The Shockingly Simple Math Behind Early Retirement
On Mr. Money Mustache, we talk about all sorts of fancy stuff like investment fundamentals, lifestyle changes that save money, entrepreneurial ideas that help you make money, and philosophy that allows you to make these changes a positive thing instead of a sacrifice.
In addition, the Internet presents us with retirement calculators, competing opinions from the mainstream media, financial doomsayers, unpredictable inflation, and a wide distribution of income and spending patterns between readers.
I reviewed my own path to age-30 retirement in “A brief history of the ‘Stash“, then I did a hypothetical calculation using two average teacher salaries to show how long it would take them to retire in “The Race to Retirement – Revisited“.
Because of this torrent of information, people tend to become overwhelmed and say things like,
“Yeah, good for you Mr. Money Mustache, but how can I possibly know when I’ll have enough to retire myself, with a completely different lifestyle?”
Well, I have a surprise for you. It turns out that when it boils right down to it, your time to reach retirement depends on only one factor:
- your savings rate, as a percentage of your take-home pay
- how much you take home each year
- how much you can live on
While the numbers themselves are quite intuitive and easy to figure out, the relationship between these two numbers is a bit surprising.
If are spending 100% (or more) of your income, you will never be prepared to retire, unless someone else is doing the saving for you (wealthy parents, social security, pension fund, etc.). So your work career will be Infinite.
If you are spending 0% of your income (you live for free somehow), and can maintain this after retirement, you can retire right now. So your working career can be Zero.
In between, there are some very interesting considerations. As soon as you start saving and investing your money, it starts earning money all by itself. Then the earnings on those earnings start earning their own money. It can quickly become a runaway exponential snowball of income.
As soon as this income is enough to pay for your living expenses, while leaving enough of the gains invested each year to keep up with inflation, you are ready to retire.
If you drew this on a graph, it would not be a straight line, it would be nice curved exponential graph, like this one from the Early Retirement Extreme book:
If you save a reasonable percentage of your take-home pay, like 50%, and live on the remaining 50%, you’ll be Ready to Rock (aka “financially independent”) in a reasonable number of years – about 16 according to this chart and a more detailed spreadsheet* I just made for myself to re-create the equation that generated the graph.
So let’s take the graph above and make it even simpler. I’ll make some conservative assumptions for you, and you can just focus on saving the biggest percentage of your take-home pay that you can. The table below will tell you a nice ballpark figure of how many years it will take you to become financially independent.
Assumptions:
- You can earn 5% investment returns after inflation during your saving years
- You’ll live off of the ”4% safe withdrawal rate” after retirement, with some flexibility in your spending during recessions.
- You want your ‘Stash to last forever, you’ll only be touching the gains, since this income may be sustaining you for seventy years or so. Just think of this assumption as a nice generous Safety Margin.
Here’s how many years you will have to work for a range of possible savings rates, starting from a net worth of zero:
| Savings Rate (Percent) | Working Years Until Retirement |
|---|---|
| 5 | 66 |
| 10 | 51 |
| 15 | 43 |
| 20 | 37 |
| 25 | 32 |
| 30 | 28 |
| 35 | 25 |
| 40 | 22 |
| 45 | 19 |
| 50 | 17 |
| 55 | 14.5 |
| 60 | 12.5 |
| 65 | 10.5 |
| 70 | 8.5 |
| 75 | 7 |
| 80 | 5.5 |
| 85 | 4 |
| 90 | under 3 |
| 95 | under 2 |
| 100 | Zero |
It’s quite amazing, especially at the less Mustachian end of the spectrum. A middle-class family with a 50k take-home pay who saves 10% of their income ($5k) is actually better than average these days. But unfortunately, “better than average” is still pretty bad, since they are on track for having to work for 51 years.
But simply cutting cable TV and a few lattes would instantly boost their savings to 15%, allowing them to retire 8 years earlier!! Are cable TV and Starbucks worth having two income earners each work an extra eight years for???
The most important thing to note is that cutting your spending rate is much more powerful than increasing your income. The reason is that every permanent drop in your spending has a double effect:
- it increases the amount of money you have left over to save each month
- and it permanently decreases the amount you’ll need every month for the rest of your life
So your lifetime passive income goes up due to having a larger investment nest egg, and it more easily meets your needs, because you’ve developed more skill at living efficiently and thus you need less.
If want to retire within 10 years, the formula is right there in front of you – simply live on 35% of your take-home pay**, which is approximately what I did without even realizing it during my own younger years. The only reason Mustachians will remain a rare breed, is because this article will never appear in USA Today. (Or if it does, people will be too busy complaining about how it can’t be done, rather than figuring out how to do it)
*If you want to play with the (rather basic) spreadsheet I made to generate this table, you can download it in OpenOffice format (.ods) here: Retirement Savings vs. Years
** definition of take-home pay: gross income minus all taxes. Remember to add back in any 401k or other savings deductions to the paycheck you see, since these are really part of what you are “taking home” – you just happen to be saving it automatically.
Note on how to track spending: we do almost all spending by credit card, and the rest by automated bank debit (checks or cash only for things that strictly require it, like Craigslist purchases). So at the end of the year just need to review the online statements for card and bank.
Recently this has been revolutionized by signing up for an account at Mint.com. Same basic idea, but it lets me see up-to-the-minute spending that is automatically categorized into nice pie charts, etc. If a figure looks surprisingly high, you can click in to see the detailed transactions in the various accounts that were added together to make that category. Quite futuristic.
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Mr. Money Mustache is a family man living in the United States who retired from work, relatively wealthy, at about age 30. After several years of retirement, he noticed that his still-working peers were envious of his lifestyle. They were making more money than he ever had, yet they were somehow still broke. So he decided to write this blog to educate the world on how it is done.
I like the simplicity of this. And as usual, the number of work years saved through small lifestyle changes boggles the mind.
Obviously it’ll be messier in real life for many of us… in my case, I’ll spend much less in retirement than I do now, because it costs me money to work, and I’ll retire to a cheaper city.
Great article. I love the “math” behind retirement.
Nords did a similar post with the math behind early retirement here:
http://the-military-guide.com/2011/01/03/how-many-years-does-it-take-to-become-financially-independent-2/
I’d suggest anyone who liked this article go read that one, as it digs into it even just a tad more (the math at least, with an equation and such, rather than just a chart).
I even hacked together a crude spreadsheet to do all the calculations on early retirement for you, given a set of assumptions (saving rate, spending rate, rate of return). It’s posted at the bottom of Nord’s post, and is also here:
https://spreadsheets.google.com/spreadsheet/ccc?key=0Av7xbSQj85XWdDlVZHpUUEkxd2xraFI3ekc0VlVEM3c&hl=en_US#gid=0
You can save your own copy to change the numbers.
MMM, feel free to post it in this post too if you want, or even improve on it and post it. MMM readers like spreadsheets, so I think some people will enjoy playing around with it.
