Being able to retire early might seem like an impossible dream, but I believe it is possible if you have a strict savings and investment plan in place.
Stage one
The first stage of this process is to work out how much you will need to retire on.
A simple calculation any investor can use to arrive at this figure is to use the ‘multiply by 25’ rule. If you take the amount of money you think you will need to live on every year in retirement, and multiply it by 25, you’ll get a rough estimate of how much you will need to have saved by the time you decide to quit the rat race.
For this article I’m going to assume a desired annual income of £20,000 in retirement. Using the rule above, my figures tell me that a saver will need £500,000 put away at the time of retirement to meet this desired income level.
The best way to build this savings pot is to invest your money. Over the past decade, the FTSE 100 has produced an average annual return for investors in the region of 7%. That’s a significantly higher return than any cash interest account offers at the moment.
Investing for growth
So, assuming that all of the savings are invested in the FTSE 100, how much would you need to save every month to build a pension pot worth £500,000?
The answer to this question depends entirely upon how much time you have left until you want to give up work.
For example, it is relatively straightforward to accumulate this level of savings over 50 years. Indeed, according to my calculations, a saver would need to put away just £100 a month over five decades to accumulate savings worth half a million pounds, that’s assuming an average annual rate of return of 7%.
If you want to hit this target within three decades, my numbers tell me that a monthly deposit of £430 is required assuming an average annual rate of return of 7%. That is excluding any tax benefits or fees accrued over the time frame.
Pension savers are entitled to tax relief at their marginal tax rate on any contributions up to a limit of £40,000 a year. So, if you are targeting savings of £430 a month, you only need to put away £344, and the government will add an extra 20% (for a basic rate taxpayer).
To hit the £500,000 target in just 20 years, my numbers tell me that a saver will need to put away £1,000 a month, or £800 a month before tax benefits.
The bottom line
That’s how I plan to retire early using nothing but the Footsie 100 and a regular savings plan.
As my figures above show, it is straightforward to hit this target if you have a regular savings plan in place and use a low-cost FTSE 100 passive tracker fund.
You might be able to generate higher returns by picking stocks yourself, but this also opens up the risk of a possible capital impairment (or loss), which could set your savings back months or even years. In my opinion, it is better to stick with the FTSE 100.