Note: This is a long post (3000 words) but it can easily save you years of your life, so take a lemonade break halfway through if you have to.
When I was a TV-watching child in the 1980s I’d see a lot of commercials for something called “Freedom 55.” It was a financial planning service, offered by a life insurance company, but at the time I didn’t know what any of those things were. I knew what retirement was though. I also knew that companies in commercials always try to make themselves sound as good as possible. So the message I took from those commercials was that age 55 was an ideal age to retire, a few years earlier than the norm.
That stuck in my mind as a pretty universal benchmark, throughout my gradeschool life and working life, and it was steadily reinforced by how the working adults around me talked about retirement. It was something for old people.
I pictured the typical career-fueled life as settling out into three distinct phases: pre-work, work, and post-work.
Pre-work lasts about 16-23 years, while you live off of your parents, student loans, or both.
Work, the longest phase, lasts about 40 years. During this time you earn an increasing amount, and so as you soldier on through these four decades, you can afford an increasingly rewarding lifestyle.
Once you are in this phase you also begin to save some of your income for the next phase. The gold standard benchmark here, culture taught me, was 10%. Save 10% of your income for retirement, beginning as early on in the work phase as is feasible for you, and you’re cruising. Almost everyone recognized this benchmark too, yet almost everyone described it as being hard to do. I found it hard.
[A word on cultures: Raptitude is read in over a hundred countries, but it is written by a sole Canadian who is highly exposed to the culture of the United States. So cultural norms referred to in this post will reflect the US and Canada more accurately than they do other countries.]
At least in my area of the planet, everyone seems to mostly have the same idea of what they can expect to save and when they can expect to retire. The average American or Canadian worker retires at about age 63, and this number is rising.
Some people really do love the work part of the work phase but it’s probably safe to say the great majority prefer its evenings and weekends. We like to be able to decide what to do with our lives. Those of us with jobs have arranged to sell off large parts of our lives (8 hours a day, 5 days a week, for decades) to employers, in exchange for money that we can use to build a life that makes us happy. Life is precious — the only thing we care about really — and finite, so most of us would like to sell off as little of it as possible.
For most people, the post-work phase marks the first time they can do what they like with their days without the approval of a parent or an employer. The post-work phase is typically shorter than the work phase. If average life span is a little shy of 80, the typical post-work phase is less than twenty years, and by the time it begins, the worker’s body can’t do what it used to do.
A good way to be unusual
Through a happy accident, I’ve recently discovered a movement of people who are finishing the clock-punching phases of their lives far earlier than the status quo. I had no idea what was possible for people willing to deviate from the norm.
If the “very good” benchmark is 55, then 50 is truly fantastic, and 45 must be bordering on impossible. After all, to retire at 45, you must save enough money in a 20-25 year career to pay for your living expenses for the next 35 years — as long as you don’t live past 80.
Yet normal people with middle-class salaries are retiring at 45, or 40, or even 30.
Mr and Mrs Money Mustache retired at 30.
Jacob Lund Fisker reached financial independence at 30 — after a five-year career making a mid-five-figures salary.
When you retire that early, you’re shrinking the work phase in order to lengthen the post-work phase, which means you have less time to earn the retirement fund, and more years of living expenses to pay for. If you retire at thirty, you need enough money to live on for fifty or more years.
This is why early retirees advocate reaching financial independence — saving enough that you can live off the interest alone without touching the nest egg itself — before you shut off your career income. This means you can live to be 200 if you like, but you’ll need to save more than a twenty-year burn-off fund.
Realistically though, most people who retire that early are going to have some kind of additional income during the post-career phase anyway. If you’re done your career at 35, you’re still in your prime physically. You need to put your energy somewhere, and there’s no reason not to put it somewhere that makes money, like maintaining rental properties, building a small business, writing books or working part-time at something you love.
But that still leaves a lot that has to be put away in the mean time.
How do they save that much?
They observe the relationship between their happiness and their spending, and they stop wasting their income on things that don’t return much happiness.
They also make a point of becoming financially literate, which means they understand (for example) that a single $20-a-week habit can add a year or two to the work phase of your life.
When you compare the amount of happiness we actually derive from our unnecessary spending habits to the amount of happiness that can be derived from years of paid-for freedom (not to mention a clear and secure financial position the whole way there), most of those consumer habits come to appear glaringly absurd.
Basically, the main difference between the ER (early retirement) crowd and regular working people is that they strive to be rational with their money, in terms of what it actually does for their quality of life.