I sure have fun playing with numbers. “HEY! I only need a 200% return for 3 and 1/2 years in a row to retire!” lol
Sounds good MMM, but I’m left wondering about the 401(k) portion of the stash, which indeed accrues earnings, but can’t be touched until you’re 60. What if that is a major portion of your ‘stash?
There are ways to tap a 401k / IRA. Fist off, when you retire, roll the 401k to an IRA. Then do a “substantially equal distribution” from the IRA. Check it out on the IRS web site. One formula is based on your age, another is like an annuity and I forget off the top of my head what the 3rd formula is. But the bottom line is you CAN tap 401k / IRA money before 59 1/2 without penalty.
A 72t can help you avoid the IRS early withdrawal penalty:
http://www.72t.net/Home
By using IRC Section 72(t), it is possible to eliminate the 10% early withdrawal penalty normally due for distributions from an IRA prior to age 59 1/2. By studying the information on this website like our 72(t) FAQ, you will be able to learn the rules that govern Substantially Equal Periodic Payment (SEPP) Plans as defined by IRC Section 72(t) and 72(q).
I’ve got two comments:
Sure, 401k (and in my canadian case, RRSPs) deductions are ‘take-home’ pay, but they are hard to access before 60/65… So not that much help in the Early Retirement scenario…
And second, would you consider mrtgage payment to have a 5% return? I mean, killing my mortgage in less than 10 years is my main financial goal (we are already down 7% in less than 8 months…) but this won’t bring me any dividends… It’ll just lower my expenses… (unless I buy another house and rent the current house…) So in a Growing your dividends point of view, I am unsure of my own strategy…
Thanks for the posts!
I should specify that my mortgage rate is 3.9% right now, thanks to the ultra low interest rate days we are livinig in…
Your mortgage payment has a 3.9% return. That’s not where you should invest your money if, according to MMM, you’re going to make over 8% elsewhere this year.
Your mortgage payment has a 3.9% return. But MMM is talking about 5% over inflation. Inflation was over 3%, so you need an over 8% return.
For the US and 401K/IRAs, you need to look at rule 72t which allow you to take early distributions:
http://www.investopedia.com/terms/r/rule72t.asp#axzz1jGaOP72E
Reduced expenses are exactly the same as tax free dividends! And Canadian RRSPs have no age limitations on withdrawal. Even 401ks have workarounds, see the article right here on this blog: http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/
Yes, it’s true… However, no compounding effect that would be yielded from dividends during the ‘mortgage payment’ phase.
I’m kindof new to the whole maths of early retirement. The concept and principles, I do all the time.
The calculations, i’m not as good.
Also, have you ever tried talking to a financial advisor about this sort of strategy? You get a loooot of funny looks.
People like to work during 40 year spans, I think.
Mortgage paydown definitely has a compounding effect! Every extra payment means your next payment will go more towards principle and less towards interest. Same effect as a compounding investment.
re: RRSP’s, as MMM says, you can withdraw these at any time without penalty. All you need to do is pay the taxes on them. In fact, if you structure it right, and live a low cost lifestyle, you can withdraw it all effectively tax free.
Thanks for that! I appreciate the input….
Good advice, I will keep that in mind. And i can definitely retrieve less from the RRSPs than the lowest taxable bracket – especially with the mortgage paid…
Good stuff.
I think RRSPs are better suited for early retirees than “traditional” ones. As mentioned above, with an early retirement, low-cost lifestyle, and good planning, it is possible to withdraw (at least some of) the money with little or no tax applied.
The problem with RRSPs that is not always understood is that when you turn 71, you are required to convert to an RRIF, and minimum annual withdrawals apply. These withdrawals (currently 7.38% at age 71, rising to 20% by age 94) can push your annual income into higher tax brackets and cause reductions in other benefits (like OAS).
My plan is to withdraw at least $5k per year from my RRSP and move as much as possible into my TFSA. Actual amounts will vary depending on how much other income I make and tax deductions that apply each year. By doing that, I will keep the same amount of capital working for me, while reducing my future tax liability.
The OAS clawback is not really an issue most Mustachians would worry about, I imagine, as it doesn’t begin until $67k annual income in retirement.
A bigger issue the Old Age Credit, worth 15%, or even GIS, if you’re truly living the low cost lifestyle. Best to kill that RRSP before 65!
Agree that RRSP’s are a fantastic tool for early retirees. By retiring pre-65 and keeping withdrawls low, you essentially game the system. Especially if you are high income pre-retirement. I could forsee a situation where an extreme early retiree could end up with a negative net income tax burden on a lifetime basis.
Actually, it is pretty much the same, since you could take the money you are not paying on the mortgage and invest/compound it elsewhere.
To give a concrete example, if your mortgage payments are $10000 per year and your marginal tax rate is 20%, you have to earn $12000 to pay that mortgage, although you may be able to deduct a portion. You will still have to earn more than $10000 to actually have $10000 to spend (on anything).
If you don’t have to pay the $10000 (or whatever), you can invest that in whatever you want, which will be compounded over time.
While you are paying down the mortgage, every extra principal payment gives you essentially a risk-free return on that amount of the mortgage rate. To compare that to a comparable rate in the market, you compare it to a t-bill. T-bills today pay essentially nothing now. So if your mort rate is 3.9%, by paying it down, you get a risk-free return of about 3.9% over what you can get in the market. That’s a really good deal. And that doesn’t even include the fact that the rate should be grossed up by your marginal tax rate, so if that’s 20%, your effective rate is getting close to 5% — risk free (minus deductions of course).
But you say, I can make 8% in the market. Shouldn’t I do that instead? Actually, you can make even more if you are willing to take more risk — maybe 12% lets say on some leveraged reits or something. The correct strategy in this scenario is usually a barbell. For example, if you had $10000 to invest, instead of investing the whole thing at an expected 8%, you take 2/3 and invest it at an expected 12% and use the other third to pay down the mortgage. You would have the same expected return, but with less risk.
So the answer to “Do I pay down the mortgage or invest the money?” is often just “yes.”
Your math is wrong: you need to earn 12.5K gross to net 10K at a marginal rate of 20%. You can’t simply multiply your net x rate to get your tax owed. You need to divide your net by (100%-rate). I know this doesn’t change the gist of your post but the math error can add up significantly at higher tax rates.
For me, my mortgage isn’t even part of the investment equation. I simply have a goal of having it paid off when I retire and I base my extra payments on that goal. Unless you plan on selling your home to pay for retirement, it should not be in your investment equation.
Yes, reduced expenses are like tax free dividends, and this makes the mortgage case a bit more complicated, because as the saying goes, “you have to live somewhere.”
It may not strictly be the most efficient thing to pay down your mortgage early. This is especially true because mortgage interest is deductible.
