Living below your means is like saving for retirement twice
Hello, GRSers. Today, let’s revisit something I tacked on to the end of my nine lessons from The Millionaire Next Door:
[T]here are actually two benefits of learning to live on much less than your paycheck.
- The first, of course, is that you can save more.
- But secondly, it also means that you ultimately need to save less.
Permit me to demonstrate.
Someone who makes $50,000 but lives on just $40,000 can contribute $10,000 a year to her nest egg, and can retire when that nest egg is big enough to generate — along with Social Security and other benefits — $40,000 a year. However, someone who makes $50,000 but spends, say, $48,000 is contributing just $2,000 to a portfolio that must eventually help provide $48,000 a year in retirement. In other words, she’s saving less yet needs to accumulate more.
I thought I’d add some heft to this argument by drawing out the illustrations with some calculations (yay, math!), as well as add a third hypothetical person with a savings rate in between the aforementioned folks.
Save Now, Profit Later
Let’s assume we have three 40-year-olds who each earn $50,000. Here’s how they look in 2011:
| Investor A | Investor B | Investor C | |
|---|---|---|---|
| Annual living expenses | $40,000 | $45,000 | $48,000 |
| Annual savings | $10,000 | $5,000 | $2,000 |
| Savings rate | 20% | 10% | 4% |
| Savings rate is the percentage of income contributed toward retirement accounts. | |||
Besides their ages and salaries, let’s assume they’ll also experience the same rate of inflation and wage growth (both 3% annually) and investment returns (8% annually). Finally, they each would like to retire at age 67, when they will be able to claim full Social Security benefits.
Note: Yes, I know we can argue about the assumed inflation rate and investment returns. Let’s not, though. They’re incidental to my main point here, which is comparing investors with different savings rates. Whatever inflation and investment returns the future holds, they will affect these investors identically.
Now, let’s fast-forward 27 years. Thanks to raises, each of our three guinea pigs earns an annual salary of $111,064. But they’ve maintained their savings rates, and thus their annual expenses (since they’re just different sides of the same 11,106,400 coins, assuming those coins are pennies). Here’s how things will look at the end of 2037.
| Investor A | Investor B | Investor C | |
|---|---|---|---|
| Annual expenses | $88,852 | $99,958 | $106,622 |
| Portfolio value | $1,245,623 | $622,811 | $249,125 |
| Income coverage ratio | 14.0 | 6.2 | 2.3 |
| Income-coverage ratio is the portfolio value divided by annual expenses. | |||
As you can see, the super-saver has more than a million dollars, quite a bit more than the other two investors. Furthermore, that portfolio is 14.0 times Investor A’s annual expenses; in other words, not factoring in investment growth, inflation, or any other retirement income (such as Social Security), Investor A’s portfolio could cover living expenses for fourteen years.
The other two portfolios would only last 6.2 and 2.3 years. This is mostly due to Investor A having a bigger portfolio, but it’s also due to Investor A needing less each year because she’s learned to live on a lower level of annual expenses. This is why living below your means is like saving for retirement twice: It allows you to contribute more to retirement accounts, and you can retire sooner because you need to accumulate less to cover your expenses in retirement.
Still Not Enough?
Thus ends the lesson about the whole “saving for retirement twice” concept. I hope you enjoyed the show.
For those who wish to continue, we’ll address another question: Does Investor A have enough to retire, even after saving 20% of income for 27 years? The answer: It depends. If Investor A were a real-life person on the verge of retirement, I’d recommend 1) a thorough retirement-plan analysis, and 2) a psychoanalysis of her parents for naming her Investor A. But since this is a blog post and there are plenty of funny YouTube videos to vye for your viewing (such as this one), we’ll do some simple calculations (yay, more math!). It involves two numbers:
- Four percent of $1,245,623 or $49,825: Financial-planning geeks (and the people who love them) know the “4% rule,” which is a guideline for how much of a portfolio a retiree can spend in the first year of retirement. It’s just a rule of thumb, with plenty of quibbles. (For an explanation and some of the criticisms, read this from Vanguard’s John Ameriks.) But it serves as a good baseline for our purposes.
- The future, inflated, annualized value of Social Security benefits, or $55,668: That’s the number I got from using the Quick Calculator from Social Security Online.
Add them together, and you get $105,493 — a good bit more than the $88,852 Investor A needs to cover living expenses. Perhaps she, being the great saver that she is, could retire before age 67.
But wait! That assumes she’ll receive her full Social Security benefit as currently estimated, and everyone knows that the program is bankrupt and all she’ll receive is “10% off” coupons from Denny’s. That leaves her with just that $49,825 — only half of what she needs.
Well, not quite. As I’ve written before in these cyber-pages, you will receive something from Social Security — but it’s prudent to assume it’ll be less than currently projected. The Social Security Administration estimates that future payroll taxes will cover approximately 75% of scheduled benefits in 2037. Let’s play it safer and assume Investor A will get just half of her benefit, or $27,834, for a total retirement income of $77,659. That’s still less than $88,852.
This is where that “thorough retirement-plan analysis” would come in. Could Investor A get by on less than $88,852? Can she downsize to a smaller home? Could she work just a few years more (by delaying Social Security to age 70, her benefit will be more than a third higher than if she takes it at age 67) or work part-time (and thus retire part-time)? She likely has a few options, which are more numerous and will entail less sacrifice than those available to Investor B and Investor C.
But even they have more options than Investor D, whose situation looks like this:
| Investor D | |
|---|---|
| Savings Rate | 0% |
| Portfolio value | $0 |
| Chance of retiring | 0% |
If you can’t save 20% or even 10% of your income, save what you can, as soon as you can. You’ll always be better off than someone who doesn’t save anything.
