Early retirement is the dream for most workers, but for many, the dream of giving up work early remains just that, a dream.
Ending your working life early requires one of two things. You could win the lottery and retire to a Spanish villa, or you can start planning for early retirement decades in advance.
Planning ahead is the best option for most people and isn’t as difficult as it sounds. It will make your life a lot easier as you approach your retirement age so here are some tips to help you prepare to leave work early.
A regular savings plan is the single most important factor in wealth creation. There’s no need to save large amounts either, the earlier you start, the less you have to save. For example, if you save £50 a month for 40 years and receive 5% interest per annum, after four decades your savings pot will have grown to £77k. If you only have 25 years to save the same amount, you’ll need to put away £130 a month, nearly three times as much.
Make the most of tax allowances
Taxes can be hugely detrimental to long-term wealth creation, which is why investors should try and make as much use as possible of tax allowances offered to them. ISA wrappers and SIPPs are perfect ways to shelter wealth from the tax man without breaking the law.
SIPP contributions are even topped up by HMRC. Any personal contributions you make, up to the amount you earn, are given basic rate tax relief at 20%, so an £800 contribution becomes £1,000 after tax relief.
Keep fees low
Along with taxes, fees can also severely hamper investment returns over time.
Over the past 100 years, the FTSE 100 average annual return has been 7%, turning £1k into £868k, excluding the impact of inflation. However, if you include fees, which I’m going to base at 2% per annum for argument’s sake, the total return falls to £132k.
Yes, that’s right, by just deducting 2% per annum from the investors’ annual return reduces the final figure by 85%. Hopefully, this is enough of a warning to keep fees low.
Look to the long term
When you’re investing for retirement, a long-term investing outlook is needed. Buying shares in companies that will be around for the next few decades is critical, as the more you change your mind and buy new stocks, the more likely it is that you will make a mistake.
Further, a high share turnover means higher transaction costs. As covered above, high fees should be avoided at all costs.
Rule number one
This brings me to my final tip for early retirement: don’t lose money.
If you want to build wealth steadily, it’s imperative that you don’t speculate on high-risk stocks. Yes, there’s a chance these companies could make you a million overnight, but the odds of a juicy return are around 100-to-1. You’re more likely to lose everything. And if you do suffer a total loss, it will much harder for you to reach your early retirement savings goal.
Put simply, if you want to retire early, only invest in companies that are already well established and are unlikely to go out of business before you quit the rat race.
Avoid these key mistakes
A recent study conducted by financial research firm DALBAR found that the average investor realised an annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually thanks to poor investment decisions.
This kind of performance will almost certainly put an end to your early retirement dreams. To help you realise and understand the most common investor mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.