But once it’s paid off, you have permanently wiped out the largest expense in most people’s lives. Also, many states have laws that protect primary residences from lawsuits and debts from other sources. If disaster strikes and you lose everything, you’ll still have your home as long as you can cover the property taxes. If you have a mortgage when disaster strikes, on the other hand, you’ll lost your home along with everything else.
A paid-off home is thus a tremendous source of life-long security. A better way to value it is to pretend to charge yourself rent. That’s your tax-free dividend.
you don’t have to pretend, you are charging yourself rent in the form of opportunity cost.
If your paid off house is worth 100K and you could earn 8% on that money elsewhere, your rent is $8000 per year.
5% earn potential = $5000, etc.
One work-around for 401ks if you don’t want to use the 72t rule (*) is taking out the money out in retirement even if you incur the 10% penalty. This only works for high bracket families, but think about it this way… Say you are in the 33% bracket. If you plan to live with say $35,000 a year in retirement (which any Mustachian can do!), you will basically be in the 10% bracket (couples exemption + standard deduction has you in the 10% bracket). Even if you start taking money out with the penalty it’s 10% + 10% (20%). 20% is a lot less than having had paid 33% during your work years.
So, for (Mustachian) families in a high tax bracket that expect to retire early, it makes sense to put in the 401k max even if you don’t need it, because 20% is a lot better than 33% :).
(*) Taking the 72t forces you to continue taking distributions even if you no longer need the income– say because you had an unusually good year due to a side job/project.
You need to add in the taxes that you need to pay on top of the 10% penalty
I am adding the taxes… that’s the 10% bracket you will be in living as a Mustachian in retirement (income less than $35k ish). So, you pay 10%, then 10% on top of that. Your mileage may very depending on your state taxes, unless you living in the 7 states that have none.
I’m Canadian.
RRSPs are not hard at all to access before you are 60/65. You can walk in right now and withdraw all you want.
The only catch is you’ll pay income tax on any withdrawals. So the secret is to wait until your income is $0/yr, then withdraw $10,000 per year from your RRSPs – you won’t pay any income tax, which means you’ve got that money income tax free (because you didn’t pay any when it went in either)
I’m 30, and I work for 2-3 years putting the max into my RRSPs I can, then I stop working for years and withdraw only $10k/yr . That means I get all that money completely income tax free.
I’m doing it. It works great.
This is totally possible, of course, in a technical sense, but has two drawbacks that should be noted;
1 – you need to be able to live on $10k per year for those years you withdraw from the RRSP’s
2 – using RRSP’s for short term arbitrage eats up contribution room permanently, meaning you won’t be able to ever accumulate long term savings in an RRSP
Both of these are workable problems, if you plan for it, though.
Absolutely, good points.
1. Well, I have other savings outside the RRSPs to live on because I keep hitting my contribution cap, so I’ll live on around $15k-$20k/yr for those years.
2. Very true. I don’t see the value in keeping money in RRSPs long-long term, I think of them more like an income-tax avoidance technique, so it’s working well for me.
I used to only pay attention to the earnings side of the equation – I wanted to make enough money so that I could save more. However, after reading ERE and MMM, I’ve recently spent more time on the spending side of the equation and I’ve been shocked by the impact on my time to retirement (I plan to retire later this year!). Reducing spending gives you the double whammy of saving more in the short term and needing less money in the long run to retire.
Completely agree! Cutting down on spending is better than making more money when you consider the tax implications. If you earn an extra $1,000 in a year, it’s really more like $850 after taxes. If you save $1,000, that’s like earning an extra $1,176!
Totally agree with you, rjack. I was the same way. Most people focus on earning more, and unfortunately this also often results in spending more. I recently saw this XKCD comic over on the reddit FI forum, and it really bugged me as anti-Mustachian, on multiple levels: http://xkcd.com/947/
To add to your comment, I’m a fan of FIREcalc (http://firecalc.com/), and it’s amazing to see what a powerful effect your spending has on the calculation.
Inflation for 2011 was over 3%. Do you really think over 8% ROI is a conservative assumption for a portfolio? A 30-year treasury doesn’t even beat 3% right now.
In my mind, the math is much simpler than percentages. You need a source of revenue that doesn’t fluctuate as much, and you need that revenue to exceed your cost of living. Rental properties seems to be the way forward for me. I just bought my first foreclosure and am fixing it up now. I estimate I only need about 10 financed properties to retire (5 owned outright).
Jeff:
Wow, that 3.4% inflation number did surprise me for 2011. Then again, the -0.4% number surprised me for 2009 as well: http://www.usinflationcalculator.com/inflation/historical-inflation-rates/
I’m not going to argue about forecasts for inflation or stock market returns, because those factors are very small compared to SAVINGS RATE, which is the whole point of this article.
But I will point out these three things:
- Pessimism about market returns is unusually high due to the Great Recession and the irrational human recency effect right now. Everyone thinks there will be no more economic growth, forever. Historically, that’s usually a good sign that economic growth is about to go ABOVE AVERAGE for a few years. Don’t bank on it, but also don’t follow the crowd!
- You are interested in rental houses: these will easily beat 5% returns after inflation: the house itself keeps up with inflation (or beats it if you happen to buy right after a housing crash – HINT!), and the rent returns after all costs can be above 5% if you buy well.
- There is plenty of safety margin in other areas of my calculations (much like Gerard pointed out – your expenses can drop after retirement). Much more than the nitpicking over stock market returns and inflation.
All I’m saying is, “If one adopts a Mustachian lifestyle and follows this chart, one will be Absolutely Fucking Fine” – so no more busting my balls over tiny percentages! ;-)
I understand that savings rate is important but rate of return is also important and certainly not a nitpick. As shown on your graph, at a 30% savings rate, the difference between 1% and 10% returns is about 30 years of work.
10 Year treasury yields, which are a predictor of upcoming market performance are at a record low right now. There are certainly reasons to be concerned. http://0.tqn.com/d/bonds/1/0/8/-/-/-/10-Year.jpg
Aha.. but you’re looking at this moment (markets at an all-time high, interest rates all-time low) as if it were a permanent condition.
For people retiring right now with an all-stock portfolio and living expenses barely covered by a 4% withdrawal rate, I would say “yes, be careful and be sure you have a safety margin like the ability to rent out a room in your house or work part-time sometime in the future”.
For people part way through right now, I would say, “If you are in the US, use the low interest rates to lock in a profitable (10%+ gross annual rent) rental property and manage it yourself”.
For people just beginning, I’d say “invest in stocks and use a split asset allocation (stocks, bonds, other) so you have something to automatically shift into stocks in the inevitable stock market crashes we will see in the coming 10-20 years. It is during these crashes that we get better deals on stocks, meaning higher dividend yields and lower prices measured by P/E 10.
If one adopts a Mustachian lifestyle then one will indeed be fine. The rub is that it is not easy to change habits especially when one is surrounded by non-Mustachians.
Self-discipline is a must.
