If you have enough money, you can retire for good and give up the rat race to retire early. But how much would you need to achieve this goal? The answer to this question depends on your particular financial circumstances. For example, if you already own your home outright, live a frugal life and have no debts, this goal is going to be easier to accomplish than if you have to pay rent every month, have expensive tastes and large credit card bills.
However, the chances are that if you have been planning to achieve financial independence for some time, you will know a thing or two about money so will have made the most financially prudent decisions up to this point.
So, how much money would you need to live a comfortable life without having to work? For this example, I'm going to use the UK average wage of £27,600 (gross) a year as recorded in 2016 as a base case. For the bull case, I'm going to double this average salary and calculate how much you would need to save to be able to live off £55,200 (gross) a year. I'm assuming all rent, financial and living costs are accounted for in this budget.
The quick and easy way
The fast and easy way to work out how much you would require is to take the amount of annual income you want, and divided by the interest rate you expect to receive.
Achieving the best returns on your money is only possible with investing as shares tend to both yield more, and protect against inflation. So for this example, I'm going to use the average yield on the FTSE 100 of 3.7% (3.2% after deducting fees). Using this method, according to my calculations if you require £27,600 a year, you will need to save a total of £862,500. If you want to live off the higher £55,200 a year, you will need a pot of £1.7m.
Investing 100% of your savings in stocks when you plan to live off the income proceeds is not recommended. Therefore, it is probably sensible to keep at least a year's worth of funding in cash.
This strategy, while financially prudent, will dent your overall returns, which means you will have to save more before taking the plunge. Nobody will live forever, so taking some of the capital out of your savings pot every year to supplement returns is also possible. Let's say you set an annual returns target of 3%, based on this objective and yearly withdrawals amounting to £27,500 increasing with inflation of 2% every year, you would need just over £1.4m to produce enough income to last you 70 years.
Considering the average life expectancy in the UK is around 80, this means you would need to have built a fortune of £1.4m by age 10, which is slightly optimistic. If you wait until age 40 before starting to live off your savings, you don't need to save anywhere near as much. In fact, assuming all the same returns figures above, you would only need £900,000 to receive an income £27,600 every year increasing with inflation.
Dividends: The fastest way to a million
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.