WealthBUILDER Series 2 - What's your wealth gap?

by Adam Marlow

WealthBUILDER Series 2 - What's your wealth gap?

Welcome to the second edition of the Financial Freedom series!

You may recall last month I wrote the first in this series of articles entitled ‘When will you be able to retire comfortably?’ which introduced the concept of formulating a wealth accumulation plan to help you achieve ‘financial freedom’ by following the simple step by step approach we use in our retireSAFE service.

Remember that I defined the term ‘financial freedom’ which for me is the point at which your pension, investments and savings can provide you with sufficient (passive) income so that you have the ability to totally give up work if one day you decide you’ve had enough.

When I say passive income, I’m referring to various sources of income that you could receive without having to work for, such as bank interest, dividends, property rent etc.

So, when you think about it, doesn’t it make sense to get to this point in life sooner rather than later, because it might not be by choice that you have to give up work. You may have a disabling illness or similar that stops you. Yes, you could insure for such accidents and illness but I rarely find that many people can stomach the monthly premiums for this kind of insurance and would prefer to put their money into their pension fund or ISA’s rather than give it to the insurance company only for them to never need it.

You may not have realised it yet but absolutely everything we do for you is designed to help our clients achieve financial freedom as soon as possible! From sorting out your bookkeeping so you have better quality information to make business decisions through to helping you with your tax planning, business structuring and investment strategy. Ultimately the financial advice we offer is there to enable you to live the life you want by providing the funds you’ll no doubt need to finance the things you and your family want to do!

So anyway, back to the educational part... where do we start? The first puzzle in the process that needs solving is really a question of how large of a wealth pot do you need to accumulate to generate enough passive income to fund your desired lifestyle in this ‘retirement’ phase of your life?

That’s a tricky question because it means looking into the future and trying to guess what life will be like, so this is effectively the dreaming stage. You need to imagine how you will spend your time when you’re not working (or working less).

From there you can list out the spending-money you’ll need to finance this lifestyle vision and I’ll tell you this for free…that when you aren’t working full time you’ll actually need more disposable income than now as you’ll need it to finance the activities you’ll want to do to fill your time. Whether that’s hobbies, clubs, travel, family etc it all costs money.

Now you have an idea of the amount of disposable spending money you’ll need, the next exercise I ask clients to do is to analyse their bank statements and credit cards for the last 12 months to find out what their cost of living is now. As you might guess this always results in a few surprises and usually that’s because they’re shocked at how much they didn’t realise they’re spending.

This will give you a long list of expenditures that you now need to go through line by line and consider what your likely level of spending for each item will be when you’re retired.

Also remember to add in future big-ticket items like holiday homes, weddings, helping children with university fees etc because it’s easy to overlook these.

Then pull all these lists altogether, the activities spending, the living costs, the big-ticket items and produce a master list of all your likely outgoings.

Finally, you need to increase this total by inflation as all this little lot will have gone up in price over the years. This can be surprising because if you’re thinking of retiring in 10 years’ time and inflation sits around say 2% you’ll be spending almost an extra 25% per year.

Then we need to gross up this net disposable income figure for tax! This, of course, depends on how much you need to receive every month but let’s say you need £4000 per month in today’s terms that’s an inflation-adjusted figure of £5000 per month (which everyone says would be more than enough until they start going through the above expenditure list building up a picture of their costs) then we need to add a notional 25% on for tax. So now we’re at £6250 per month and £75,000 p.a.

If you do plan to finance this level of income via safer lower risk investments and therefore lower returns it’s currently considered prudent to use say a yield of 3% p.a. as the likely return on your investment, then you’ll need to accumulate 33 times this annual income figure. This equates to £2,475,000. Staggering isn’t it?

Yes you could cut back a little and not need so much income but do you want to be watching day time TV to avoid spending money going out, I know I won’t and yes you may take a little more risk in your investment choices but if the capital is lost then you probably won’t have the means to replace it if you’ve sold your business!

Whatever your circumstances and life-style choices that figure might seem massive but in next month’s article, we’ll look at how to calculate your current wealth gap and take action to close this.   

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