Thank you for the extremely concise breakdown on this point. This is one of my favorite charts in the ERE book and I think it’s perfect for illustrating this.
@rjack and Jeff, I was in the same boat for a long time, only focused on earning more. I overlooked the very important point you both made. A penny not spent is a penny saved for all intents and purposes.
a penny not spent is (almost) 1.5 penny earned, due to my high level of taxation. (I’m not super rich, I am just Canadian). Calculating this with your level of taxation is a great way to get thrift motivation.
Love the remark “I am not super rich, I am just Canadian”. In terms of health care costs, Canadians are super rich by U.S. standards.
One thing I would like to caution super-early retirees on is to allow some slack in your budget for increased health expenses as you get older. It’s easy for a thirty-something to assume they will maintain a superior lifestyle and stay healthy. But life has a way of catching up with you, and who wants to face having to go back to work when you’re not well?
One of the reasons I love this blog is MMM’s concept of the safety margin. A generous safety margin should cover most such contingencies.
I’m Canadian too and I have to agree with mugwump. Yes we pay higher taxes, but don’t underestimate the cost savings for health care. My first son came 10 weeks early and easy would have cost us over $500,000 in the US (two rounds of brain surgry). In Canada, my cost were easily under $5000.
I pay my taxes with a smile on my face and plan my retirement knowing I’ll be looked after for basic health issues.
I’m not defending our system, and I agree that you shouldn’t underestimate the cost savings for healthcare, but don’t overestimate it either. Most health insurance plans in the US have out of pocket maximums around $10k per year. If your increased taxes are roughly equivalent* to an insurance premium, your savings for that tragic event were just over $5,000, not $495,000. Not saying what you’ve got isn’t better, just saying it isn’t as scary to live here as some of our northern neighbors seem to think. I’d rather pay $5k than $10k, but $10k doesn’t keep me from sleeping at night like $500k would.
*It goes without saying, but that is a very very very rough guess, as it would of course be highly dependent on your income, obviously.
Are you perhaps being slightly hyperbolic here? As another reasonably well-paid Canadian. my marginal income tax rate is 36%, with an additional $3150 for CPP/EI. Sounds painful, and seems to illustrate your example rate.
However, my net tax rate (all income-related taxes/CPP/EI, no sales taxes) for the last few years has floated around 16%. For US readers, remember that includes health care.
And remember too, the more you save into RRSPs, the lower your net tax rate becomes.
BMO bank in Canada just cut the 5 year mortgage rate to 2.99%. MMM suggests 5% after inflation is a reasonable amount to expect from investment. Canada’s inflation rate is around 3%. It just doesn’t add up.
Do the banks make so much off of extra hidden fees, that they are actually making the equivalent of 8% on the mortgages? If invested money was worth 5%+inflation, that’s how much the banks would have to charge us to borrow it, no? If not, why not?
My own so called “balanced” RRSP investments were barely keeping up with inflation over the past 10 years, and are probably below at the moment.
This conflict leaves me gridlocked into inaction. I leave my RRSPs in the hands of my seemingly poor investment advisor, because I don’t trust that the grass is really greener elsewhere.
No wonder people spend crazy amounts of money on houses. At least you can see your money. But we all know there’s a Canadian housing bubble burst looming, so I’m not keen to do that myself.
Perhaps financial pessimists are doomed to financial mediocrity.
At least I’m relatively thrifty by nature.
Heather – banks are complicated businesses, and they get to employ leverage on your deposits to get greater returns, plus they have various consumer fees, consultancy and brokerage stuff, and other profit streams. Go look at CIBC’s annual report and find what their actual “Return on Invested Capital” is. I haven’t looked myself, but for most profitable businesses, this is nowhere near 3% – it’s more like 8% or higher.
In the S&P500 index, the median ROIC is around 7% and the market-weighted average is actually over 17% because some big companies that are not capital-intensive (like Apple and Microsoft) make loads of profit relative to their invested capital, skewing the average upwards.
Here’s a much more exciting and practical example: Guess what the dividend yield on CIBC stock is right now? 4.57%. Buy stocks like that, and the stock price will on average keep up with inflation or greater, plus you’ll get 4.57% to take home every year as well.
You are correct – financial pessimists ARE doomed to mediocrity. This is still pretty good, because most people are financial illiterates, meaning they are doomed to the even lower level of Shitocrity.
But with optimism and armed with just conventional knowledge, anyone can do better than inflation. It’s the simple idea behind owning a business (either a real business, or rental houses, or a business through stock ownership which pays dividends). I’m not a genius, nor am I unusually lucky, but I do expect to continue to make several percent above inflation on my investments on average!
And again, don’t use the last 10 years as a representative sample – that is just as bad as using 1990-1999 as a sample (20% annual gains or whatever).
It might be more clear to simply realize that the money banks lend didn’t exist before it was lent. Say a bank loans me $200,000 for a house, they might only have as little as $20,000 of that actually on deposit from other customers. So if they make 3% on the $200,000, then they are actually making 30% on the $20,000 that was used to create the rest of the money. Makes you want to go into banking doesn’t it… :) It’s obviously very complicated like MMM said, but the simple idea that banks create money with loans (and in other ways) is something we all need to be aware of, since this is fundamental reason the financial crisis is so extreme.
Kudos for putting the spreadsheet out in OO format. Might want to include links to OpenOffice (and LibreOffice, which I prefer these days) for those that aren’t familiar with the software.
In fact, that would be a possible topic for another post, “The Mustacian Computer User”, getting good quality Free software. I’d be happy to help you with it if you think it’s a good idea. That sort of thing is right in my wheelhouse.
I’m quite familiar with the concepts discussed here like SWR, years to retirement, etc, but one issue I struggle with is that most early retirees essentially have two financial life phases to deal with, and that is rarely addressed. One being the early retirement part where you are on your own, and the second being the traditional retirement part (65+) where your pensions are unlocked, you get senior tax breaks and discounts, and most likely social security (CPP and OAS in Canada).
I believe the way MMM addresses this is to ignore the benefits of the second part, making them part of his Safety Margin. Essentially just a bonus. That’s nice if you were two high incomes and smart enough to start early enough, but for those of us who still want to retire early and didn’t have this, how best to approach it? The standard approach of save enough till you can live off 4% plus inflation would mean years of extra working before you could retire, and likely dying with a sizable estate.
I’m considering a different approach where we save enough money to get us to 65, and then that money is gone. So instead of 4%, my calculation would be more like Required Savings = Living expenses for Number of Years Till 65. These savings would have to be invested much more safely due to the need to eat capital in the short term, and any compound interest would be my Safety Margin. We have enough saved already in locked in pensions that even if we never added another penny, we’d be able to live off a 4% SWR from 65 onwards. House would be safety margin, and if not needed, go to kids.