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There are 81 comments to "Living below your means is like saving for retirement twice".
I always wondered about people who live on like 25% or 40% of their income and saved the rest by basically being as cheap as possible. These people will likely have a huge nest egg, but then not really be able to enjoy any of it because they have been practicing for years at being a huge cheapskate.
I think it is most important to find that perfect balance between enjoying life today, and saving money so that you can enjoy life later also. I think the idea of pinching every single penny now because you are “saving for retirement” is dumb. These people are going to wake up someday and realize their life is almost over, and they never did anything much except “plan for the future”, which is now almost finished.
I personally slant more toward enjoying life more today, because I know what options are available to me today, and I know what my health is like today. I know nothing about any of the variables in play 30 years from now. Sure, I save for retirement, but it’s not the entire purpose and focus of my life today.
Why can’t people enjoy life as a cheapskate? You are saying a cheapskate and poor people can’t enjoy life. That’s 99% of the people in the world. Do you really believe 6.9 billion people are not enjoying life?
Heh, I live on 43% of my income. My ‘nest egg’ is doing alright and I enjoy my life.
I don’t feel that I am pinching every penny, just those that are in excess of what I use to live my life. When people judge my lifestyle as ‘cheap’ or somehow lesser than their enlightened lifestyle, I congratulate them for being content and go along my merry way.
Tl; dr: I live in a Now that prepares for a Later while remembering & honoring the Past.
Hm. I’m wary of this too. I live on a fair bit less than I earn, but that doesn’t mean every available dollar I have goes towards retirement. I’m also trying to save for a down payment on a house and am hoping to pay cash for my next car.
The car I can see as “spending”, but how does my down payment figure in?
Great post!
That’s the point I was trying to make the other day (in the comments) about why saving up for a 20% down-payment is a good thing. If you’ve been saving the mortgage payment (or more) every month anyway it won’t be so difficult to adjust to making it.
High income (compared to the median income– we qualified for a Roth IRA this year, so we’re not raking in the dough) me doesn’t feel particularly deprived even though we’ve been saving somewhere around 50% of our income (we save less than 50% of our take-home pay, but before it becomes take-home we send a bunch to our 403(b)s). After spending a certain amount, our “enough” is pretty stable and is pretty insensitive to changes in earnings. If we were lower income we’d probably feel a little deprived. We’d need a LOT more money for us to change our spending (with 10 million in the bank we’d totally move to the SF bay area and buy a house.)
One thing I love about Your money or your life is how your measure of “enough” can and perhaps should be income insensitive. If you save when times are good then it doesn’t hurt when times are bad because you won’t have to decrease your spending, especially if your savings are spitting off passive income. It’s not just about retirement! http://nicoleandmaggie.wordpress.com/2011/02/07/i-know-were-preaching-to-the-choir-but/ A large bundle of precautionary savings before increasing your spending can benefit a lot of ways.
Although the topic isn’t about money hoarding as Back Nine mentions… I have personally found this to be true in my family as I have a few money hoarders in the gene pool. They seem to die with a lot of money saved – and some with not even any kids to give it to. I don’t know, it seems to lack balance and maybe imagination.
Having said that, I’ve had savings rates over 70% in some years – but that’s at a pretty high income so I wasn’t giving up much. But I do regret some of the belt-tightening and am lightening up a bit since I’d really like to die broke.
I live on a very small fraction of my income right now. I find it disingenuous that many financial advisors artificially inflate the number when it comes to how much we need to save for our retirement. In order to provide a concrete example, here my numbers for this year:
I make a little over 100K a year gross. I live in Canada, so I will be taxed approximately 23k, not including deductions for mandatory employment insurance and Canada’s pension plan, but including any tax benefits I get for investing in registered savings plans. AFTER taxes, I pay about 12K per year in childcare, save 29k for retirement, and pay about 12k for my mortgage. I spend everything else — which is only about 25% of what I am making.
But financial advisors will tell me that I need to save enough to give me about 75-80% of my income.
Why?
Almost all of the major expenses I have now will be gone when I am ready to retire. My mortgage will be gone, childcare will be long gone, I will no longer need to save for retirement, and I won’t even be paying into the employment insurance or pension plan. I should be taxed at a lower rate (but at this point I think I’ll be richer than an Arab sheik, so maybe not). I just don’t get the math. Can anyone explain this bad advice?
I think it’s to make us save more than we need, in order to line their own pockets (not you specifically though, Robert).
@ ArandomPerson
Let me make this clear, I certainly don’t judge or look down upon people who are saving a huge percentage of their income. I might have come accross as a bit harsh. I apologize if I did.
I guess it would also help to understand how much income a person has in relation to their savings proportion. 43% of a million bucks in income a year would be easy to live off of. But 43% of $25,000 a year would be impossible to live off of (for me).
I just see so many articles on the web that talk about saving, planning and thinking about retirement. I always like to try and provide balance by reminding people that life is not all about saving for retirement.
Why would I want to spend most of my life, planning for a later time in my life? Eventually, later runs out.
I also don’t believe that people should spend every penny they earn right when they earn it. It’s all about balance. My preference leans more toward giving more credit today, and less credit to tomorrow, since tomorrow is not guaranteed.
Saving is not all about retirement but also about having choices along the way. My wife and I have saved a large percentage of our income over the years, living on one income when we were earning two. And like Robert’s example, we were able to retire early because we saved a lot and had a low cost of living to fund in retirement. But our saving also gave my wife the opportunity to go back to college full time and complete her degree without taking out student loans. It gave me the opportunity to quit a good job and start my own business without getting into debt. Later, it gave my wife a chance to quit her job and care for her ailing mother.
