44-year-old Canadian-born blogger Peter Adeney has developed something of a cult following in the personal finance community.
His blog, Mr Money Mustache, gained popularity after Adeney began posting about how he had retired from his job as a software engineer at age 30 by spending only a small percentage of his annual salary, and consistently investing the remainder – primarily in stock market index funds.
Adeney typically posts about the strategies he used when investing in these index funds, but mainly focuses on the excesses of middle-class living and cutting back on expenses to live within your means.
It’s a fun read, and gives good tips on how one can prepare for early retirement – but it also begs the question whether it is plausible to actually retire at 30 in South Africa.
The South African example
Speaking to BusinessTech, Andrew Davison, head of implemented consulting at Old Mutual, explained that Adeney’s story was very interesting as it introduces some very useful ideas that are foreign to most people – especially the idea of saving a large portion of your income and living way below your means.
“Its not as simple to say that as soon as you are at a level of growth that exceeds your expenses you can retire and remain like that from age 30,” he said.
“People are living until 90-plus – and sixty years is a long time, during which a lot of unexpected expenses can come up.”
However it is still plausible, Davidson said, providing a calculation of how a similar scenario could work in South Africa.
Note: The following does not constitute financial advice and is purely for illustrative purposes.
The scenario assumes two young people in their early 20s, with degrees and good jobs, with good starting salaries. One earns R300,000 a year and the other R250,000:
- After tax they would take home R251,735 and R214,735, respectively (based on new tax tables as per 2018 Budget).
- Assuming that this couple has joint living expenses of R25,000 a month (so R300,000 a year). Davison explained that there was no real ‘magic’ behind this number other than it was ‘doable’ for a couple living frugally in South Africa.
- They thus jointly save R166,470 in year one. This is 30% of their income before tax and 36% of their income after tax.
- They are successful youngsters and they climb the corporate ladder quickly so they both get salary increases of 3% above inflation.
- Their expenses increase only by inflation, so each year they increase their savings. After 10 years they’re saving 40% of before-tax income and 49% of after-tax income.
- Because of their extreme objective of retiring very early, they save outside of a retirement fund so they can access their savings in their thirties – although they could do this by resigning from a company pension fund, they would pay tax and they couldn’t access a Retirement Annuity before age 55.
- They earn investment returns of 5% above inflation per year after fees and costs – this assumes a low-cost, high-equity, diversified balanced fund.
- Because they save outside of a retirement fund, their growth isn’t shielded from taxation. Davison therefore deducts tax from the investment growth. Dividends tax, tax on interest and CGT is assumed to apply.
- After 12 years (making them closer to 35, than 30) the couple’s investment growth after tax would exceed their expenses. Davison explained that it is not their income that is the target, but their far lower expenses. There is a double-whammy effect here in that their savings are high but they also spend much less, so they don’t need to replace their full income to retire. This same effect happens in a more typical scenario of someone saving for retirement.
- Davison assumed that the new Finance Minister manages the economy well and there is no bracket creep on taxes in the future.
- As soon as they reach their goal and retire, their income will cease and they will then actually pay less tax on the investment growth because their marginal tax rate will reduce so they will not only be retired but will have an immediate boost to their finances.
“The powerful point about this is that saving for retirement often seems like an impossible goal for people, but it really isn’t. However, it does take some very diligent and disciplined saving and expense management,” Davison explained.
“This example assumes a uniform level of investment growth, whereas an investment that targets CPI + 5% after fees would in reality be volatile and may not even achieve the goal.”
In reaching this target, Davison suggested targeting a low-cost, diversified portfolio (it doesn’t have to be an index tracker) which included exposure to both South African and US markets.
“Retiring as soon as one gets to the point where investment growth exceeds one’s current (very low expenses) doesn’t allow much room for any change in circumstances,” he said.
“It also assumes that the investment will continue to grow at least by inflation. If that is not the case, and it lags behind, there may be adjustments required.
“Being a ‘DINK’ (Double Income No Kids) couple may be fine in your twenties, but now that the two of you have no job and lots of time on your hands, the next event might well be the start of a family and this is a sure fire way to lose control of one’s spending. A return to work might be inevitable,” he said.
Another major drawback facing South Africans when compared to the US and other developed countries, is the social support that may be able to be accessed – whereas this is limited or non-existent in South Africa, Davison said.
However, the good news is that the picture completely changes if you were to change the target retirement age from 30 to something more reasonable such as 50 or 55, Davison said.
In doing so, not only will you be able to live more comfortably, but will also be better able to deal with unforeseen expenses, he said.