The problem I’m having with this approach, though, is that the amount required to cost living expenses is almost as high as just saving enough and then using 4% SWR! For example, say we wanted to retire at 45, and needed $25k per year to live. 20 years x $25k/year is $500k. I know this ignores inflation and compounding, but I think that wouldn’t change the number drastically after netting the two. If we just saved $625k instead and live off 4%, we’d have our $25k.
Am I making an errors here? Any other thoughts or comments on this?
Yes! I’m in the same boat as you! Only recently came to the realization that I didn’t have to work until ‘retirement’ and could fund a ‘young age retirement’ fund that only had to last until my (near as I can tell, fully operation old age retirement fund!) kicks in.
The way I’ve gone about it is to project out my income, living expenses, savings amount and expected growth rates (both ultra-conservative and conservative). I then keep cutting back the years of income until the amount in the pre-retirement fund goes to zero at age 60. By my calculations, it is just over 10 years away….though I’m still trying hard to grow my mustache. Like MMM says, cutting an expense and adding it to the savings has an amazing affect on the time required!
If your interested, I could sanitize my spreadsheet and post it…
mike
I’d love to see it!
Okay, I had a quick go of seeing how long $500k could last at $25k per year spending plus inflation of 2%. I assumed money would be invested in guaranteed products paying 2%.
https://docs.google.com/spreadsheet/ccc?key=0AgEx7EZh8s8RdGNhSU9DQ2M0WG1UdW50UHRGQVh5c3c
Wasn’t as easy to cut/paste as i thought i’d be, but I think I got most the formulas entered.
https://docs.google.com/spreadsheet/ccc?key=0AhDLWD_ESOY_dFhFMmNfR3YzWWg1UEpZcWpZdWM3Wmc
Other approaches I’ve considered;
- Save a chunk of money and use a withdrawl rate of more than 4% to account for the pensions and other stuff that kicks in at 65. I’d have to do more math to find the correct safe number, but probably doable?
- ignore the SWR altogether, and just build enough assets that pay income until that income hits my $25k. Ensure that the income is inflation protected. This would mean dying with a sizable estate, but I believe it would actually mean that the required assets would be lower than other methods, if structured right. For example, say I built a $200k stock portfolio that had an average yield of 5% (easy at current prices, even with blue chips), and then purchased a $200k rental property with cash that yielded 7.5% after all costs (easy to do in the US right now, but also possible in certain Canadian cities like Hamilton or Kitchener). My total savings would only need to be $400k in this scenario, the income would grow with inflation (more or less), and all 65+ income would just be gravy
This is the exact quandary I find myself currently in. The first question that jumps to mind, are you comfortable chasing a 5% (is this inflation adjusted?) return with your stock portfolio? When I run the numbers on my own portfolios it’s easy to calculate the assumptions on the tax-advantaged accounts but I’m having a hard time structuring the taxed account.
I take a lazy portfolio approach but it’s easier with a portfolio that will start draw-downs in 30 years versus a portfolio that will start draw-downs in 5 years. Risk over 30 years can be spread out, not so with the 5 year.
It’s not a 5% return, but a 5% dividend yield. Many blue chips have yields around this level, and many I would consider sustainable. I wouldn’t be worrying about total return. If stock price went down, I would still get my 5% yield on the price paid.
Ok, so you are assuming a 2% inflation adjusted return. Other people I have been talking to are also recommending this path. The numbers are less attractive though. I’ll plug it into my worksheet tonight to see how that affects our ER scenario.
No, I’m assuming that dividend yield growth will roughly MATCH inflation, and income would go up every year to maintain buying power. Most solid dividend payers raise their dividend annually, as they raise prices on the goods/services they sell.
Dividend yield growth can not keep up with inflation if you are spending the yield each year. That’s the problem with draw-down.
Not sure what you mean. If I have $25k in dividends and $25k in expenses at beginning of year 1, and the companies I hold raise their dividends on average by 3%, then I have $25,750 in income that year. If inflation is 3%, then my buying power is the same as the year before. As long as the dividend increases match or exceed inflation (most increases exceed it, as there is also profit margin increases), then my $25k original buying power will always be the same.
Ah. I see it now. Thanks for correcting me.
Just did a number crunch. If your assumption is correct then in 20 years the stock will be paying a dividend of 8.7%. This doesn’t sound reasonable if inflation is still at 3%.
Inflation compounds as well. Something that is a dollar today costs $1.03 next year (at 3%), and $1.061 the year after.
Look at the $25k of expenses in the Google docs spreadsheet I posted above so see how this works in detail.
Agent9, I think your calculations assume that the proportion of the share’s value paid out in dividends increases every year, which (if I understand equities properly) is not what actually happens. Yes, the dividends increase by 3% or whatever, but so (usually) does the share price. A share may indeed one day pay dividends that are 8.7% of what you paid for it originally, but the ratio of dividend to (current) share price is actually semi-stable in the long run.
Dividends as a percentage of current share price. I think I understand. Thanks for the clarification.
Kickass! You’ve really cut through the complexity and delivered a clear statement of the core idea of early retirement.
My personal savings rate has been 58% over the last two years, and my goal for this year is to bump that up to 70% by reducing expenses and selling off some fancy equipment that I rarely use. I see every big ticket item in my collection differently now – would I rather have this item, or the cash I could get for it? That’s worth one vacation day… etc.
Thanks a million (maybe literally) for the inspiration!
Thanks for the great post! I had done dozens of retirement calculations on my own, but I tend to be too “gloom and doom” with my assumptions. I’m not making 8% ROI at the moment, but hopefully it’s reasonable to assume over the long run. Using your chart and referencing my own spreadsheets, I’m now feeling much better about my chances for early FI. In 2010, I saved 47% of my take home pay. In 2011, I saved 65% (due mostly to an unexpected salary boost). I now have renewed motivation to make it 70% this year!
We’ll either be at 60% (GeekHubby goes back to work in corporate-land, OR earns a good salary from his business… we’re saving 20% of one income now, and we’d save all of his, which I’d expect to be close to mine) or “windfall-land” (GeekHubby sells business) within a year or two…
Nice to see I could be out of the rat race by 40 if I wanted.
Though the new job is a little too good for me to want to leave at the moment. We’ll see how I feel in a few years.
I just calculated how much I spent last year: $42,500 and change. That was a crazy figure for this reason. My plan is to retire in 10 years at 42. My goal for early retirement is a nest egg of $1,000,000. I take $1,000,000 x 5% (income produced from nest egg) and get $50,000. I take $50,000 and subtract 15% (the IRS cut) and get $42,500! I think my expenses this year will dip into the high 30′s because I soon won’t have a car payment anymore (yeah, yeah). I think that the $1,000,000 goal is solid for my current lifestyle.
I currently save/invest half of my take home pay, which is awesome and I calculate I will in fact reach that $1,000,000 mark in ten years. Also, I am single but if I settle down with a special lady and am able to split costs then my financial independence will come even sooner.
