March 17, 2018
Here’s a question. How much money do you need to last you a lifetime? A majority of people will either not know / don’t care or exaggerate the number and say $10 million. Plucking such a large number from the air isn’t helpful as it sets you up for failure. Every journey starts with a single step and the focus should be first on achieving the minimum before moving onto higher goals and higher sums.
In other words, focus on “how much is enough?”
Now that we shift our mind-set to what the ‘minimum’ is, let’s focus on how to get there. Once you are equipped with the tools and make the right calculations, getting there will be a cinch. Your ultimate goal should be to have enough money to pay for your monthly expenditure. The first step is to determine how much you spend each month. While you calculate how much you are currently spending, which will be a good initial estimate, what you will find is that likely you will need much less as work-associated expenditure will be taken out of the picture.
Your biggest expenditure item is likely to be housing (rent or mortgage), followed by items such as bills and food. Also factor in work-related spending, discretionary spending and entertainment. Break it down into a list and see what you can cut.
Now think about how you might cover that monthly expenditure other than through a monthly pay-check. There are two ways about this – capital or cash flow. The cash flow option is often the easiest to conceptualise because the sums are much more manageable and easier to understand logically. Simply be able to cover your monthly expenses and then you will be able to comfortably live month on month throughout your life. You can achieve this by owning a passive income stream such as rental income from a property or via dividends from stocks or an index.
Alternatively, accumulate enough capital (25x your annual expenditure) and then spend 4% of that capital each year. This is popularly known as the 4% rule. Studies such as the Trinity Study have shown, that following this rule will allow you to never run out of cash for the rest of your life. Sounds too good to be true? Not really if you follow the right steps.
The average household in the US spends $40,000 a year, so for the purposes of this example, let’s say you spend $40,000. That means you will need 25x this amount, which equates to $1 million. That might seem like an enormous sum and I know myself that I’m not able to simply save that sum alone without having to wait a lifetime. This is why it is crucial to invest and invest wisely. Those at a younger age should feel free to take more risk, especially when choosing investment options for their pension. As mentioned in our previous article, a good way of measuring how much risk you take should be based on the 100 – AGE % rule. While you might treat it as your ‘golden number’ that you target, you can effectively retire before reaching this number. That is the beauty of investing as your capital will continue to grow over time.
The fundamental rationale behind saving and investing is that your portfolio will continue to grow over time if you have the long term in mind. This is also the reason why that $1 million will continue to last you throughout your lifetime. A simple sum might suggest that if you spend $40,000 a year you can only last 25 years but that is a fundamental misconception. As your portfolio grows, the power of compounding does the rest. Each year your investment gives you a return, which then gets reinvested, thereby snowballing into larger sums.
So how do you get to $1 million? There are multiple ways to do so.
- Save for a deposit on a property, purchase the property and either live in it or rent it out. Either way you get the benefit of property prices growing over time in the long term. By renting it out you can focus on getting to a point where the monthly rental after tax can cover your monthly expenses. This is probably one of the lower risk options of investing though it gives you a tangible asset that you can see and feel, so probably most comfortable for the new investor.
- Keep track of your pension. One of our colleagues reached the $1 million from his pension alone simply by investing wisely. Don’t underestimate the importance of a pension and the tax-free benefits it comes with. Remember that pension funds are businesses not charities. Usually the default investment options on your pension comes with high management fees. If you can change your investment option to passively managed funds, you will pay less fees.
- Invest in a low-cost index fund. Rather than overcomplicate, simplify your investments by investing in an index tracker like the S&P 500, which on average consistently earns 10% p.a.
- Invest in cryptocurrencies that provide dividends. Cryptocurrencies such as XLM have a weekly pay-out of 1% of your holdings. NEO allows you to earn GAS every month. Cryptocurrencies have shown the potential for astronomical growth time and time again but it is important not only to focus on growth.
You could even get to a point where you could live off the weekly or monthly dividends that these cryptocurrencies produce without touching your original capital.
Once you reach the $1 million mark on any of these, start thinking about withdrawing. (We’ll suggest ways of withdrawing in future articles.)
The sense of security that you get when you have cash in hand is priceless. This is so important we cannot stress it enough.
Given market volatility and uncertainty, the probability of loss remains high, and as Kahneman’s theory on loss aversion suggests, it is basic human nature to feel that losses are twice as powerful, psychologically, as gains. A simple guideline is to withdraw enough so that you will be comfortable for the next 10 years. The rest, rebalance and put into a safer investment such as the S&P 500 tracker.
In summary, focus on achieving the ‘minimum’ before going further. You don’t necessarily need more than $1 million or $3,000 a month, so focus on achieving those numbers first.
We hope you found this useful. Stay tuned.
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