuss it with them. Do they share your vision for the future?
The strategy to achieve financial independence for a person whose goal is to be able to leave the corporate world and live on a small farm in the middle of Tasmania is very different to someone who wants the option of being able to exit their stressful teaching job and run a furniture restoration business. And it might be different again to someone who wants to be able to spend 4 months of the year living in Nepal each year.
Clarity on your goals then, is an essential first step in you achieving financial independence, because it has a huge impact on the appropriate strategy to be used.
Lock in the long term
Australia is fortunate to have a robust retirement income system in the form of superannuation. Your goal of achieving financial independence in your 40s or 50s likely means earning less income once you reach your goal. Less income, perhaps even no income, means your superannuation savings growth slows. The ultimate value of your super will be less once you reach preservation age of 60, compared to had you stuck to the traditional path.
In pursuing financial independence then, a key initial element is ensuring that your superannuation savings are on track to cover your needs post age 60. We can check this via financial modelling.
If we determine that upon the achievement of your financial independence goal, let’s say at age 50, your superannuation won’t be of a value that, when compounded through to age 60 is able to generate sufficient income for you, then you can take strategy steps such as salary sacrifice to boost your superannuation savings now.
Financial independence is a lot easier to achieve if you only need to solve for the window between the achievement of your financial independence goal and age 60. If we can say that from age 60 onwards your superannuation will cover your expense needs, then financial independence becomes a lot more within reach.
Clear debt
As with ensuring your superannuation account is appropriately funded for later in life, another key enabler to achieving financial independence is the clearance of debt. Owning a roof over your head, with minimal ongoing costs, is a huge help. For many people, their mortgage repayments or rent payments are the largest single expense in their budget. Remove this and the income needed to survive is considerably less, which gives you huge choices.
Focus therefore on paying down debt makes clear sense when you’re pursuing financial independence. But paying down debt isn’t the only element. You could reduce debt by shifting to a less expensive home. Perhaps once the kids have moved out you downsize from a large family home to a smaller apartment or unit. Or maybe you move from the inner city to the outer suburbs or a rural area.
Another approach we see is where a client might sell down an investment after they reach their financial independence goal and retire or semi retire, and then use the proceeds to clear any debts that they have left. The timing of this, being after they have exited peak earnings, is so as to minimise the capital gains tax impact.
Invest to provide for the pre-60 phase
As mentioned in item 2, when we help our clients plan for financial independence we generally think about it in two phases the pre age 60 phase in the post age 60 phase. I actually dig into this in a document on our website that you might want to take a look at. I put this together a few years ago, so it has our old logo and the presentation is perhaps a little basic, but the content remains spot on. If you go to the Tools and Resources page on the Financial Autonomy website and scroll down to the Early Retirement for Australians document. It’s a free download. In there we explore the different phases. I think you might find it useful.
So the phase of your life after age 60 will be provided for predominantly via your superannuation savings. For you to achieve financial independence in your 40s or 50s however we need to solve for how you will generate income sufficient to meet your expenses in the period leading up to age 60. Likely, this pre 60 phase will be funded, at least in part, by investment wealth.
Dividend income from your share portfolio, and rental income from an investment property are front of mind when it comes to investments providing for your income needs. But income from your investments need not be the sole method of meeting your needs. This is where adequately funding superannuation is so important to financial independence. With the secure knowledge that when you hit 60, you have this bucket of savings that you will be able to access and look after you into old age, you can afford to sell down your other investments in your 40s and 50s to meet your living costs. Now clearly you need to have crunched the numbers on this well to make sure that you make it to age 60, and even when it looks like you are on track, you need to be re-verifying those numbers each year to ensure no nasty surprises at age 57 or 58.
But provided your plan is well constructed and thought out, drawing down on your savings is a totally valid way in which to achieve financial independence. As a simple illustration, if your goal was to achieve financial independence at age 50, and you wanted to be in a position where you generated no employment income whatsoever, then you need to cover your expenses for 10 years. This is on the basis that at age 60 you have confidence that your superannuation will kick in and produce the income required for the remainder of your days.