Ultimately, super saving has given us more choices. The more choices, the more freedom. It’s the freedom that we value.
I want to second what Alexandra (#6) said. The big takeaway for me from this (well-written!) post is not the “what percent of my income do I live on now?” but the “how much do I need to retire?” I have always been perplexed by all these retirement calculators that do the calculations based on a percent of my current income that I will need, rather than my monthly expenses. They are assuming that we all live on 85-90% of our income. Nope!
@6 and 9,
I think the financial planners who assume you will live a huge percent of your income believe that increased medical expenses will replace a lot of the expenses, like mortgage and childcare, that will go away. Of course, #6 is writing from Canada, and the stuff I’ve heard is from a U.S. perspective.
Thank you for this post. We are house shopping and this post really helps put into perspective the notion of buying what we should buy and not what we can buy.
*** Side Note **
I just want to say that this author is really funny. To get me laughing this early in the morning WHILE reading a financial blog is no easy task. Please write more.
I think one reason for the 80% income replacement estimates is because of the effect of inflation 30 to 50 years from now. Your investors are now about 45, will retire between ages 67 and 70 and then likely live another 15 to 20 years after that. Whatever you take into retirement has to last, hopefully. I realize you will still be getting returns of some kind- hope they’re positive!
Although I plan to have my savings, 401k, pension, and Social Security, most of my current excess income is going to pay off the house. With that expense gone, my other expenses become very flexible.
@Another Kate — trust me, our healthcare system (I’m writing from Canada too) doesn’t cover everything. People will chronic illnesses spent a lot of money out of pocket every year. There’s also a move towards “aging in place” (living at home as long as possible) and that’s going to have increased costs too.
After re-reading this post (and now being fully awake!) I see what I missed in this post. I’m ignoring the % of income you live on part and focussing on the the % you’re saving for retirement part.
Good post!
The 70-80% is just a heuristic, based on some numbers from the past and the life-cycle model, and has come under a lot of disagreement in the academic community, not just among folks for whom those numbers don’t fit. Also, some folks spend more in retirement. It isn’t constant across people by any means.
Yes, the focus should be on spending, not on income. For most people income and spending track each other, and income is much easier to measure than spending– it’s what is in most data-sets. So that’s what academics use. But Robert is right, maybe they shouldn’t track, and that’s not what we should be using.
For different areas of the income distribution, Social Security (in the US) replaces different percentages of income. It’s a big secret, but Social Security is progressive. So someone who is low income would need to save a smaller percent to get the same percent of income back in retirement compared to someone who is higher income. On average, low income people who are saving nothing for retirement are getting it “about right” given their expected SS earnings according to some researchers. (Other researchers disagree.)
And yes, health care costs will be going up at a rate faster than inflation, even with Medicare available past age 65.
This is very true. It is what allowed me to retire at 55 with only half a million, instead of the millions most people think they need. I would add that if you invest all your raises, and remember that you will probably be in a lower tax bracket when you retire, that might be enough to get you the rest of the money you need to retire.
Loving the comments today. This community is a joy to read.
I’m in the same position as #6, living in Canada, 34 years old, making in the lower 6 figures, saving like the dickens. Except I’m not going to have any kids to pay for (no day care or the ubiquitous I’m going to fund my child’s ivy-league education 100% inexplicably).
Assuming by the time I retire I’ll have no mortgage to pay for, it feels kind of stupid to assume I need 80% of my gross income. I am saving 20.5% to retirement through my company plans, on top of that 5k a year (the max) to our Roth-IRA (TFSA in Canada), and about 18k a year into a high interest savings account.
I’d say I live on about 60% of my take home income roughly (significantly less of my gross income), but the retirement planners indicate I’ll need 80% even though my costs for housing (30%+ of net income currently) will drop to just property tax and condo fees/insurance/etc. I should think that would balance to spending more on travel/hobbies when you retire to fill your days? Perhaps.
Medical expenses will go up even in Canada where insurance is universal, but probably not until the late stages of retirement when you’re spending a lot less on travel and hobbies (how much travel will you do if you need to pay for major medical expenses?)
I agree with those saying retirement planners should look at your expenses rather than your income to determine how much you need, and factor in an inflation rate (3%?) and assume no mortgage payment for most people (maybe a tick box on this one for the all your life renters).
#7 makes a great point. Living on 50% of your income is easy to do when you’re making 6 figures, and correspondingly much harder when you’re making less than $50k. Some expenses are hard capped even if they are variable, and don’t just translate into a neat percentage of everyone’s income (food costs for instance may increase in relation to the income of the person but will cap in absolute terms baring some ridiculous eating caviar and truffles for every meal scenario).
Great discussion guys.
It’s nice to see it spelled out like that. Investor B, C, and D are in a world of hurt.
Even Investor A doesn’t have enough cushion to weather the kind of down market we’ve seen. If A’s portfolio shrunk down to 75%, it would be quite difficult to cover expense with the 4% withdrawal rate.
Investor A probably needs a bit more to cushion any big stock market dip. I don’t count on social security at all, if I get anything it’ll be gravy. If not, I plan to be able to live without that check.
Right now we are doing 33,000 savings a year. Hopefully, we can add another 5,000 a year starting this June for my wife’s IRA.
Once I get a job I will max my savings at 21,500 yearly. I don’t care how painful it is. When I will reach my magic number, Im gonna start business again. Wuhooooo…..
Hopefully, I will need less in retirement than I do now. Since I will have my house paid off (along with all other debt!), won’t be commuting to work everyday, etc, I won’t be spending nearly as much as I do now.
