Can I retire when I’m 40? 50? Never? How much do I actually need to be saving? Retirement planning can get really complicated. In fact, it is often complicated enough that people tend to put it off or not do it at all. Is there a simple way to get an idea if we are on track? There are hundreds of complicated formulas that can be used to answer these questions. In actuality, it is pretty easy to get a quick idea of where you stand financially.
Financial planning has become a complex industry. Comprehensive planning takes into account plenty of different variables such as longevity, taxes, distributions, government programs and estate issues. Inevitably, when we try to predict the future we are required to make lots of different assumptions. However, sometimes it is nice to take a step back and look at the basics to see if we are really on track.
So, what can you fit into a simple graphic that will give people the information they need to know if they are moving toward financial independence? A simple graph that illustrates the time it takes to reach financial independence based on your saving and spending rates. The chart above explains the amount of time it takes to retire (or become financially independent) at different savings rates. Simply find the amount you currently save and see how many years you need to work until you can retire. Or, find when you want to retire and see how many more years it will take of work to reach that goal. If you already have substantial savings, subtract out the number of years you can already cover with the amount you have saved.
I’ll follow in the footsteps of fellow bloggers MMM and Jacob who both retired in their thirties and have written about the shocking simple math it takes.
– Earn 5% inflation adjusted returns
– Live off the 4% Rule
– Consumption will remain relatively consistent over time
– Continue reading for answers to your complicated questions
It certainly takes more information to get a fully comprehensive picture of an exact retirement plan. However, most people need a place to start. Popular gurus like to give a concrete number such as 10%,15% or 20% of your income. These numbers may be achievable to the masses, but not really useful for individuals who are starting late or looking to become financially independent before they turn 67.
For example: A 35 year old couple bringing home 100k and spending 60k would be saving exactly 40% of their income. They have been in the workforce for several years and have about 200k in retirement savings. According to the graph, it will take them approximately 18 (22 minus ~4 years of accumulated income) more years until they can retire. So, at the ripe old age of 53 they would be financially able to replicate their income through traditional investments.
It is simple, but I really like the idea of making recommendations based on a percentage of income saved. This does two things. It shows people in years what additional income can do, but also reinforces the idea that we do not get ahead if our spending increases with our income. In fact, I’ve learned from experience the best way to develop financial margin is attack financial freedom from both ends. If you go from saving 20% to 30% of your income you gain an extra 9 years of retirement. That is equivalent to taking Thursday and Friday off for the next 31 years! How much is that extra 10% worth?
The Full Picture
The initial analysis presented my seem a bit simplistic for many financial professionals, academics, or individuals that read this blog. And that is the point. The goal is a simple heuristic that gives people information without being overwhelming. Each situation is unique but we all need a place to start. In fact, this model actually tends to be relatively conservative but still useful for many of the SE readers. The beauty of a simple analysis like this is that it reflects the idea that a reduction in spending is just as useful as an increase in earnings. Someone making millions but spending more than they earn will never attain true financial independence.
There will be many other factors not included in this approach. Things like Social Security, inheritance, drastic changes in investment returns, pensions, major raises, lifestyle inflation, and tax issues. To account for other variables, Jacob from ERE has written an entire book to cover all scenarios and also included this graph to show different assumptions and various projected rates of return.
“It’s not possible to save that much of your income.” That is simply not true. When I work with young professionals and students I often encourage them to reject the idea of retiring at 95 and only saving 10% or less of their income. I like to start by suggesting people begin their baseline spending at 50% (or less) of their income. We can spend everything we earn and it will still not make us the happiest person in the world. We certainly must change our assumptions and learn more about the hedonic treadmill. We will never get ahead unless we learn to get out of the race for incremental comfort.
On a personal note, we are well on our way based on this plan. After reading Your Money or Your Life many years ago we decided to make a plan for early financial independence. One of the main tenants of YMYL is that being conscientious of our spending puts us in a place to evaluate our time and money. So, we decided that saving around half our income would be a nice baseline that introduces plenty of margin but also gives us flexibility for the future. According to our current calculations we are well on our way to being able to retire by age 40.
What about you? When do you plan on becoming financially independent? Do you plan on waiting until you are 70? 40? Do you have a plan at all?