To be financially free and retire early from the rat race is a goal many of us aspire to. But because retirement products in South Africa can only be accessed at age 55 or 65, what’s an early retiree to do when they want to retire at 45?  

Enter the two-stage FIRE (Financial Independence Retire Early) approach by Just One Lapper, Kris Naidoo. Kris’s solution tackles this conundrum with a staggered fit-for-purpose approach. The first step is to invest in a discretionary investment to get you to the retirement age mandated by your retirement fund. The second step is to let your retirement fund to take you the rest of the way.

A quick look at the “traditional” FIRE approach

“The single-stage approach usually means that you should have amassed a portfolio of liquid investments which is 25 times your annual expenses and is based on the 4% rule (i.e. drawing down 4% of the portfolio per year). Because we generally cannot access these funds between 55 and 65, a discretionary investment portfolio is required for a two-stage FIRE,” says Kris.

Let’s break it down:

Step 1: The discretionary investment

The first stage would be living off your discretionary investment until it runs out. It also means the discretionary investment can be drawn down at a rate higher than 4%, since it doesn’t need to fund 25x annual expenses – it just needs to last until formal retirement age. 

Step 2: The retirement fund

In the background, your retirement fund needs to grow from the day you stop working to a level that will satisfy the 4% rule at retirement age. 

“The two-stage FIRE approach is applicable to those who have a significant proportion saved in Retirement Funding (RF) vehicles such as workplace pension funds, preservation funds or retirement annuities (RA’s),” he added.

Hypothetical calculation of two-stage FIRE 

Kris provided this calculation with two variables, expenses and financial independence age, to illustrate how two-stage FIRE will play out in numbers.

Stage 1: How much is needed in your discretionary investment?

Based on the above variables, you would need R4.3m in your discretionary investment. Let’s assume a 4.5% real return and 6.5% drawdown rate. This will exhaust the discretionary pot in 20 years. So drawing R280k per annum divided 6.5% = R4.3m.

Stage 2: How much is needed in your retirement fund?

The retirement fund value at FIRE age (45) should be able to reach R7m in 20 years.

Let’s assume a real return of 4.5%. Compounded growth at 4.5% growth over 20 years = R7m

This means you would need R2.94m in your retirement fund at age 45.

So to reach financial independence and retire early at 45, you need R4.3m in your discretionary investment and R2.94m in a retirement fund.

“If we bump up the real return to a less conservative 6%, then you would need R3.7m in your discretionary investment (at a drawdown rate of 7.5%) and R2.24m in your retirement fund. This gives you a total of R5.94m – way less than the R7m target! Obviously, for every 1% increase in real return the total collective pot required gets further and further away from the R7m requirement, and thus two-stage FIRE wins over normal FIRE!”

The challenge 

The challenge lies in balancing two investments. Your discretionary investments should see you through to the age where you can access your retirement fund. The longer your discretionary investments can support you, the longer you can wait before accessing your retirement product.

Tune in to this blog next month for more of Kris’ thoughts and calculation on this approach. Listen to our discussion on Kris’ two-stage FIRE approach here.

Read Retire: Two Stage FIRE Part Two

Saving for retirement is the biggest investment most of us will ever make. Sadly, it can also be very complicated. In this monthly blog, we try to answer some of the retirement questions we hear most often, ranging from which products are best suited to different circumstances to efficient tax treatments. Words by Carina Jooste.