Your Money & Investment Questions Answered

How to Retire Debt-Free and Financially Independent

Everyone dreams of retiring free from debt and stress, able to live independently and pursue the things there wasn’t time for during their working years. Despite recent economic setbacks this dream can still be achieved. It just takes commitment, and the earlier one starts the better. Those who wait to start tackling their finances will have a steeper climb, but even for those starting late, following these simple rules can make retirement goals into reality.

Set a Budget to Live By

The first step to financial independence is setting a realistic budget, and staying with it. Remember, the goal is retirement. This is not about living like a monk, but it is about staying within one’s means and reducing unnecessary expenses. Tracking expenses for a month and seeing where the money is going may lead to some surprises - £3 for a cup of coffee can really add up, as can £8 tickets to the cinema. Here is a guideline for what a comprehensive budget should include:

• Income from all sources. Include wages, interest income, and side jobs.
• Housing. Include rent or mortgage payments, taxes, and property insurance.
• Food. This should be a best estimate for groceries and dining out.
• Utilities. Include the average amount (round high if necessary) of all utilities.
• Transportation. Include bus fares, taxi fares, and all costs for car maintenance.
• Debt. This should be the maximum amount comfortable to pay towards debt each month.
• Clothing and incidentals. Include clothing, shoes, and personal care items.
• Savings. Include the money to put towards investments and savings.
• Entertainment. Allow a small amount of money to go towards extras.

If any monthly income is left unspent after outlining the budget, a portion of that money should go to savings and a portion should go towards investments. If the budget totals more than monthly income, adjustments will need to be made. For a budget that includes debt payment, it’s generally recommended that part of the savings budget be diverted to pay debt. If there is not debt payment in the budget and it still totals more than income, some expenses may need to be reduced to ensure retirement.

Pay Down Debt

Repaying debts as early as possible is the most important step to take towards retirement. Setting a budget will help available income to go towards this goal. For serious debt situations, debt negotiation or a debt management plan may be in order. Otherwise, simply focusing on repaying as much as possible will go a long way towards retirement. Consider that every month debt is carried over, the interest charges increase – especially if only the minimum payments are being made.

Mortgages should also be included in the early repayment goal. Although the thought of paying off such a large amount before the end of a 25 or 30 year term can be overwhelming, simply paying 10% above the mortgage note each month can shave years off of a mortgage. This both increases equity and reduces the amount of interest owed.

Avoid Further Debt

After reducing or eliminating debts held at the outset, the next goal is to avoid incurring any further debt. Some types of debt are necessary – a mortgage, for instance; few can afford a home without one. However, other types of debt, such as store card debt for a new television, or car loans, are not. A general rule of thumb is to pay cash or go without. This is similar to another time-honored rule of thumb: make it do or do without!

The exception to this is debt because of an emergency. Emergencies happen, and when they do, it might be necessary to use a credit card or take out a loan to deal with the situation. This is fine, and should not be viewed as a roadblock to retirement goals. Once the emergency has passed, concentrate on repaying the debt as quickly as possible. One emergency usually will not derail an entire retirement plan.

Hire a Professional Financial Advisor

While individuals are ultimately responsible for reaching their retirement goals, a financial advisor can help them get there. Financial advisors provide advice about investments, planning, and insurance. Their job is to educate and guide their clients. Financial advisors can either be independent or work through a brokerage firm. Which advisor a client chooses is up to them; some are more comfortable working through a brokerage, while others may feel that independent advisors are less influenced by others.

In either case, the selection of a financial advisor should be a long-term commitment, like investing. A financial advisor will need to know more information about a family’s financial position than anyone else, so it’s critical that decision-makers are comfortable and get along well with the advisor.

Invest As Much As Possible

Income after retirement is mostly investment income. Take every possible opportunity to build investments, from savings accounts to retirement accounts. Ideally, those planning for retirement will use every method possible to increase their net worth and take advantage of tax savings.

• Savings accounts. A savings account should have about six months’ living expenses readily accessible in case of emergency. Because this amounts to a larger balance, using a savings account with a competitive interest rate is wise.

• Personal investments. Personal investments are not as tax-advantageous as retirement accounts, but since the amount that can be contributed towards retirement is limited, a diversified and balanced personal investment portfolio should be maintained. Even if only £5 a week can be contributed to a brokerage account, that will buy stocks that will pay dividends and increase in value over time.

• Retirement accounts. Anyone who is eligible for a retirement account, whether through an employer pension, Self-Invested Personal Pension, or Stocks and Shares Individual Saving Account should be participating and contributing the maximum allowed amount wherever possible. The tax benefits and compound interest over time can turn a small investment into a very large one come retirement.

Maintain Good Health

This step, critical though it is, is overlooked by many financial advisors. The fact is out of pocket health care items can be expensive, especially for those who reach retirement in ill health. Besides which, retirement is meant to be enjoyed, so taking care of our health during the working years is important.

Taking just a small step towards retirement may be enough to gain momentum and speed towards retirement goals. For others, it may be more of a commitment. However, keeping an eye on the ultimate goal of a financially independent retirement will help guide those who want to retire comfortably to wise financial decisions.

Sponsors