The idea of stepping away from the nine to five to live off your investments may seem like a pipe dream. But it doesn’t have to be. Living off your investments is possible, but there are some key things to consider.
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Where do I start?
You don’t have to start with an inheritance or a lottery win. But if you are starting with no investment at all it is a good idea to have a plan. As part of your plan, there are three things you should consider.
1. Time period
You will need a realistic time period in which to build up an investment portfolio. This will give you an idea as to when you will be able to start living off your investments.
If you are starting from scratch, it’s a good idea to give yourself at least 10 years. While there is no guarantee, long-term investments tend to show less volatility compared to short-term ones.
Over the long term, your investment will also be more resistant to market downturns.
2. Future living expenses
If you want to live off your investments, think about how much income you will need for your lifestyle. This will depend on your own personal circumstances, but bear in mind that your lifestyle could change if you stop working.
For example, if you live in a major city because of work, you may want to move to the countryside when you stop working. The cost of accommodation could be cheaper.
If you are unsure about how to work this out, you can use a rule of thumb often used by retirement advisers. They estimate that retirement expenses will be around 70% of a final salary. If you are younger, increase this to around 80% to 85%.
3. Investment size
Once you know how much you want to live on, you can then work out the investment needed to generate this income.
In order to do this, you can use the 4% rule which is used to work out retirement income. This rule is based on research by a financial advisor called William Bengen who looked at 30-year periods between 1926 and 2017.
Using this rule, you will need an investment amount that is 25 times the annual amount you will need to live on.
So, if your total living expenses will be £24,000 per year, this will be the minimum income that you require from your investments. Using the 4% rule, you will need a total investment portfolio of around £600,000 (£24,000 multiplied by 25).
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What if I’m not earning enough?
If what you will need to live off your investments seems like an overwhelming amount of money, don’t worry. There are other steps you can take that can help you along the way.
Increasing your current income
If think your current income is not enough to accumulate such a large sum of money, think about other options.
First of all, be honest about your situation. There may be other opportunities such as a promotion or employment with another company that might be worth pursuing.
Next, consider taking on a second job or starting your own business. Thanks to the internet, there are plenty of opportunities to create an alternative source of income. Check out our articles on making money selling on Amazon and selling online.
Reducing your current expenses
If you are planning to be financially independent in the future, it’s a good idea to get your finances in order. This will give you an idea as to where your money is going and how you can cut your current living expenses.
You could start by paying off any existing debts, including high-interest credit cards and loans.
Once you have done this, review your expenditure on services such as subscriptions to magazines or on-demand TV. Check to make sure you are getting the best deal on necessary services such as insurance for your car and home.
Working part-time in the future
You could use your investments to pay for a portion of your living expenses and earn the rest by working part-time.
So, for living expenses of £24,000 per year, you could work part-time and earn £12,000 per year. You would need £12,000 from your investments, which would only need to be worth £300,000.
If you decide to work for yourself, make sure you understand your income tax liabilities. You may need to register for self-assessment tax returns.
Take home
If you want to live off your investments, this is entirely possible. However, it does take some careful thought and planning, and you need to be prepared to put the work in.