Saving 20% seems easy on paper, but when you have to deal with goods rising in cost faster than my paycheck is rising, it makes it harder to save more and more.
@ Bogey@BackNineFinance (#7)
No worries, my post probably sounds defensive.
I agree, giving just a straight % of income without a total yearly amount makes it tough to evaluate how tough/easy it is live on that given amount. I use %’s because I don’t want to broadcast my income on the net. What can one doe, that is net-life.
I agree too that spending/saving balance is important. I believe that this ratio can only be comfortably set by the individual. The problem is that most people avoid making those choices and ‘wing it’ though their money life. Or do not know how to even think about money, avoid it for personal/social reasons, etc.
Without giving any thought into if one’s balance of spending/saving, one is probably going to run into money problems. The same can be said about mindless eating or unthinking political allegiance, etc.
So one person/family might save 10% and be fine with that (due to high income, no debts, terminal illness, no children, whatever) and another might save 50% (due to their own life circumstances and motivations). The %’s & totals don’t matter (IMO), what matters is that both have thought about what they are doing money-wise, are content with their behaviors, and that it leads to their own desired outcomes.
Sometimes we saved 5% and other times 50%. We were called cheapskates by male family members like Bogey (BTW- Bogey- you need to meet my”live for today”60 year old brother who has never saved and will never be able to retire). We have a great life out on a great piece of land- all paid for- along with cars and children through college.Our motto seems to be “live for a lifetime”. It is possible. We do live on less- retired at 53 and 60- since our habits never became high spending. We travel and enjoy life. The women in my family are all retired— none of the men are even close.
We have been following the frugal part of the above post which was pointed out to us 30 years ago by a 45 year old woman stock broker who had just been left by her husband-with nothing. She was starting over. She made an quite an impression. BTW- she lived the motto and retired at 64!
I agree with the previous commenter who laughed out loud. I did too–thank you!
But I’d appreciate an occasional example that considers families with lower incomes. It reminded me of the Yahoo Finance article I read about the family that saved 50% of their income (!!). When you read further, you found their gross annual income was $250,000.
Well, gee, I’ve always lived on less than $125,000 a year. And as long as I work for a nonprofit, I don’t anticipate ever having a household income anywhere near $100,000.
Those of us who live on less also have to prepare for post-work life. But when I apply Robert’s math to my income, the results are laughable.
If I were the kind of person to fret my post-retirement security (which I’m not), I’d be feeling a bit ill about now. I wonder if other (modest income) readers have the same reaction.
Please don’t think I’m being bitter. I’m not trying to sound that way. And I’m happy with my life choices even if they’re not very lucrative. I’m just trying to inject a missing piece to the discussion.
While I, in theory, agree that people shouldn’t need 100% of their income in retirement, I think that practically, they will.
For example, our two biggest expenses right now, other than food, are the mortgage and gas (we commute pretty far). However, these add up to around $10,500 a year. That’s around 1 good trip – Europe, Japan, etc. So if we plan on traveling (at least in early retirement), then we would still need the same amount available, it would just go to travel instead of housing/gas.
And as mentioned, medical care will be a factor in later retirement – a hip replacement now costs almost $100,000, a revision twice as much. Heart medication can be up to $1,000 a month. Of course, we hope the medical cost system will be fixed, but I doubt it. Right now, it takes over $1 billion to bring a new medicine to the market – with regulations on the rise, that cost will increase too.
Finally, these numbers assume the investors do not have anyone they want to leave money to when they die. For people with children, favorite charities, and so forth, they will need more money to be able to leave something after they die.
I did enjoy the math exercise, but like most retirement calculations, it is overly simplified. The real take home message is to save as much as you can and diversify the holdings.
I liked the article and demonstration that building a lifestyle (hopefully happy and sustainable) with savings built in helps to ensure ability to enjoy retirement.
Two points I would add. 1) I prefer that the ratio Robert uses be called “Expense coverage” ratio because that is what it is, as opposed to Income coverage. It is also similar to what startups use when they describe “burn rate” of initial startup capital. 2) When the Expense coverage reaches 25 (inverse of 4% rule) expenses would be covered completely (assuming all the usual fine print.)
Thank you for an interesting article.
What I find funny is that Investors A, B, and C have uniform earnings, expenses, and returns over the course of a lifetime.
When I look back at the last ten years of earnings, expenses, and returns for me individually, they are not uniform at all. Simplifying them down to a linear regression is laughable. To me, the unpredictability is the biggest reason to save.
I always find these sorts of analyses too simplistic. For one, they neglect to take into account that your expenses change over the course of your life. For instance, a lot of people reading this are paying a mortgage today, but plan on having it paid off by the time they retire. That means if you’re living on 90% of your income today, that may be something like 60 or 70% by the time you retire. Ditto for college savings. And here’s a big one: retirement savings. You don’t have to pay into your retirement savings account after you retire.
So if investor A is putting away 20% of their salary into retirement savings, and 25% more into a mortgage payment, she’s only needs 55% of her current income to maintain that lifestyle after retirement.
Also, she can boost her retirement savings quickly after the house is paid off if she keeps paying the mortgage payment, but now puts it into a retirement account instead. Five or ten years of this probably makes a difference.
Also, I’m glad I’m not one of these hypothetical people who works the exact same job for 30 years and never gets even the slightest promotion above a standard cost-of-living raise. Who are these people that are satisfied to make no career progress at all in their lives?
I also think the assumption that you’re going to live forever (which is what the 4% withdrawal rate is based on) is a bit on the cautious side. What if you set up your withdrawals assuming you’d live to be 110? Might that be adequate?