Most people’s financial decisions are driven by what the people around them decide — which, in this culture, typically ranges from thoughtless to completely backwards — and conscious thought about the getting the best deal on happiness doesn’t enter the picture. Would you rather have five all-expenses-paid years off to spend with your family, learn a language or build a business — or drive a big car instead of a small car? It’s shockingly normal for people to choose the latter, because they have no idea that they’re making that choice at all.
The long-term effects of a single financial decision
The biggest re-calibration for me has been the shift in what it means to be able to “afford” something. In my culture, to be able to afford something seems to mean, “to be able to acquire physical possession of that thing in a socially acceptable way” — if you have to steal it or take out a payday loan in order to buy it, you can’t afford it. But to borrow money from a bank to buy a car, rather than saving the money first, is normal.
My first car was $15,000 and I only had enough money to put $1,000 down on it. As far as I was concerned, I could “afford it” because the payments didn’t put me in the red.
The car is getting old and has been paid off for years now, but my next vehicular decision will be much more rational. A contractor at work asked me why I drive a little Civic — it’s normal in my industry to buy a full-sized pickup truck once you can “afford” it, because we work on construction sites and it’s just altogether more manly and awesome to be able to drive over curbs onto muddy new developments than it is to park your hatchback on the nearest pavement and walk.
I can imagine a few other benefits. You also get to spin your tires angrily, you get to sit up high, you can haul snowmobiles and other expensive toys out to the lake, if expensive toys are your thing. But all of these minor thrills seem pretty frivolous for my life, plus you have to help people move all the time. Still, those advantages may be worth more to others.
But how much more? The extra monetary cost is astounding. When you’re saving to retire at some point, as all workers are, any unnecessary costs should be seen as being sucked from your retirement fund (along with years of corresponding investment gains) which is tantamount to adding to the length of time you have to spend working.
The difference between a new, loaded half-ton and the small car I would otherwise buy is about $35,000, in terms of purchase price. Plus financing. On top of that, conservatively, another $50 a week for gas (and that’s at today’s prices) for the life of the vehicle. Then more expensive insurance, tires, oil changes and repair costs.
If that money was socked away in investments instead, after only ten or twelve years it could easily make a hundred thousand-dollar difference, which at my level of living expenses would allow me to take four years off work.
That enormous increase in freedom represents the fruits of only one financial decision. Imagine if you applied this kind of clarity and rationality to every area of spending in your life, and invested the savings for long-term.
The most important number
The math might seem murky, but there’s really one main factor that determines how long you must work until you reach financial independence, and that’s the percentage of your take-home income that you invest for retirement.
Aside from that percentage, it doesn’t even matter what your income is, and here’s why: your saving percentage indicates both how much of your money you can save, and how much you can’t — which is how much you need for your annual living expenses. The proportion between the two determines how much paid-for time off you can buy with each year’s savings, regardless of income.
Example. If you take home $40,000, and you save 50% of that, it means you’ve learned to live happily on $20,000 a year. This means for each year you work, you put away the other 20k — enough to live for a year without working.
If you save 75% of your income, it means you’ve cut your living expenses to a lean $10,000 a year, and every year you have enough left over to live on for three years. You invest this 30k, and after a decade or so it’s grown into almost five years of living expenses. Plus, in each of those years you’re putting away three more years of living expenses. You won’t have to work for long.
Obviously by saving more, your retirement stash grows much faster, but each saved dollar goes so much further, because you need far fewer of them to pay for your living expenses. Add in compound interest, and you are creating some enormous personal leverage every single time you can cut costs in your life.
Think about it this way: if you decide to live without your daily Starbucks, not only do your savings grow that much faster, but you need to save less overall, because your retirement fund no longer needs to include a thirty-years’ supply of Starbucks.
On the other end of the savings scale the leverage is very low. If you save 10% of your 40k income then it means you insist on spending $36,000 a year on your lifestyle, which means it takes nine years of saving to pay for one year of living without a job. Your nest egg will grow far more slowly, but worse, it will need to be huge compared to your apparent ability to save.
This works the same with any income. A Wall-Streeter who nets 1 million annually and saves 10% will still have to build that money pile for 50 years in order to retire indefinitely, because he’s accustomed to spending most of a million dollars every year on boat parties and restaurants.
So, Wall-Streeter or Wal-Marter, if you save 10% of your income you will need to work for 50 years to have enough to live off the returns, all other factors being the same. If you save 55%, you’ll only need 15 years (these lengths of time are starting from a net worth of zero.) If you save 80%, it’s five and a half years. There are some factors that can stretch these numbers a bit left or right, but the general principle always holds.
