How will I retire, and how much will it cost me to retire? In today's post, I'll go through some simple math to help explain why the conventional wisdom on retirement--to save 10% of your income--is not only laughably insufficient, it condemns people to a lifetime of wage slavery. At the end of this post, as a bonus, I'll show you how you can apply an extremely aggressive savings strategy to retire, comfortably, in about eight or nine years. Yep, you read that right: eight or nine years.
[A quick warning: readers who are unwilling to save money, or those readers who carry around a prepared list of ego-defending excuses why they CAN'T save money, please don't read any further. This post will be useless to you.]
Those of you still here, consider the following five savings options:
Option 1: Save 10% of your income:
Let's say you obey the conventional wisdom and save just 10% of your take home pay. That means, by definition, you will live off of the remaining income you take home, or the 90% that's left. To illustrate it in dollars, let's say your household takes home $75,000* in income. If you set your savings at 10% of your take-home pay, you would save $7,500, and your spending (or better said, your annual expenses) would therefore be $67,500.
Thus at a 10% savings rate, it will take exactly nine years to pile up the $67,500 needed to have a one year war chest of savings ($7,500 x 9 years = $67,500).
10% savings per year = 9 years to accumulate one year's worth of expenses.
Ugh. Nine years to save up one lousy year of expenses? Nine? If it takes that long, why bother? Sadly, that's most people's default response when they start thinking about their financial future--and it explains why few people bother to save at all. It just takes too long to see results. Clearly, we need a better, faster and more aggressive option.
Option 2: Save 20% of your income:
Once again, by definition: if you save 20% of your income, you'll live off the 80% left over. So, using the numbers from above: on a $75,000 income, your savings will be $15,000 (that's 20% of $75,000) and your expenses will be $60,000 (80% of $75,000).
Therefore, using a 20% savings rate, it only takes four years to pile up a one year war chest of savings. ($15,000 x 4 years = $60,000).
20% savings per year = 4 years to accumulate one year's worth of expenses.
That's a lot less painstaking, isn't it? Less than half the time! But we're not finished yet. Let's look at another example:
Option 3: Save 33% of your income:
Let's be still more aggressive. Save 33% of your income, or one third. Again, using the numbers from above: if you save 1/3 of a hypothetical $75,000 take-home pay, your savings will be $25,000 and your spending--once again, by definition--will be the remaining $50,000 left over.
Therefore, using a 33% savings rate it takes just two years to pile up a one year war chest of savings. ($25,000 x 2 years = $50,000).
33% savings per year = 2 years to accumulate one year's worth of expenses.
Wait, you think two years is still too long to build up a huge, one-year financial buffer? Keep reading.
Option 4: Save 50% of your income:
What would happen if, in total contravention of the American way, you were to save 50% of your income? That's right, half. In this example, your savings would be $37,500, and you'd live off of the other $37,500.
Presto: you've saved a full year's war chest in just one year.
50% savings per year = 1 year to accumulate one year's worth of expenses.
By now, I'm sure you can see exactly where this is going. This percentage-based savings formula gets incredibly powerful the lower you manage your expenses relative to your income. But keep reading... it gets even juicier.
[A brief, final warning for any close-minded or consumerist readers who have--against all odds--made it this far into this post: stop reading now. What you're about to read will be even more incomprehensible than what you've read so far.]
Option 5: Save 75% of your income:
What happens if you save 75% of your income? Let's go through an example:
If you had a hypothetical income of $75,000 and you chose to save 75% of it, or $56,250, you'd have a gloriously low expense line of $18,750 per year. But wait: if you can maintain a savings rate and expense line like this, it will take you a mere four months to save one year's worth of expenses.
75% savings per year = four months to accumulate one year of expenses.
The Secret To Retiring Early
Okay. Now, let's look at the 75% example in a slightly different way. Forget four months: if you can manage to maintain this kind of a savings rate for a full year, by the end of the year, you will have saved three full years' worth of expenses.
