I have noticed that more people are attracted to seeking out work that they have a personal connection with, particularly since the beginning of Covid. That is, for a growing number of people, the emotional rewards (satisfaction) that their work offers is becoming more important than the financial rewards. This might include working in the not-for-profit sector, working for a socially conscious organisation or starting their own business.
Of course, not everyone has the flexibility to immediately resign from a high paying job. But of course, you can put a plan in place that allows you more freedom and flexibility in the future. I wanted to discuss the common considerations we tackle when working with clients in this regard.
Three phases of wealth accumulation
It is important to recognise that there are typically three phases associated with becoming financially free as illustrated below.
Phase one: Accumulation – this phase involves accumulating the required quantum of assets needed to fund retirement. That could include acquiring investment property(s), making additional contributions into super, investing surplus cash flow into shares and so on. This phase typically requires you to contribute as much cash flow as possible i.e. to maximise your earnings and minimise your expenses.
Phase two: Income flexibility – the main aim of this phase is to give your investment assets enough time to benefit from the power of compounding capital growth. This phase requires you to earn enough income to pay for living expenses and maintain your investment portfolio. That is, you may have flexibility to earn less during this phase either through changing roles or not working full-time.
Phase three: Retirement – it probably goes without saying that this phase doesn’t require you to generate any personal exertion income. All living expenses are funded from your investment/asset pool.
Therefore, if you would like to get yourself into a position where you have more choices regarding the type of work you do (i.e. less pressure to maximise your income), what you must do is focus on accelerating phase one.
This is a less aggressive version of FIRE
FIRE is an acronym that stands for a movement called Financial Independence, Retire Early. The idea behind FIRE is that you must minimise your expenses as much as possible to allow you to save and invest more, so that you can retire a lot earlier than a traditional approach allows.
The approach I have discussed above can probably be best described as a less aggressive version of FIRE. That is, my approach requires you to maximise your income and minimise expenses for a finite period (could be anywhere from 5 to 15 years). This allows you to reduce your personal exertion income for the next period (could be another 5 to 15 years) as long as it’s enough to cover your living expenses. By doing so, you delay the need to ‘eat into’, your financial resources. It allows your investments to benefit from compounding growth until you can start to draw on your superannuation (from age 60).
Maybe you don’t need to earn as much as you think
One of the advantages of formulating a plan is that it quantifies what income you need to generate and for how long in order to reach your goals. If you already have a reasonable asset base, it is possible that you may already have the flexibility to reduce your personal exertion income.
Specific financial planning considerations
I have listed below some common considerations we encounter when we formulate a financial plan for a client that wants to have more income flexibility in the future. Of course, every clients’ situation and goals are unique, so the matters below are generalisations.
You must begin as soon as possible
It is important to begin your investment journey as soon as possible because a key ingredient for building wealth is time. There are no shortcuts to substitute for the financial impact that compounding returns produce – it just takes time. Warren Buffet put it succinctly when he said “No matter how great the talent or efforts, some things just take time. You can’t produce a baby in one month by getting nine women pregnant.”.
Consider being more aggressive e.g. maximising surplus and borrowing more
In phase one you must be as aggressive as possible, but not too aggressive. An aggressive approach to investing can include tactics such as borrowing more money to invest, investing in riskier asset classes (such as emerging markets and private equity/small cap fund, etc.) and so on.
If your goal is to accumulate a certain amount of assets as quickly as possible, it is likely you must consider adopting an approach that is more aggressive than what a traditional retirement strategy requires. But that is not to say that you should take unacceptable risk. The risk must be appropriate. You can mitigate risk by doing certain things such as adopting evidence-based approaches, formulating debt exit strategies, not putting all your eggs in one basket and so on.
Need to focus on non-super investments (to access prior to age 60)
If your goal is to retire before age 60, then you must ensure you have sufficient assets (investments) outside of super to allow this. These assets should either produce a high level of income after all expenses (including interest) or be liquid to allow you to progressively sell down. Residential property, for example, rarely meets with these requirements. However, shares are often the perfect asset class.
There’s less room for error
If you are in your 30’s and are happy to work until at least 60, then you have 30 years to build wealth. Also, since you plan to retire after you can access super, it is likely that super will play a big role in funding your retirement. As such, even if you make a few investment mistakes in your 30’s and 40’s, you probably have enough time to make up for them.
However, if you are in your 30’s and would like to have the flexibility to reduce your income (work fewer hours or do different work) by the time you reach late 40’s or early 50’s, then you have less tolerance for mistakes/errors. Therefore, there’s a greater need for you to obtain professional and independent advice to avoid making mistakes.
Family home downsizing
If you expect to have substantial equity in your home in the future, then it may be possible to develop a strategy that allows you to have more income flexibility in the future by putting this equity to work.
Of course, that will require you to sell the family home and either downsize or relocate i.e. spend less money on a replacement home and invest the difference. Sometimes doing this perfectly aligns with a clients’ lifestyle goals anyway e.g. when they seek a tree or sea change i.e. sell the family home in the city and relocate to the country.
Remember, the role of financial planning is to help you achieve your lifestyle goals
A traditional approach to retirement planning included working in your currently role/job until you could access super (age 60). However, the whole point of financial planning is to design a plan that meets your goals, not the other way around. If you no longer enjoy climbing the corporate ladder (or whatever your job entails), it might be time to start planning.