Mr. Money Mustache did a great rundown on this elegant mathematical phenomenon. If the idea of financial independence interests you at all, read this post.
Having a higher income ought to make it easier for you to raise your savings percentage, but Parkinson’s Law often whittles it down again. As we get pay increases, we tend to reward ourselves with more expenses, instead of rewarding ourselves with more years of freedom and autonomy. Because I always expected to have more stuff next year than I do now, I had just as much trouble saving 10% when I was making 25k as I did when I was making 50k. This year I’m on pace to save 50% of my take-home, and as my income goes up I want that to go up too.
The two big rebuttals
Over and over, in discussions on the topic of early retirement you see two major objections:
1) I can’t possibly save anything in my circumstances!
I realize that there is a whole galaxy of different financial situations out there, including those of people who are unemployable due to disability or illness, or are otherwise totally dependent on others financially. Obviously talk about how to allocate your income isn’t relevant to you if you never expect to have an income.
But everyone else out there in the workforce, whether they’re high-income or low-income, debt-free or underwater, still makes decisions every day regarding where to allocate their money. The financial philosophy that leads well-positioned savers towards early retirement is the same road that leads people out of consumer debt, they’re just farther along it.
Early Retirement Extreme is a fantastic place to start if you’re in a low-leverage situation because it shows you what is possible even with a very low income. Most career people wouldn’t have to make anywhere near the spending cuts Jacob did to get his working obligations over with in five years. In his left sidebar is a 21-day crash course on how a person can adopt a lifestyle that saves $500 a month even on a minimum wage income.
Whether you must first put your monthly surpluses towards debt, or whether you can start investing it right away, you are still getting ahead of where you would have been.
2) But I would rather enjoy my life than deny myself everything I want!
From reading angry internet threads between ER people and their critics, it seems that most of the objections stem from one common Western fallacy: that for you to be as happy as you currently are, you need to spend as much as you currently do.
As these threads unfold, it becomes clearer that the root of the critic’s fear is always that they will end up less happy as a result of giving up certain luxuries. Every early retiree I’ve read about says sacrificing their expensive habits made them happier almost immediately (sometimes there is an adjustment period), and quickly pays dividends in other ways: switching to a bike commute saves thousands while making you fit and spry; selling the boat creates an instant windfall, and a load of invisible stress evaporates; limiting yourself to one drink (most of the time) means no taxis and no hangovers, and teaches you how overrated alcohol is as a fun-maker.
I am way happier already. In the three months since I’ve been smarter about my spending, I’ve saved three months’ worth of living expenses, which has an immediate stress-reducing effect. I could get laid off or fired and have plenty of time to figure out what to do, so there’s much less day-to-day stress about my job performance, which has actually led to an effortless improvement in job performance. I have a sense of control over my life that I’ve never felt before. These intangible dividends are immediate, and they don’t cost a cent because the money is still mine.
Critics of the ER movement seem to believe that saving a large proportion of your income means you live a life of sacrifice and deprivation. I had always regarded saving like that too — that saving means you are denying yourself happiness now so that you can have a little more of it later. This is the heart of the Western Consumer Fallacy: that happiness comes from spending, and therefore less happiness comes from less spending. So far there’s nothing I miss. I am worlds happier. Right now. I have no envy when I see people in fancy cars and clothes, rather the opposite, because those luxuries represent to me what they’ve given up, not what I’ve given up.
Sacrifice is a misleading word, because life is all trade-offs. A sacrifice implies that there is a gain somewhere, a reason to do it, but the word mainly connotes a loss. To say something is a sacrifice is to have tunnel vision on what is being given up, and misunderstand or forget what is being gained.
Do I feel deprived getting into my old Civic when I know I could be getting into a big awesome truck? Definitely not, even though I would admit that if it cost the same (both to me and to the planet) I would prefer the truck. But the personal cost is devastating: four years of work, which amounts to more than 1,000 days of doing what someone else tells me to do. The time I feel most deprived is when I wake up and remember that it’s Monday, and that my day will not be mine today.
If this topic interests you, browse the websites linked in this article, particularly earlyretirementextreme.com and mrmoneymustache.com. Canadians will find Free at 45 especially useful because they don’t have to translate terms like 401k and Roth IRA into Canadian. Brave New Life is also great. Read these blogs, explore their archives. Get a sense of the mentality and how to apply it into your own situation. Also check out Reddit’s Financial Independence forum. If the math is intimidating, check out /r/personalfinance, although you can expect a more mainstream outlook there on the subject of retirement age and savings rate.