Personally, I also question the idea of a traditional retirement in general. It sounds boring. I think I’d want to keep working indefinitely, at least part time with a flexible schedule. If I eventually have to stop for health reasons, it seems unlikely that I need to have enough saved at that point such that I can live off just the interest for the rest of time, since I’m basically retiring because I’m dying.
Great article! I’d encourage you to look at Jacob Fisker’s book, particularly the last chapter. He has similar calculations plotted out with the addition of the robustness of the portfolio.
Very funny article from Robert – I can see J.D. pinching a couple of the juicier bons mots in future 😉
@Janette (#17) – I completely agree re. people ‘living for today’ at the expense of planning for their futures. Reminds me of a work colleague who moans constantly about money, has 15-20 years left on his mortgage (at 57), carries unsecured debt and credit card debt, but spends more on lunch than I could/would ever want to!
I suppose he’s my reverse role model, if such a thing is possible?
I like living below my means, it gives me options. I pay 7.5% into my pension, save/invest another 17.5%, spend 17.5% on fun stuff and still have 15%? left over. I’m happy with my life, but I’ve never been the biggest consumer.
I am sick of these stupid growth projections using high investment returns. The S&P 500 had a 2.62% average annual return over the past 10 years.
I can’t trust any financial advisor that consistently overstates what you can reasonably expect to earn on your investments.
@Nelson
That sometimes bothers me too, but at least it’s not as bad as Dave Ramsey’s 12% (on the website in some calculations) or from the Wealthy Barber 1990s edition 15% which made me want to burn the book and not read any further.
I think the new reality is we should use about 5 or 6% in these for long term growth rather than 8% or more, but really–who the heck knows?
Thanks for a fun and informative article! Seeing recommended amounts for retirement scare the crap out of me… how can we ever save a million dollars?
I earn 27,000 a year (great salary for my part of the world). We save 33% of that, and once my husband graduates and starts working, we’ll save 100% of whatever his paycheck is.
With our small salaries, it just seems like such an astronomical amount… but with some careful investing and by avoiding lifestyle inflation, we just might do it!
Thanks for the reality check 🙂
@Adam – Given that we don’t know, I’d prefer to err on the cautious side.
@Laura – You don’t need a million dollars if you can live off of 18,090 per year like you’re doing now. I looked up the “immediate annuity” (basically, a do-it-yourself guaranteed pension) cost for a 65 year old couple to be paid 1600 per month for as long as either of them live and the price was $301,267. This doesn’t account for inflation so adjust accordingly.
@ Pamela — yes, I find the same thing! Much easier to live below your means when your means are high.
@Tyler — good points. Right now, I’m planning for retirement as a single person, but my financial picture could change drastically when I marry. There’s no planning for that now!
I don’t know what I am doing wrong, but when I enter our numbers into these retirement calculators for my husband and I’s income combined, what I contribute to retirement (10% + 5% matching) adjust prediction of return to 6 or 7%, it says we will be covered for retirement.I’ve read elsewhere that these calculators are conservative so I’m wondering what I’m doing wrong. Is this because it is assuming we will receive full social security benefits?
I think the arguments about uniform earnings is off point. If anyone has learned recently many people can go through big ups and downs, including unemployment with their earnings. It doesn’t argue with the point that that the higher % income you can save, you both save more and need less income for retirement. I know one should also factor in uncertainty in job income, and returns in market, and future tax rates, and environmental degradation costs, but as I’m a natural worry wart as it is, the last thing I need is to inject additional anxiety in retirement question. out money and chill.
Why stop at $40k? The poverty line is only $10k. If you live on $10k your entire life, you can save huge amounts for retirement. Just think of all that money! And, when you retire, you’ll already be used to living with no money, so why spend any then either! You can die with huge amounts of money, and then you can take it all… oh, wait.
Good Article! Sometimes though, we concentrate on saving money with no real plan on what to do with that money. If we simply buy stocks (for instance)when we have money regardless of the price at the time (dollar cost averaging) we are simply relying on luck to help us grow and not lose our investments. If we do not learn how to invest our money, no amount of saving will help us reach our goal.
Absolutly right! Far too many people live above, rather than below, their means. In their attempt to “keep up with the Joneses,” they’re throwing away their future. Bill
I found the thing that helped me the most in planning for retirement was Amy Dacsyzyn’s Tightwad Gazette; she said that we should plan for even keel on expenditures, regardless of income. Since my husband has a very stable income, and mine has been unstable, we based our spending on his income and used mine to invest. The amount we had available to invest has varied greatly over the years as a result, but the net result has been sufficient.
@Nelson – Thanks for running those numbers! Taking into account salary increases over the years, that looks like a very attainable number, even considering future kids and cars (we have none right now).
1 million sure would be nice, though! haha
This article sounds exactly like a recent study from the Journal of Financial Planning: http://fpanet.org/journal/articles/2007_Issues/jfp0407-art6.cfm
It might be enlightening for some. It gives detailed math and charts. You can easily see how much saving you might need to do and furthermore, how much any savings you have already will further offset any needed future savings.
Don’t let the mention of math put you off from reading it. It’s not all that long and basically just a more detailed version of this article backed by some folks with PHDs
I TOTALLY DISAGREE. The biggest waste of your hard earned money today is to save it. Here’s why. The current inflation rate, NOT what the government says, which as of yesterday was 3 percent when you take in account gas, food, healthcare is running about 15%.
As yourself, what is your cd paying right now? Exactly. How about your real estate investment? STocks over the past decade. Exactly, all making basically NOTHING, or if you are lucky 2-3 percent. That means, if you are saving your money, you are LOSING about 12% of it’s value every year. So in less than 10 years, YOU HAVE LOST ALL OF YOUR SAVINGS. WAKE UP PEOPLE. You might as well spend it now, because your dollars are going to be worth shit in no time. This article is just more bad information.