Even better, find a special lady with $1,000,000. ;-)
Sorry, I just couldn’t resist.
You have a good plan, though.
Yes, I would be game for that as well haha! Honey, enjoy work today…I will be at home managing your $1,000,000.
I’m a long time advocate and practitioner of the Your Money or Your Life approach you’ve outlined. Now that I’m reaping the rewards I would suggest two big factors that influenced my results.
1. Education – Without the college degree I received via scholarship and the two Masters I earned with my employer paying for it I would have been in dead end, physically debilitating jobs or saddled with big school loans. That said, your plans should include getting and continuing with your education.
2. Health – As others have said, without the health insurance I’d had from my employer the two serious illness I had (neither preventable; childbirth complications and brain tumor) my assets would have been wiped out. Any plan needs to include some provision for catastrophe.
This was a great post. I have to admit complete ignorance on what % we are saving these days. I am going to make it a goal to figure that out for 2011, at least sometimes in the next month.
I also enjoy reading everyone else’s comments, and hope to read them in more detail when I’m not at work.
That was very helpful. I’ve never figured out my total savings rate before – it never occurred to me to just add the pre-tax savings to my post-tax income amount. (duh) I track my spending so it was easy to look at my average expenses for 2011, compare it to my income, and see I’m saving 30%.
Now that I have a baseline I can work on improving my saving/spending rates!
Every student that graduates from highschool should be required to create this spreadsheet from scratch, rather than books of useless facts that can be looked up on google in less than 5 seconds.
The math may be too simple. This model assumes an individual is making the same amount every year. If someone starts out their career making $78k per year, and after 12 years are making $178k per year, and during that entire time are saving 40% of their income, your model states they could retire after 22 years on 60% of $178k.
Their absolute savings rate would need to to be 40% of their ending savings rate throughout their career, which would be 91% of their starting salary of $78k.
Your model works if it used average take home pay for the career opposed to using salary as a constant.
Nope – your example would just mean the person could retire even earlier. You start with making $78k per year, and that’s when you set your mind to early retirement.
So you start saving 60% of that. Then your income goes up, and your savings rate goes up, because you don’t go out and blow your raises on a McMansion and a Mercedes GL450. You just save 100% of your extra cashflow.
But despite the incorrect pessimism, you have cleverly discovered yet another one of the amazing MR. MONEY MUSTACHE SAFETY MARGINS that I secretly build into all of my calculations. I make everyone assume that they will never get a raise. But then they do get raises. And everything ends up turning out even better than expected.
Develop yourself to be tough enough for the worst, yet execute for the best. That’s the way of the Mustachian. You just can’t fail.
I agree 100% with the basic premise, but doesn’t this assume that expenses are fixed and not variable. Some expenses grow more than others (healthcare). In some years, expenses will be higher due to things like college expenses for kids, etc.
Sorry if this is complainy pantsy. But what I have trouble with is the variability of expenses in the future.
This is a linear model, and life doesn’t work in linear terms – so it isn’t really fair to expect it to perfectly match “real life”. The model expects that you are starting with a net worth of zero, and that your savings rate never changes. In reality your expenses might go up, but it’s just as likely that your income would go up – people do tend to get raises and promotions over time, and if you’re careful you can leverage those raises and promotions into an increased savings rate.
This model, though, provides a good way to look at savings and some targets to strive for. Personally, I think the “be as efficient as possible and save as much as you bloody-well can” method is the mustachian ideal, if your goal truly is to achieve financial independence as soon as possible.
Agree with you here George.
It’s just that we’re getting very close (if not already there) where our income thrown off from our investments pays all expenses plus a little cushion to keep up with inflation. It’s just that we’re afraid to stop working while the kids are still young (for fear that our expenses will rise in the future). We’re early 40s with a 7 year old and a 5 year old. I have only a vague idea of what our expenses might be in 10 or 12 years. We probably just need more cushion.
Hi JJ,
My experience in having five children is that even though I didn’t want to believe it, they do get more expensive. We pay no universtiy education but we try to help them out in other ways ie. pay for some dental coverage, money towards textbooks, few clothes, track fees even in their 20′s we keep helping them out. We figure we dont’ pay any tuition so this is our way of helping them get their education. Also as they get older they start developing their own interests ie. piano lessons and hockey. I am pretty frugal but if they beg me over and over again like my 11 year old son did for two years to play hockey, then I will try to accomodate their requests. It is easy when they are 5 or 7 because they don’t seem to cost much then. Also our groceries go up because they eat alot in I find after age 10. Just my two cents here.
But don’t forget, a big item in of most people’s expenses doesn’t go up: your mortgage (assuming a fixed rate product). By assuming everything increases by 3%, you have actually added MORE SAFETY MARGIN.
read your fine print. very hard to actually have a fixed rate mortgage after 70′s stagflation. Most mortgages have a clause for consecutive high inflation quarters allowing a raise in mortgage rates.
I’ve never heard of that, even though I did read my own mortgage documents back in the mortgage-having days. But mine was from a small private bank that holds its own loans. Does anyone else have information that can confirm or deny this? (For now I’m assuming we are talking about US mortgages – many other countries have never even heard of the fixed rate).
Hi MMM, love your blog. But I have a question concerning this table here: say i earn $30,000/year and i save 50%, that’s $15,000, now your table says after 17 years i could retire, that would be just $255,000, clearly not enough to retire. Am I missing something?
Hi Ed,
Yup, you sure ARE missing something! It’s the rewards you’ll be getting for investing your money for those 17 years. Because of that, the spreadsheet tells us that you will have about $397,000 and it will safely provide about $15,750 in annual income. And this is after adjusting all of these numbers for inflation, so the amounts will pay for roughly the same lifestyle in the future as they do today.
Without the concept of money earning money, there would be no such thing as early retirement (and no such thing as rich people). Both concepts would be impossible.
ah… right, should have read the assumptions above it, sorry! Thx for clearing that up.
It is an interesting table. Of course, meeting 5% of investment return after inflation seems not that easy, it means 7-8% return, with a risk, and since your table is based on that number as a performance, that means you have to risk ALL of your savings into that kind of return… Of course, apparently Buffett did a 25% return according to this web site http://www.zimbio.com/CEO+Warren+Buffett/articles/214/Berkshire+Hathaway+Historical+Total+Return plus they show a portfolio based on BH purchases which performed higher than the market, i suppose that is with buying at prices after the purchases by BH become publicly known. This might be an interesting place to start or combine with high dividend stocks.
My savings percentage has taken a big hit recently. I’m at the beginning of pursuing a second career. Although the ultimate aim is to grow my income by multiples of what it was, it means taking a major cut in salary right now. I’ll get there, but it’s going to take time,
You mentioned that the time to reach retirement depends on only two factors:
– how much you take home each year
– what percentage of this you can live on
If you know the percentage of your take home pay that you live on, then why does it matter how much you take home each year? It seems that your calculations are only a function of this percentage, not your take home pay each year.
