How can we save enough to retire in our mid 50s?

Jimmy is age 32 and earns £100,000 per year before tax. His wife is self employed and usually earns the same amount but is currently on maternity leave. They have two pre-school age children. They have a  mortgage of £410,000 on their £540,000 home to be paid back over the next 23 years. They also own a buy-to-let property valued at £310,000 with £246,000 mortgage to be paid over the next 21 years.

“Our first priority is ensuring that we have enough to provide for and educate our children,” says Jimmy. “We would also like to retire early, ideally when we are in our mid 50s. We would like to have built up assets worth £1.5m plus by the time we’re 50, and £500,000 by the time we’re 40. This might sound unrealistic but I’m really hoping there’s a way to do this if we’re astute and frugal enough.

"We have some unsecured loans and credit card debt worth around £44,000, which needs to be repaid in the next two years. I pay 3.1 per cent interest on the personal loan, but the credit cards do not incur any interest at the moment.

"My workplace pension is worth about £56,000. I contribute 3 per cent of my salary to it and my employer puts in equivalent to 13 per cent. But my wife doesn’t have any pensions.

"I would like our investments to make an average annual total return of 20 per cent, and I’m willing to put money into very high-risk ones to achieve this. I'm happy to ride out market turbulence as long as the reasons why I invested in the holdings in the first place still stand. I would be prepared for the value of my investments to fall by up to 15 per cent in any given year to get higher returns over the long term.

"But I would like to know if I could moderate my high-risk approach while still aiming for high returns. I’m also open resetting our goals and rethinking what I want to achieve, if they seem unreasonable in the current investment environment.

"I have been investing for around 10 years, initially for fun and to learn about it. I mainly look for big dividend payers that seem like contrarian bets and small-caps with sound fundamentals. I also like looking for stocks whose share prices don't appear to have caught up with their real value, whether because of an anomaly or lack of coverage. I think at the moment in particular there are many undervalued shares whose prices have been hit due to the Covid-19 pandemic, but which could also rebound strongly if they can withstand this downturn due to having decent balance sheets. I have recently bought LoopUp (LOOP) and Anglo Asian Mining (AAZ), and am considering investing in other small-caps that look good value such as Xaar (XAAR).

"I prefer to invest large sums in a few select direct share holdings that I’m confident will make strong returns, so I am not very diversified. I also have some spreads open in Apple (US:AAPL), Microsoft (US:MSFT) and the silver price, worth £8,000, although I use these intermittently for trading rather than investing.

"I think my biggest weakness is cutting losses and/or taking profits at the wrong time – my exit strategy has been particularly poor of late. For example, I have recently sold Barclays (BARC).

"I’m also wondering whether to sell my buy-to-let property and reinvest the proceeds in equities that look like safer bets over a five-year period. I feel that there would be a better chance of a higher return on these investments than property in the near term."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

FINANCIAL PLANNING

Shelley McCarthy, managing director at Informed Choice, says:

Having a financial plan in place would be a good starting point. This will help you to understand how realistic your goals are, particularly if you need to factor in private schooling for your children. 

Private school fees for secondary school and sixth form for two children might cost in the region of £202,000 in today’s money – without allowing for inflation. And school fees typically rise at a higher rate than inflation. So you need to factor into your plan that you will have less income to save over that period. When your wife goes back to work you may also have to build the cost of childcare into your financial plan which likewise can be expensive.

I suggest repaying the unsecured debt as soon as possible – particularly the loan with an interest rate of 3.1 per cent. Both your outstanding mortgages are due to be repaid when you are in your mid 50s, in line with your plan.

Trying to achieve annual returns of 20 per cent annually is unrealistic. Excluding the unsecured debt you have net assets of £357,000. Your existing assets, including your property, would need to grow about 5 per cent a year to reach a value of £500,000 by the time you are age 40.

Given your earnings level and additional rental income, you should always make sufficient pension contributions to bring your income below the £100,000 level to ensure that do not lose any of your annual personal allowance. The effective tax rate on income between £100,000 and £125,000 is 60 per cent, so the return on a net pension contribution is significant – before any investment returns.

The minimum age at which you can access your pension is age 57 – something to be aware of when making pension contributions. So if you retire at say, 55, you might not be able to access your pensions in the first couple of years of retirement.  However, pensions are a highly efficient way to save for your longer term plans – particularly given your level of earnings. You receive tax relief on pension contributions, the assets within them grow tax free and you can take 25 per cent of their value tax free when you start to draw from them. Pensions are also outside your estate for inheritance tax purposes, if you die. 

I would suggest having sufficient protection in place to provide for your children in case either of you die or become unable to work. I would prioritise this over your investment objectives. This is particularly relevant if your wife is self employed and would not benefit from any company income protection plans or death in service.

INVESTMENT STRATEGY

Chris Dillow, Investors Chronicle's economist, says:

The good news is that your objective of amassing £1.5m by the time you are age 50 isn’t wholly unrealistic. If equities deliver a total return after inflation of 5 per cent a year, as they have over the long run in the past, you could build up this amount by investing a little over £20,000 per year. So you don’t need a 20 per cent annual return, which in any case is unachievable. Rather, you need equities to do what they’ve done in the past and the power of compounding, plus a little frugality on your part.

But this raises a problem. Where is this frugality going to come from? You already have personal loans and credit card debt worth £44,000, so a lot of your savings will have to be diverted into paying this off. It also means that you’re going to have to change your borrowing and saving habits. Accumulating wealth is not a matter of intellect but rather a matter of character – having the discipline to save a lot. So do you have this?

Another problem is that the future might not resemble the past, and equity returns might not be the same in the next 20 years. In the past hundred years returns were boosted by decent economic growth, and the defeat of things that worried investors such as inflation, worker militancy and communism. It’s not at all obvious that the next few years will be as favourable as the past hundred.

With regard to whether you should sell your buy-to-let property, I would generally expect equities to outperform property over the long run. At the moment, property seems overvalued by historic standards whereas equities don’t. However, a geared (debt-financed) investment in a lower-returning asset can do better than an ungeared one in a higher returning asset – at least in an environment where interest rates are unlikely to rise.

There is also a lot of idiosyncrasy in the housing market, with some properties overpriced and others underpriced. Perhaps you should test the market by putting your property up for sale and, if you get a ridiculously high offer, sell. But don’t rush.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

It is true that Covid-19 has caused some stocks to be underpriced. But many of these underpricings are disappearing fast. As I write this [in late November] stocks such as easyJet (EZJ), Carnival (CCL) and International Consolidated Airlines (IAG) have already risen more than 35 per cent in just three weeks.

And there are only two proven ways of beating the market in the long run: defensive and momentum stocks. Pursuing these strategies, however, requires strong discipline and incurs significant dealing costs. You can overcome these issues to some extent by investing in some of the several exchange traded funds (ETFs) which invest in momentum and low-volatility stocks. But these are not a rapid road to riches. Their outperformance might be slight and they might even underperform for some time. They are a compliment to a diversified portfolio – not a substitute for one.

Shelley McCarthy says:

It is very hard to time markets, so time in the market is much more reliable. And you are prepared to ride out market turbulence. That said, it can also be argued that it is never a bad time to take a profit.

I believe in having a diversified portfolio, which can deliver decent returns with substantially less risk than a small portfolio of direct share holdings. As you have few investments you are subjecting yourself to company-specific risk in addition to market risk. You can end up with too much risk for too little possibility of reward.