I think financial advisors use the percentage of income number because people don’t know where they spend their money and that assumption like the 4% income we project that you will receive from your retirement assets is at least a place to start working from. Without at least some plan, you have planned to fail…..
That’s a great argument for living beneath your means. I’m going to try my hardest; I want retirement to be a blast!
I have no idea what the world will look like by the time I retire in 22 years, so I am just saving as much as I can, and hoping for the best. Investing well is hard, and requires a lot of study – I admit I’m lazy and am basically relying on low-cost index funds, but I hope it will work out for me anyway.
I don’t see how anyone can claim 15% inflation when housing is down 25-30% over the last five years, and that’s most people’s single largest expense. If anything, that sounds like deflation to me.
But that’s not the main point I wanted to make. I went and looked up my tax records for the last five years. Here’s my adjusted gross income for each year, as a percentage of the previous year’s (except 2006 because I don’t have 2005).
2006: 100% (baseline)
2007: 251% (of 2006)
2008: 181% (of 2007)
2009: 100% (of 2008)
2010: 113% (of 2009)
This looks nothing at all like even being in the same ballpark as the 103% every year that the article uses. Now, I’m not arguing that my numbers are typical, but I *am* arguing that even if most people have lots of stretches of 3-5 years with 2-5% increases every year, a lot of people are going to see big positive jumps in income every few years when they either get a promotion, or take a new job. Three percent per year every year just isn’t realistic for anyone who’s trying to build a career and move upwards.
The average 50 year old makes more than the average 20 year old and this article doesn’t take that into account at all.
After taxes, I live on $27,500/year in a crazy expensive state. Granted, I’m young, single, and childless, therefore it is assumed I don’t need a whole lot. But I’m having a really hard time saving for anything with that, much less retirement and I don’t see how much further from my means I can go without moving back in with my parents. I think working my ass off and still being broke allows me to have my once a month top shelf drink every now and then, since it’s pretty much the only thrill I can afford. /endrant
Actually, Tyler, I find expecting a COLA every year to be ludicrous. My salary has dropped fairly steadily over the past 5 years and my partner’s has plateaued. Businesses are giving out very few COLAs, and it’s easy to reach the top of your salary band if you don’t want to enter management. (And no, continuous learning doesn’t get you raises, it just keeps you employed.)
For folks like us, I think you need to assume that your salary will be flat once you reach your 40s, and you need to save like crazy since you could be laid off or unemployably old at any point.
I have to say, I really wonder why so many people seem to think saving money is a bad idea. I guess they just *like* being in debt and always having financial “emergencies” to cope with? It must be FUN to live with all that drama! NOT!!
Robert’s illustration seems reasonable. Someone making $50k at 40 has a very good chance of making $110k at 65. And living on $40k when you make $50k is pretty darned do-able.
Using this post as a jumping-off point to argue about stock market returns is just avoiding the real issue we should be looking at, which is, how much are we saving.
Like Luke says above, ‘I like living below my means, it gives me options.’
I always enjoy the articles from Robert.
My whole motivation for saving is to have flexibility and freedom in life choices down the road, as KC(#8) said.
Health care and more specifically, end of life care, is a huge factor that will eat up the savings of even the most financially careful individuals. I have seen this recently with three of my grandparents. However, the cushion they had allowed flexibility in their choices to the very end, which made everything easier for them and for our families.
Jen,
Hang in there! When I was your age I was saying the same thing as you. Start by putting away whatever you can, even if it is a $20 bill per month. I started saving that way and I am now in my late 40’s and am on course to retire at 55. The trick is not being brilliant, but being consistent.
Similar to what the other posters are saying, I also wonder how much I’ll need to live on in retirement. Rather than thinking in percentages, (I’ll live on 80% of my income -or 70% – or whatever) I wonder about what will happen. I’m only 32. My husband and I would like to build a cave house when we retire. But then all the what if’s start to come in. I really feel like I can’t guesstimate what our health costs will be. We have one son who is autistic – will we have longer terms costs associated with his education/therapy? What if we have a second child? All of these factors affect both how much we can save now and how much we’ll need to live on in retirement. So I just get overwhelmed calculating how much we’ll need and just go with the “I’ll save as much as we can” plan. But I always wonder if it’s enough.
Jen – thanks for sharing your info…I`m in the same boat and it is definitely discouraging. I used to tell people that the thing I wanted most was a savings account. I got a second job which has been surprisingly great. I’m not tempted to buy STUFF because I’m busy, I don’t compare myself to other people because I don’t have time, AND I save most of my second paycheck in an ING account. The remainder goes toward treats like dinner out once in a while, music for the commute, and manicures…lol!!!
Jen… I feel your pain! I’m a young woman, not married, no kids- although I have a live-in boyfriend (barely employed, a whole other story) and way too many pets. After a few flubs and false starts, I finally have a small savings. Don’t get discouraged! It’s a struggle and you may have to try several times to find a strategy that works for you. I’m still working on finding my own money groove and am learning quite a bit about myself in the process. It makes me feel more at ease to have even a small cushion of money “just in case.”
Wait… I assume we’re taking net income not gross income? I hate it when people talk income and don’t specify.
For instance, in Canada, take home pay for $50K income would be about $36-$37K — so saving $10K would mean living on $26K, and that would include saving for down payment, paying off any debt, building an emergency fund, etc.
I’m not sure if this post makes me feel better or worse!