BAH!! You are RIGHT! I tried to make it sound as simple as possible, but yet you have simplified it even further. Early retirement is now 50% simpler than it was even this morning!
Thanks for the correction, I just updated the article.
My only concern is that there are some articles coming out that the SWR assumption of 4% may not be conservative enough. Recently updated studies using the last few turbulant years have cast doubts about it and suggested numbers as low as 2.5%.
If the Safe Withdrawal Rate declines to even 3.5% it throws these assumptions off by a good margin.
I understand the desire to be conservative, but I would still totally disagree with the idea of going for an even lower SWR.
If anyone doesn’t believe me, go read the “Safety Margin” article and think carefully about the layer after layer of safety margin that is already built into my assumptions for this table:
- no income at all for the rest of your life
- no windfalls or inheritances
- constantly increasing spending according to the CPI (no further increase in frugality skills)
- no social security
- no drawing down of your principal
What I’m trying to encourage people to do with this article is this: FIRST get to the point where you can easily live on a small fraction of your take-home pay, and you have enough savings that you could theoretically live off of the proceeds at a 4% withdrawal rate. You have a nice low-cost lifestyle with a wide variety of useful skills, and you’ve read lots of books on investing and other subjects.
THEN, try to tell me you are still afraid to quit your job.
If you worry about “will it be enough to retire?” before you even have the savings and the frugality skills to get to that point, you are putting the carriage in front of the horse.
Well – I certainly hope 4% is right too since that’s what I’ve been basing all my assumptions on. 3-5 years and I’m there!
It’s important to realize where the “4% Rule” comes from. It came out of research (the “Trinity Study”) into safe withdrawal rates for a traditional 30 year retirement. It might surprise you to learn that many of the portfolios studied did not even last that long! The single biggest risk that retirees face is longevity risk.
This article discusses the applicability of the 4% rule to early retirement in some detail:
http://arilamstein.hubpages.com/hub/The-4-Rule-and-Early-Retirement
MMM,
Thanks for this old-fashioned “numbers don’t lie” look at what it takes to retire early. Your spreadsheet and chart simply reinforce what I already knew. I started my journey to FI at 28 and plan to reach it by 40. I saved 60% of my net income for the full year of 2011, which puts me on a 12 year trajectory…exactly what I had figured.
Good stuff. Best wishes!
Loved this article. But what I don’t get is how do we account for a safe 4% when the markets have done so poorly recently. I worked our stash out and all we made this year was 2.3% and our investment advisor tells us that this is better than some other portfolios. I am very new to learning all about investing and ERE, so can somehow help me out here. Am I missing something?
Hi Mr. Money Moustache! I stumbled onto your blog via Early Retirement Extreme. I’m a 20something professional living in a Third World country (which makes it harder, but also more imperative, to save). Recently I’ve been finding it harder and harder to justify to myself why I’ve been saving 50% of my salary since I started working about three years ago, especially when I see my colleagues and friends buying new stuff, going on foreign trips, and doing all sorts of cool stuff that costs money, even though I actually earn a lot more than most of them.
Your article inspires me to keep on saving by keeping the end in mind: not only am I working towards a comfortable early retirement, I also enjoy the peace of mind that comes from having a solid emergency fund. It’s especially important for someone like me, living in a country with poor job prospects, and where there are no such things as 401(k)s, welfare or unemployment benefits. Now I’m actively looking for ways to reduce my expenses even more. I’m also going to start working on increasing those Safety Margins you talked about (I’ve only counted out 3 so far).
So thanks! :)
Hi Makee…
very interesting and I’d like to hear more about the unique challenges pursuing this in the 3rd world presents. what country are you in?
Mr. MM…..
perhaps a guest post?
I’ve lived in the Philippines all my life. To put my personal financial situation in perspective, I’m part of the middle class of a society in which 1/3 of the population earns about 1 USD a day.
How did you get that referral link from Mint.com? I’m trying to find one, but there seems to be nothing about that on the site.
Last year I got the blog signed up for a couple of affiliate programs – if you want the inside scoop, feel free to email me through the contact button. Commission Junction is a well-known one, you can visit that directly as well.
Thanks for the reply, I see.
I was just looking for a quick, dropBox style referral link to share with friends, but I’ll keep that in mind for the future if I decide to get serious about it! Right now my blog doesn’t really have much of a readership, so it wouldn’t make that much sense.
I know of two co workers who save upwards of 30% take home pay, eventhough they do this I dont forsee them retiring as they like coming to work. I currently save about 15%, but I am now jazzed to increase this every year with additional raises.
I don’t know if anyone is still tracking these comments, but the GIF image in the middle is missing.
Thanks Russell! Yes, all articles their comments section active forever, so thanks for letting me know. It seemed to be a bug in the WordPress system’s ability to display an otherwise-fine .gif. So I replaced it with a .jpg version.
here’s a slightly better graph than what MMM provides
http://freeat33.com/from-never-saved-to-retired-in-ten-years-this-is-how/
BTW I mentioned this to Derek in an email but almost no bloggers talk about saving. It’s all getting out of debt or spending less, not even GRS or The Simple Dollar talk about that. So when I first read this I thought it was all BS!!!!
“Or if it does, people will be too busy complaining about how it can’t be done, rather than figuring out how to do it”
This is what I always say about faster than light travel in spacetime!
Nay sayers always say, “it can’t be done”, when we have discovered a star’s gravity bends light to it’s will, let alone planets of huge mass, and a blackhole completely stops light once it is close enough, let alone pulls in an entire galaxy. As scientists and engineers, the scientific community can’t even fully understand gravity and it’s impact on what we call spacetime. We just measure what we see, experiment, and base understanding on what we discover. The vast majority of the Universe is a complete mystery to us.
Almost like FI and mustachianism were complete mysteries to us before we stumbled upon this blog or our first FI book and began to question our spending lifestyles, investments/income generators if any, and future goals.
So when you hear a habitable Earth like planet is 22 light years to 5,000,000 light years away, don’t rule out traveling to it! At Warp 8, you can be there in 3 seconds or 7 days, respectively. (Warp = 1 LY/sec, in my/this instance.)
A small example to get you interested:
Say there is a stronger form of gravity that holds protons and neutrons together, for now science calls it Strong Nuclear Force in the Atom’s nucleus. If we ever discover or find an element that has this strong nuclear force extend outside of it’s nuclear boundaries, and this force has wave like properties (as i believe general gravity does, and should be on the EM spectrum), we could then amplify this micro strong gravity/nuclear force, to a meter scale, and potentially use it for bending spactime to our will with enough energy for amplification. Thus achieving interstellar and intergalactic travel within minutes.
That is just a theory to get you intrigued in all these mysteries, that many people are unaware of, or will not ever question.
http://ct.fra.bz/ol/fz/sw/i54/5/8/24/frabz-who-the-hell-is-this-guy-127851.jpg
Where should I be investing? I currently save 10% of my check to savings and another 5% goes into 401k. Another 10-20% goes towards student loans. Where and how should I be investing that money sitting in my savings?
