How much of your income each month do you contribute towards achieving your financial and lifestyle goals including retirement?
Every employee already contributes 9.5% of their gross salary towards their retirement savings in the form of compulsory super. But super is just not enough for most people. Firstly, depending on your income level, working lifespan and super investment choices, your super might not be worth enough to fund your desired lifestyle in retirement. Secondly, if you are solely reliant upon super to fund retirement, you must realise that you are putting your entire retirement plan in the hands of the government and as they are constantly changing the super rules they will decide when you can access it.
You have probably heard of the financial advice “pay yourself first” which means you should make saving or investing a portion of your income a priority before anything else. If you think you don’t have any income to invest, you probably do… read on.
How much income should I be contributing?
I believe if people get into the habit of contributing 10% or more of their after tax income towards saving for the future they will be able to retire early. When I say ‘save for the future’ I refer to their financial goals – call it retirement, financial freedom, having the flexibility to work whenever you want – whatever.
How much you save (5%, 10%, 15%, etc.) will depend on your particular circumstances and goals. But you need to pay yourself first and you need to be super-disciplined with doing so.
I often help clients work out what their strategy is and how much they need to allocate towards investing so if you need help, please reach out to me. But the first step is making a commitment to yourself about how much money (per week, month or year) you want to set aside for your future. Do that now.
Where do I get the money from?
Most clients I meet don’t realise or know exactly how much they spend on living expenses. If you don’t know where your money is going, how do you ever think you will be able to get ahead and successfully implement a realistic retirement strategy? Your first step must be to review the past three months of credit card and bank statements and work out how much you spend and what is left over. If you do this and the amount is higher than you expected (or want it to be), you then need to dig deeper (see below). I suggest undertaking this exercise every 6 months or so. That way you can keep tabs on your expenditure and make adjustments wherever necessary. Remember, all I am suggesting is a high level review – you don’t have to count every dollar and cent if you don’t want to.
If you don’t have a surplus income (i.e. you are spending everything you earn), here at a couple of tips to help you find a surplus:
- Identify your two largest discretionary expenditure items and cut them by 20% or more. For example, if you are like me, you spend money on dinning out and buying wine. I really enjoy spending money on these two things so I wouldn’t want to eliminate them completely. However, shaving 20% of my spending probably won’t impact on my quality of life too much but will put some extra dollars in the bank.
- Humans typically don’t miss what they don’t have. Also, people are more likely to avoid the impulse of instant gratification if they are making decisions about things that occur in the future. Knowing this, one promise you can make to yourself is to direct all future pay rises or bonuses (and the like) towards your retirement savings.
- Aggressively cut back on expenses that add little to nothing to your lifestyle. Think about the Foxtel channels you never watch, the gym membership you never use, the second car you never drive, the gardener that comes too often and items like these. Sometimes people spend money on things that they could easily live without and that don’t add any enjoyment. Eliminate them.
If you still don’t have a surplus income after trying the above three suggestions there is probably only one reason. You think spending all your money today is more rewarding than securing your future. If that’s the case, I can’t help you.
What do I do with the money? Some sensible strategies
There are a few things you can contribute this money towards. Perhaps the most important thing is that you do it regularly and start as early as possible. Here are my top four things to do with your money for the future – do at least one of them:
- Make extra repayments towards your home loan – the interest saved by making extra repayments have a large compounding effect. For example, repaying an additional $500 per month into a $500k home loan will save one third of the interest you would have otherwise paid i.e. a saving of over $150k (and you repay the loan in 21 years, not 30).
- Make regular investments into an index share fund – there are two types of fund managers; active and passive. 96% of active fund managers fail beat the market over any 10 year period. So if you invest in an actively managed fund, you only have a 4% chance of doing better than the market – they are not good odds are they? The solution is to invest in low cost passive (index) funds or ETFs. Fees for these funds are extremely low typically ranging from 0.20% to 0.50% p.a. (retail active fund managers charge 1.5% to 2.5% p.a.). So not only will your long term returns be higher but you will also pay fewer fees. While we are on the subject, make sure your super is invested in a passive (index) fund to maximise returns and minimise fees – there are some cheap options around.
- Borrow to invest in a property – if you invest in a high-grade property for $500k and it appreciates in value by 8% p.a. (on average), in 20 years the property will be worth over $2.3 million. A $500k investment property will produce a negative cash flow of approximately $150 per week after tax (if you borrow the full cost) – so it’s very affordable.
- Contribute more into super (particularly if you are less than 10 years from retirement) – if you are aged 49 and below, you can contribute up to $30,000 p.a. into super including the 9.5% your employer contributes (if you are older than 49 you may be able to contribute $35k). Contributing into super saves tax (15% tax versus the highest marginal rate of 49%) and helps your retirement savings grow.
Two brothers: one ends up with $2.7m and the other only $400k… why?
Author, Professor and director of the largest index fund provider Vanguard, Burton G. Malkiel tells a story about two brothers in his book The Elements of Investing:
The first brother, William starts investing at age 20. He invests $4,000 per year until he is 40 and stops. The second brother, James, starts investing when he is 40. He also invests $4,000 per year until age 65. Both brothers retire at age 65. William’s investment balance is $2.7 million whereas James’ investment balance is less than $400,000.
This story (illustrated in the graph below – click to enlarge) clearly demonstrates the power of compounding returns and how important it is to not delay investing. Albert Einstein is quoted as saying “compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
And your ‘retire one month earlier’ strategy is?
The financial services industry makes investing look a lot more complex than it really is to create dependency i.e. if its complex you need help. It is not complex. It’s simple so keep it simple. The theme of this article is to simply be disciplined and save a certain percentage of your income regularly. Pay yourself first. Every little bit counts. Saving an extra $20 per month (for 20 years) will help you retire one month sooner. So what is your ‘retire one month sooner’ strategy? What percentage of income can you commit to securing your financial freedom?