JD, go to the shadowstats website and revisit what Don #41 said. The federal gvt. constantly fudges the numbers for inflation and cost of living to keep their payouts nil or low. Meaning, they lie through their teeth. My income hasn’t gone up for years, the COLA is 0% and my employer just lowered the % they pay retired from 3.5% to a max of 2% or whatever the federal CPI-W is which is 0%. And inflation in food and fuel is way higher than 0%, those aren’t used when they factor in the calculation. Housing prices are lower, but that means most are not buying houses but renting which is increasing way faster than the cost of living.
I love the psychology of money. A simple change in thinking can have profound effects for your future quality of life. I really wish congress would begin running this country like a household that was concerned for a prosperous future.
Yet another variable to consider: for example, my University hasn’t given us a cost of living raise in 7 years. Yet, our medical insurance premiums continue to rise.
But that is missing the point of this very fine article. Thanks Robert!
This new math is killing me!
Then you have me. Married for 20+ years to a hardworking fellow. Between the two of us we averaged annual gross income of $45K. I saved as best I could by setting aside $5, $10 and $100 a couple of times. In 1996 I had 78K in retirement funds and was 32 years old (hubby was 38). Then our home was flooded because a contractor doing a city project made a mistake. While struggling with being unable to live in the house, I was diagnosed with cancer and needed surgery (no insurance). Within a year I had cashed out the $78K to begin rebuilding the house and pay for surgery. (we recuped a very small portion of the loss from the contractor). We sold the house and walked away with $11K to our name. That was in 1998. We’ve tried to get back on track, but every time I save something happens to eat it up: chronic illness, cost of experimental medication, hurricane and tornado damage to home over 3 years (part not covered by insurance), and more.
Life lesson for us: continue to save because it’s the responsible thing to do. Plan for the future, but be prepared for something to get in the way of those plans. We changed are idea of retirement to be a working retirement – doing what we each love to do. We’re on track to begin that in 2 years. I’ll be 49 and he’ll be 55.
Nice theory but the reason why I can save so much now is that I am single with no kids.
Which probably won’t always be the case.
Also, I am saving a high percentage of my money now so that later I can afford to spend more. While I plan on always living below my means, I am not naive to think that I will constantly keep up the same lifestyle. I am 27 now and working and saving hard so that I can afford to go on vacations around the world (possibly living in other countries) buy a larger house, be able to help my niece, nephews, and my future kids go to college, etc etc.
So it’s not really like saving for retirement twice in my case because I don’t plan on much of the money I am saving today to even make it to retirement, and I don’t plan scrimping as much as I am now. I’m scrimping now so that I don’t have to later. It’s easier to scrimp when you don’t have to, than to scrimp because you have to.
You can save which is the right thing to do, but there is no guarantee that those savings will even get close to retirement age. I went on disability two years ago due to a recent chronic illness (ie. no cure; will have it until I die). All the out-of-pocket expenses for healthcare ($600+/mo) not including dental ate everything in its path. These are expenses I may have forever. I’m now 32.
I guess the moral of the story is SAVE. You’ll never know what may come up (to echo what #59 Charlene said). Having a life where you’ll will hit retirement without any major financial crisis is a luxury.
@Charlene – Thank you for your example. It shows the importance of having insurance… both for home and for health. It might be expensive but not having it is even more expensive.
Great article! I am another person who lives on less than half of my income….and I don’t feel deprived in any way. I am in my late 30’s, and I hope to retire from my “day job” by the time I am 50, although I am sure that I will continue with odd jobs and running my blog (thethriftynation.com) long after that. There are so many areas where it is very easy to save money and not feel “deprived”. When I buy a computer, I always buy a used “top of the line” model from 2 years ago. I drive my car until the wheels are about to fall off, and them replace it with a 2-3 year old used model. The list could go on.
Keep posting great articles like this one!
Something that never gets mentioned at GRS but which has a major impact on one’s finances is divorce. Some financial experts contend that the single most important factor to financial “success” is staying married. I would love to hear more stories about people who have had real life bumps in the road such as illness and divorce, how it affected their finances and how they recovered. Much as I appreciate “The Fool”, I find his examples unrealistic for the majority of folks, myself included.
@ #41
Perhaps instead of not saving, you should diversify into commodities as a hedge against inflation. While it is true that inflation reported by the Gov’t is grossly understated, not saving will accomplish nothing more than a person’s long term misery. Real estate, if that’s your thing, is at bargain basement prices now, and if you can get property of investment vehicles that invest in real estate, that too will hedge against inflation in the long run.
You know you are a PF geek when you can’t wait to turn 50 because you’ll be able to make catch-up contributions to your 401k.
On a tangent from this article, I’d love to see a post on balancing retirement savings vs. college savings.
MrP and I contribute the maximum to our tax-sheltered retirement funds (401k, Roth IRA), and any savings beyond that and our emergency fund go to our kids’ college accounts. If we were to put the additional funds into a non-sheltered account that we earmarked for retirement, we would be required to tap it for college anyways.
I’d be interested in learnign about other approaches to this issue.
to Jen & friends,
I need to agree with what has been said. The most important thing about savings is to start. The second most important thing about savings is to keep at it.
I’m 63 now. I did not save anything in my 20’s and when I was in my late 30’s I started to think I’d better get started, But the idea of living on less than my income induced panic.
I started with $15 a week which seemed unbearable deprivation to my life. It touch and go for a few months, I even depleted it to zero after a short time, and had to start again.
Now it is easier with direct deposit. I have a set amount sent into an on-line back saving account (despite the miserable interest rates these days, some are definitely mildly higher than others), and the balance goes to checking for bills; these are at two different banks so transfers take some time, and I cannot drain the saving at a moment’s notice.