So we’ve got a 10 year window that we need to cover, and for the sake of easy maths, if you said you needed $100,000 per year, then were you to have $1 million of investment assets at age 50, you could declare yourself financially independent, in the knowledge that you could simply pull out $100,000 from your $1 million investment portfolio each year, and be covered for those ten years. Now of course there’s tax and inflation and all the other complications which we need to think about, but the point is it is reasonable to draw down on capital to achieve a financial independence goal, provided you have ensured that your post age 60 phase of life is adequately funded.
This is really important because if you think about the amount of assets you would need to generate $100,000 of investment income without using any of your capital, it is huge. If you assumed a 4% income rate, then you would need $2.5million of investment wealth in order to produce that level of income. That requires a lot of saving and investing to achieve. It may well be unachievable.
Thought of another way, financial independence can be achieved a whole lot earlier if you can engineer your situation such that you can afford to draw down on your investment wealth, rather than only be able to gain the choices in life that you’re pursuing when you’ve accumulated a much larger amount of wealth that can meet all your needs through passive income alone.
Other income solutions
This is where the financial autonomy concept and the strict definition of financial independence diverge. Technically, for you to be truly financially independent, you would have no need to get out of bed in the morning in order to cover all your living costs. Financial independence then means you hold investments, usually shares and property, that pay income out to you without you needing to lift a finger.
Financial Autonomy differs from this in that it is about you gaining choice. So long as you’re doing what you choose to do, I’m not too fussed how you generate the income. For instance if you determined that you needed $80,000 to live, and a piece of the puzzle in achieving that is to work three days a week in some role that you quite enjoy, then that’s completely consistent with achieving financial autonomy, even though it doesn’t meet the definition of financial independence.
For most of the people we work with, the financial autonomy approach is far more sensible. Indeed this is probably where the retire early portion of the FIRE acronym went wrong. Most of us don’t strive to build wealth and autonomy for the purpose of then sitting on the couch and doing nothing. The whole reason for pursuing this goal is to then have the freedom to pursue things that interest us, and quite often those interests produce an income.
Often I get clients who enjoy the underlying nature of their profession, but they’ve been promoted into a role with a whole bunch of responsibilities that then create huge levels of stress that just become too much. What they seek then is to be in a financial position where they can turn down the promotion, step back to just doing the thing that they enjoy and are good at. Potentially work something less than five days a week. But quit work altogether? That’s not the goal of most people that I see.
So if you’re happy to embrace my idea of financial autonomy, then solving to achieve independence in your 40s and 50s need not necessarily require you to have huge investment assets. Perhaps, as I’ve just mentioned, it’s simply a case of down grading your work commitments and simplifying your life such that your lower income is enough to meet your needs.
As mentioned earlier, clearance of debt can be a key enabler here. Particularly as you get into your 50s, it’s quite possible that your kids are moving out, and if you also own a debt free home, then it’s quite likely your total annual expenditure need not be enormous. With your post age 60 phase well funded, perhaps you can achieve the independence and autonomy that you seek simply by changing to a more interesting or less stressful role, without any need for investments at all. Alternatively it could be that your investment income generates a portion of the money you need, and you do some employment income to cover the rest. I have a couple of clients in the IT space who do contracts, usually three to six months each, and have breaks in between times. This seems to give them great flexibility and independence.
So this 5th and final item then is just a prompt to think a bit more broadly about how you can achieve financial independence. It need not meet the technical definition which requires a lot of sacrifice in order to build up very large investment wealth. It may be simply reaching a point in life where your living costs are a bit lower, and then only working enough to cover those costs.
Well that’s it for this week’s episode – 5 Strategies to Achieve Financial Independence in your 40s and 50s. I hope you found it useful. Do check out that free download from our website, again it’s on the tools and resource is page and is called – Early Retirement for Australians.
And of course as always, keep in mind that helping people achieve financial independence is what we do everyday for our clients, so if this is an aspiration that you hold, and you’re looking for a partner to help you get there, please do book an appointment and let’s have a chat.
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