Let’s say I wanted to retire 20 years from now. I’d like to quit work and live off a second income for the rest of my days. I’ll also assume I have no pension, income or savings whatsoever.
In short, I’d have two decades to build a nest egg big enough to provide consistent passive income to last me for retirement.
Building this kind of wealth in such a small amount of time is no easy task. So let’s dive into an investing strategy that might help me reach such an accelerated retirement date.
Firstly, let’s address the ‘investing timeline’ here. As a rule of thumb, a typical timeline is 30 years. Three decades is plenty of time to earn big money through investing, while also being short enough to fit into an average person’s career.
One step further
I could get a grip on my finances at 25, invest for so many years, and then retire at 55. That sounds like a pretty good deal to me. I can see why so many people divert excess savings to this goal even if they have a pension already.
But I’m aiming to take this one step further. I want to shave a decade off. In my above scenario, I’d retire at the age of 45 instead. Who doesn’t like the sound of that?
There’s a problem, however. Over 30 years of investing, an outsized amount of the wealth is generated in the final 10 years.
For example, let’s say I put £1,000 to work at 10% average returns. By the 20-year mark, my money has climbed to £6,728. By the 30-year mark, £17,449. Over half of all the investing returns come in the last third of the process.
I think this highlights the difficulty of reducing an investing timeline. For those of us on average salaries, we need the full 30 years.
Another strategy
Is that it then? Is it time to give up and abandon the dreams of early retirement? Well, perhaps not. There are two main ways to counterbalance the effect of a shortened investing timeline.
The first, and most obvious, is to funnel in more money. The more I save and invest, the bigger the second income I can create. Sadly, the advice of ‘just make more money’ isn’t particularly useful to most of us.
Another strategy is to pursue better investments. Rather than putting my money in safe index funds or blue-chip shares that might offer average returns, I could buy high-quality or underpriced stocks to target a better return.
Build wealth
I wouldn’t need to find the next Apple or Amazon either. As Warren Buffett says, even a 1% difference in return makes “an enormous difference in how much money you’re going to have in retirement.”
Over a 20-year investing timeline, an increase from 10% to 11% returns doesn’t give me 1% more money. It’s actually 19.8%.
With prudent stock picking, I could build wealth faster and target my earlier retirement date. This is one reason why anyone might want to take an active approach to investing.
The post How I’d build a second income to target a 20-year retirement date appeared first on The Motley Fool UK.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. John Fieldsend has positions in Apple. The Motley Fool UK has recommended Amazon and Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