Now, imagine sustaining this savings rate for a series of years. This is more or less what Laura and I did during an eight or nine year period beginning in the year 2000. We chose to make a temporary (readers: notice the emphasis on temporary) choice to be crazily aggressive in maximizing our savings and minimizing our spending.
Think about it: if you spend eight or nine years saving and spending at the rate discussed in Option 5, you'll have put away at a minimum about 24 years' worth of expenses. And this ignores any compounding of additional income you could earn by cautiously investing your swiftly-growing pile of capital into income-generating investments like dividend-paying stocks, preferred stocks, bonds or tax-free municipal bonds.
In other words, at a 75% savings rate, it takes about eight or nine years to get to a state of financial independence. Read that sentence one more time.
Finally, note that you can apply this same math to the other, less-aggressive savings options. For example: at a 50% savings rate option, it takes about 20 years to save up 20 years' worth of expenses (it could take far fewer years if you can earn solid investment returns over those 20 years). Oh, and don't bother to calculate the time to 20 years' worth of expenses using the 10% savings option. Just trust me: it takes a really long time.
What's the central lesson here? Well, one sad lesson I've learned is to expect a lot of blank, uncomprehending stares when explaining these ideas. :)
Beyond that, however, the central lesson is this: we love to pretend our expenses are largely out of our control. But in reality most of us passively permit our expenses to be set for us by outside factors like social conditioning, our need to fit in with an imagined peer group, or by ego-protecting justifications that we "deserve" a certain standard of living.
And yes, it's easier to hold the limiting belief that it's all out of your hands than it is to put the creative work into actively and aggressively managing your savings and expense levels. I get that. Even worse, in order to take back your power over money, you'll have to directly contravene our consumption-based and status-based culture. You'll undoubtedly face difficult social pressure from friends, family, co-workers, or anyone else who may want to validate their own egos and consumption-based financial decisions--at the expense of your personal financial health.
But in eight or nine years, which path would you rather be on?
Readers: which of these five savings options will you choose... and why?
For Further Reading:
1) Early Retirement Extreme: A philosophical and practical guide to financial independence by Jacob Lund Fisker
See also Jacob's excellent blog, where he shares in great detail how he essentially applied "Savings Option 5" and did it on a surprisingly low income. I discovered Early Retirement Extreme some years after Laura and I had already shaped our ideas about consumption, saving and spending, but Jacob's blog echoes our views closely. It's a mind-opening read and well worth digging through his archives.
2) Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence by Vicki Robin and Joe Dominguez
As readers know, this is the book that changed everything for us. It helped us shift our minds so that the ideas I've shared above shifted from laughable to plausible.
Update! I've since written an in-depth, chapter-by-chapter handbook for Your Money Or Your Life that readers can use to help them along with Joe and Vicki's book.
3) Recent articles in the New York Times (on living in a low-return world) and Yahoo Finance (on early retirement). PS: note who's the final example in the Yahoo article.
* Last of all, a few important footnotes:
1) Don't let the specific $75,000 income number sidetrack you from this post's central idea. Rather than fixate on the dollar amount, focus on the percentages and apply them to your own income situation, whatever it may be. Depending on your level of creativity--and your lack of a need to impress people with your possessions--you can apply the ideas of this post to an extremely wide range of income levels.
2) All dollars are in "take-home" (read: after-tax) dollars, not gross salary. By all means feel free to use your gross salary to try and impress the ladies, but if you base your spending and budgeting decisions off your gross pay, you will live a miserable, debt-mired life.
3) I'm grateful that CK's regular readers never slip into excuse mode after reading posts like this. However, if you do find yourself tempted to leave an excuse-based comment (such as: "it's ridiculous that people take home $75,000 a year," "these ideas are easy for you but they're impossible for normal people," "there's no WAY I can save that much money, here's why" or my personal favorite: "you're just an elitist who has no sympathy for those less fortunate who can't save like you do"), do yourself a favor and read my post on excuse-making, and then read my series on the Yes-But Vortex. Then you may comment. After that, though, please take action.
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