Hi Chris.. I’d start by maxing out 401(K) instead of having the money stagnate in an after-tax savings account.
Then, if you have more left over and if the student loans are about 4% or so, you might as well wipe those out first (effectively guaranteed return that affects your everyday cashflow).
After that, more investing: http://www.mrmoneymustache.com/2011/04/10/post-4-what-am-i-supposed-to-do-with-all-this-money/
Hi, I think the 5% figure is ridiculous. Here’s why.
I started saving for retirement in 1993. I have perfect data on the dollar amount and date of every single retirement contribution I have ever made.
I have saved for retirement pretty consistently since then, and that consistency has been affected only by things that would reasonably affect anyone. I was able to save a little more when times were good, and I had to save a little bit less when times were bad.
It’s worth noting that when times are good, the market tends to be up, and when times are bad, the market tends to be down. This means that the average retirement investor tends to buy into the market more when it is up, and less when it is down.
I have compared my deposit dates with the historical records of an S&P-500 index fund, and here’s what I found. If I had aimed on simply buying in to the S&P-500 every single time I made a deposit, my lifetime APY as of today would be 3.35% And right now happens to be a good period – the vast majority of the time between 1993 and now, that APY would have been negative.
I know the stats on how people can’t reliably beat the market, and how it’s unreasonable for anyone to expect they can beat the market year in and year out. Most people have trouble even matching the market, and simply buying into an S&P-500 index fund is a useful approximation of that.
Here’s the other thing, from June 1993 to November 2012, inflation went up 59.43% Yearly, that is 2.45% APY.
What that means is that after inflation, a reasonable investment schedule over the last twenty years would mean a performance of about 0.9%. In order for someone to have matched that 5%, they’d have to have beaten the market by 4% per year, which is astronomical. I’m sure someone will brag that they have done so, but if it’s not as easy and repeatable as buying into the S&P-500 index fund, I don’t consider that valuable “advice”.
The market is different than it was thirty years ago. It is volatile and automated, and trading programs chase each other up and down the board. I think that any advice that relies on the old “safe assumptions” of 5-8% annual investment returns is hopelessly ignorant and out of date, and I think holding on to those figures will only give your readers false hope and lead them astray.
Interesting set of results tunesmith, although I’m not sure I believe you (I could be convinced with a spreadsheet).
Did you remember to account for the reinvesting of quarterly dividends of the S&P500 index funds? Many stock market cynics do calculations like this based on the quote price of the index itself, while neglecting the real reason we own stocks: the flow of cash they provide in the form of dividends.
From 1993 to today, the CAGR of the S&P including dividends is 5.65% per year after inflation: http://www.moneychimp.com/features/market_cagr.htm
That’s not the greatest rebuttal, because it doesn’t take into account a stream of investments like you made, but rather a lump sum in 1993. If anyone has a better tool that can do the same calculation for a stream, let us know.
Most of my own retirement stock holdings were bought between 2001 and 2005. Not the cheapest years to buy shares, but not awful, looking at the market value today. But again, I don’t really care about the quoted value of all these businesses, I care mostly about the annual dividends they pay out, which would more than cover my entire living expenses if all my savings were invested in stocks.
.. even better is the fact that I actually have a good portion rental real estate right now.. which yields much more and will soon exceed 8% annually after expenses and after inflation (and many of your fellow readers are in the same boat)!
Thanks for the reply.
You are right about the dividends. I wrote a perl script long ago where it relied on downloading historical “adjusted close” data from Yahoo – which takes dividends into account. That’s the coding library that powers many of my scripts. I knew about dividends and adjusted close, and wrote my library to use adjusted close.
At your response, I double-checked my library, and… it is using the non-adjusted close now.
I’m guessing that during one of my many OS upgrades on the Mac, the upgraded version of Finance::QuoteHist changed how they reported “closed” versus “adjusted closed”. Or it’s possible that even though I knew about dividends and intended to use adjusted-close, I just missed it.
I re-ran my analysis using adjusted close. Now it tells my my APY (had I bought VFINX on each date) would have been 5.22%, not the 3.35% I mentioned above. While that still doesn’t rise to the level of 5% after inflation is taken into account (now it’s more like 2.75% instead of the 0.9% I mentioned before), it’s not as bad a picture as I painted, so I apologize for and retract my strong wording.
What sucks is that I have based many of my own financial strategies off of the previous numbers, so I have to rethink a lot of things. I’m glad your response encouraged me to take a second look.
BTW, I am calculating my figures using a simple software representation of excel’s XIRR, assuming continually compounding interest.
At 2.75%, your table above would change. For high savings rates (50-70%) it looks like it would add a couple of years. For a savings rate of 20%, the number of years needed goes up from 37 to 49.
How do you plan to pay for long term care when you and your wife need it? I totaly agree with you about saving, I’m 68 and spend less than I receive from investments.
Hi,
Just a short question: if I pay mortgage on our primary house, does that count as an expense or saving?
I am not sure how much I would have to be making to get to 40 or 50% of savings if the mortgage payment is counted as expense.
Thanks in advance
I’ve always thought of payments to principal as savings and payments to interest as expense. But I have never made additional payments to principal in the 10 years I’ve been a home owner. I like having a fixed living cost and more flexibility with investments for the extra cash.
Having said that, when plugging in figures into retirement spreadsheets I leave out the value of my primary residence and just include all payments as expenses. That way the housing market doesn’t affect my retirement calculations at all and we can move at any time as long as the new payments will be acceptable. In fact, housing payments are a hedge against inflation with this method because we only use fixed rate mortgages.
I am very conservative though so people may disagree with me.
The house itself is an asset, worth whatever the current market value might be. The mortgage is a liability – a loan that’s secured against the house.
Payments to the mortgage are a combination of two things – interest (pure expense) and principal reduction (which reduces the loan balance and is a form of saving).
So, I guess the answer to your question is that mortgage payments are both saving and expense. Except the expense portion is a lot larger at the beginning and goes down as you pay down the loan balance.
I think early retirement is a great goal to have, but I think some of the assumptions are a bit rosy. The 5% return on your investments is unrealistic. Who can forget 2008? I watched my Vanguard Allocation Fund lose 45% of it’s value. The income side of my investments were paying 9% while the principle drifted down and down by 50%. “Oh well, at least I’m earning 9%,” I thought. Then Calamos cut their dividend from 14 cents a share to 9.5 cents. Ok, the markets have come back, but it took five years and the interest rates are way down. Calamos still pays 9.5 cents, but I noticed some of it is now return of capital. My point is that nothing is sure in life, and what you think is enough and safe might not be. I guess that means save more than you think you will need and spend less than you think you can. Maybe that will require you to work longer than you think you need to.