Early retirement has been getting harder to do.
There's lots of reasons for that. Pensions are becoming less generous and less certain and it’s harder and less lucrative to generate income from renting out property, which many people have used to fund themselves thanks to years of runaway house price growth in developed economies.
Given that, it was surprising to see last week headlines about Canadian couple Kristy Shen and Bryce Leung. “They became millionaires and retired at 31” is how The Guardian sold it. Shen and Leung, now 36 and 37, told the newspaper that they now spend their time travelling the world and writing a blog (these are millennials, after, all) after saving C$1million (Canadian dollars) in nine years.
When you delve into the details of their case you begin to see what a feat this was - but also that it isn’t completely unthinkable either. According to the couple, they had saved C$500,000 after seven years and by nine years had hit the C$1million mark. That’s the level they calculated they would need to stop work, assuming they can live on 4% of that total each year indefinitely.
After some crude calculations, that means they had been saving and investing at a rate equivalent to C$5,000 (about £3,000) a month between them for seven years, assuming investment growth after fees of 6%. If their money grew faster than that they could have achieved it by saving less. After seven years, they must have either rapidly accelerated their saving or benefited from very high (although not impossible) investment growth for two years, taking them to C$1million.
It’s an extreme example of a trend that many young people are catching on to, and which is encapsulated in the acronym FIRE: financial independence, retire early. You can find many websites and blogs dedicated to FIRE, with more and more young people hoping to achieve what Shen and Leung have managed.
We shouldn’t pretend that this is realistic for many people. It clearly isn’t. There are valuable lessons, however, in understanding what it takes to achieve it. Here’s six takeaways from hardcore FIRE savers like Shen and Leung.
1. Make the sacrifices you can, when you can
Saving at the levels Shen and Leung say they managed is not normal. I’ve estimated it would take £3,000, or £1,500 each, a month. That’s feasible for a high earner but a twenty-something at the start of their career? In reality I suspect the couple saved less at first and accelerated once their earnings rose.
It doesn’t say exactly what their salary was - both worked as computer engineers - but I assume it was in the higher bracket. The point is that they based their saving on a tightly drawn budget of essential spending with anything saved. They avoided eating out, didn’t run a car and lived in cheap parts of town and even when their earnings began to rise, they stuck to the plan.
2. Don’t just save, invest
Stashing away your earned income is the main factor in achieving extreme savings goals like this, but the higher returns potentially available from risk-assets - like stocks and bonds - is essential too. In particular, investment returns are needed once you stop earning a salary. Shen and Leung relied on low-cost passive investments which don’t need day-to-day attention or any specialist investment expertise.
3. Do it tax-free
I’m no expert on the Canadian savings regime but it’s fair to assume saving at this level is only possible thanks to tax-efficient vehicles which allow investment gains and some contributions to escape tax. In the UK, that means ISAs.
Company pensions and SIPPs are also tax-efficient and can allow access to savings from age 55. That might be too late for the extreme few hoping to retire in their 30s, but will be invaluable to those with more realistic early-retirement goals.
4. Set realistic expectations of retirement income
The most extreme part of the task that Shen and Leung set themselves is arguably not the saving bit, it’s the fact that they were happy to retire on an income that many would see as insufficient. C$1million (about £616,000) sounds like a lot of money but it has to last a very long time.
The couple worked on the basis that they could safely withdraw 4% a year and keep pace with inflation. In UK terms that’s an annual income of £24,600 - and that’s for two people. It’s hard to imagine that sort of money covers anything more than the bare essentials, which means….
5. Living in a couple is a big advantage
Given their extreme budgeting before retirement and relatively small after retirement, it really helps to live and share costs with another person. If you won’t spend money on going out it makes it easier if there’s someone at home to keep you company, while housing and living costs are likely to be lower when split between two.
6. Be flexible and stay flexible
When the bulk of your income depends on investment returns, it’s essential to be able to adjust to ups and downs in markets. The 4% withdrawal that Shen and Leung based their plans on is a widely used rule of thumb. It comes from analysis which tested how likely it was that a pot of invested money would last for 30 years, in a range of historic market conditions. It shows that withdrawing 4% means it will last that long in almost all scenarios - and of course in many scenarios will do far better than that.
But that’s just an average - in reality markets will grow by far more in some years and will lose money in others. Shen and Leung have had the good fortune to ‘retire’ at the start of an historically long winning streak for global markets, giving their fund a healthy leg up in the early years. Even so, they will have known that markets can change and will have identified the spending that they would cut in order to ride out leans spells.
This week's MoneyTalk Podcast explores the subject of FIRE saving in more detail, download the Podcast.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.