Anyway, keep at it. You can do it. Here the cliche, but it is true: If I did, you can too.
Back then I remember reading a book called “Money Is My Friend”. A lot of new age stuff, but the concept stuck with me; if I make money the enemy, I will have a hard time. If I look at money as not an enemy, maybe my attitude can shift, and my life too.
Tyler @26: I had thought that the 4% rule assumed unlimited lifespan as well, but the linked Vanguard article implies that the rule assumes only a 30 year horizon. Of course, I’m sure if you asked 10 economists what “the” 4% rule was you’d get 11 different answers.
In any case, I concur with the other commenters: great post! And if you haven’t already, check out the Vanguard article — the chart right at the beginning is very intruiging.
That person saving 20% probably also prepayed his mortgage by about 10 years because he knew it would make it easier to retire. 🙂 Just something to think about. It’s much easier to retire early if your largest expense (besides medical insurance) is reduced to property taxes and homeowner’s insurance.
Well I’ll tell you what we’ve done. Our combined annual income is about 110k/yr. Right now, we are saving 10-12% of our gross salaries into retirement accounts.
With our remaining money, we have four different bank accounts. The first account is basically the “paycheques go in…bills come out” account. The second account is our “long-term/emergency” account. We also have a “short-term/vacation” account that we use for items we plan to buy/travel to over the next year. Our final account is a “mad money” account that we use for things such as eating out, entertainment etc..
So, with each pay period, we put money into each of these accounts. We also give about 3K to charity each year plus saving money for my daughter’s college (currently she is 6 years old).
As time goes on, money will be delegated to different areas. For example, when my daughter no longer needs child care (which is about 10k annually), money that was used for that will be divided between savings and larger monthly contributions to my daughter’s college account.
When I reflect on this “80% income” requirement for retirement…I think it is a bit inflated. It doesn’t take into account that you have your mortgage paid off, additional money coming from CPP (I live in Canada…this is the Canada Pension Plan).
Right now I feel I’m on the right track.
Ok, Mr. Yay Math. How does investor B end up with less than 1/2 of investor A? Reverse graduated taxes? If I make an investment of $5,000, and save it with 8% return, it will always be half as much at the end vs. a $10,000 investment (unless you are taking out income taxes).
#71 is correct. When I run through $10k a year with 3% increases at 8% for 30 years, it’s twice the amount of when I run $5k a year with 3% increases at 8% at the end. Which makes sense, since it’s all multiplication. The original blog post should be edited (it doesn’t change the discussion but the numbers are skewed in a way to make it look more favorable than it is which is wrong). Or at least explain how it is that the amount is less than 1/2.
The biggest thing you can do is reduce the amount of money you’ll need.
You have to work YOUR numbers to see how changes to your financial plan affect your retirement. We are in our 40s, so we’re looking at a shorter time frame than some people. We just refinanced our mortgage and got a much lower rate (sub 5%) Let’s say we have a $1000 mortgage payment. In order to cover that mortgage payment in retirement, we’d have to contribute an additional $1600 a month to our retirement funds using conservative assumptions. If we took that same $1600 and applied it to our mortgage, we’d pay off our mortgage before retirement and wouldn’t need the additional money during retirement. What if, when the mortgage was paid off, we took the extra $1600 per month upgrading our energy needs and installing solar panels (or something yet to be invented). Then when that was done, if you’re still working (because you haven’t been forced into retirement and your health is still good) you could save up for a really efficient automobile, or invest in a farm coop for future food purchases, or anything else to reduce future expenses.
We contribute the maximum contribution to our 401K that the company matches. Any retirement money beyond that goes toward reducing future expenses.
I’m making corrections to the post, per comments 71, 72, and 74…and I’ve revoked Brokamp’s math merit badge. 🙂
I think I can keep my math merit badge. It’s my spreadsheet badge that has been tarnished. Also, I still have my marksman merit badge (earned way back in 1982). Just sayin’…
Pondering what it means to “live below one’s means”, and thinking about whether I qualified as Bogey’s “cheapskate”, was more interesting to me than the math. (no offense!) When I reached a salary around $60,000, I reached my magic number, apparently, and it even felt like that at the time. I could buy what I wanted. I could go on vacation every year. I could eat out a lot. Today my salary is about $95,000 per year (before taxes), and I painlessly save a minimum of $35,000 per year. I suppose I live below my means, but I don’t feel that I pinch pennies, as Bogey would believe. Somehow, I managed to stabilize my idea of what my standard of living should be years ago, and I didn’t mentally adjust upwards as my salary increased. I’m sure you read about the study that found that money buys happiness, but only up to about $75,000 in income. I believe it.
Thanks for a great post. This was a really good concept on the double benefit of living below your means. I even enjoyed the link to the Sax Man! Keep it up.
My mother in law is 53 years old and has $100k in her 401k account and that’s it. She’s always borrowing against it and every time i see her i tell her how important it is that she leaves it alone and ups her investments. She’s been with the same company for 25 years, her 401k should be huge.
Unfortunately for some people they’d rather spend for today than save a little for tomorrow. I believe you can easily balance it out, but some people just don’t like the idea of saving or sacrifice.
Fantastic article. It really pushes me to be cutting my expenses, putting aside a heck of a lot more, and investing with greater ferocity. I can see that it will pay off in dividends in a relatively short period of time 🙂
Tiny quibble – Can you please remove the phrase “Rule of Thumb” from your article, as it stems from an ancient ‘rule’ around a man beating his wife. The ‘rule of thumb’ means that the item (usually a rod/stick) the man uses to beat his wife with cannot be of greater width than his thumb. There are better phrases to use.