Saving for Retirement: You’re Doing It Wrong

Smart saving for retirement

saving retirement doing wrong

For most people, a job is a necessary evil. Lots of us dream of retiring early — leaving the workplace in our forties or fifties instead of sticking it out until age 65 — but we keep working to support the lifestyles to which we’ve become accustomed. We like our iPhones and PlayStations and Priuses, so we surrender to the idea that we’ll have 50-year careers.

Still, there are a surprising number of folks who manage to retire young. In fact, the 2016 EBRI Retirement Confidence Survey found that 35 percent of retirees left the workforce before they turned 60. Previous surveys have shown that 18 percent of people retire by age 55. These folks aren’t lucky lottery winners, and most didn’t have high-paying careers. In general, those who manage to retire early have opted to live with less when they’re younger so they can obtain financial freedom before they’re too old to enjoy it.

Read: 30 Ways to Retire Earlier

Early retirement is a fantastic goal, but it can be tough to achieve. Three major obstacles stand in your way:

  • You have less time to earn money. If you start working at 20 and retire at 65, you have 45 income-producing years. But if you retire at 45, you only have 25 income-producing years.
  • You spend more time living on your savings. The average American will live to be nearly 80. If you retire at 65, your savings will probably have to last only ten to twenty years; if you retire at 45, your savings might need to support you for 30 or 40 years.
  • You don’t enjoy traditional retirement benefits. If you retire young, you can’t access Social Security or Medicare for several years — or decades. You also face penalties if you choose to access your retirement accounts before you reach the minimum age requirements.

In short, early retirees have less time to make money, and that money has to last them longer. Even if you stay healthy and the economy cooperates, that’s asking a lot. That’s not to say you shouldn’t plan to retire early — it’s a laudable goal — but if you’re serious about doing so, you need to be diligent. You need to have a plan. And you need to understand the numbers.

The Extraordinary Power of Saving

Here’s the fundamental thing you need to know about early retirement: The more you save, the sooner you can retire. 

Obvious, right? Maybe so, but just because it’s obvious doesn’t mean it’s easy. Most financial advisers urge their clients to save around 10 percent of their income for retirement. Bold advisers recommend saving as much as 20 percent. These numbers are safe. They’ll get you to retirement at age 65 without making many sacrifices along the way. The downside, however, is that by saving only ten or twenty percent of your income, you’re tacitly agreeing to spend 40 or 50 years working for the man.

A growing number of people have realized that they don’t want to work for fifty years. They want to trade the commute, the coworkers, and the hassle for something more meaningful. These folks have crunched the numbers and seen that if they’re able to increase their saving rate, they can retire sooner.

Consider the following:

  • With a 10-percent saving rate, you’ll need to work 50 years before you’ve saved enough to retire. If you start working at 21, you can be done by the time you’re 71.
  • With a 20-percent saving rate, you’ll need to work 37 years before you’ve saved enough to retire. If you start working at 21, you can be done by the time you’re 58.
  • With a 35-percent saving rate, you’ll need to work 25 years before you’ve saved enough to retire. If you start working at 21, you can be done by the time you’re 46.
  • With a 50-percent saving rate — if you save half of everything you earn — you’ll only need to work for 17 years before you’ve saved enough to retire. If you save half your income from age 21, you can retire by the time you’re 38.
  • If you’re able to achieve a mind-boggling 70-percent saving rate — I know people who have done this — you’ll have enough saved to retire in less than nine years. If you managed to do this from age 21, you could retire by 30.

I’ll be honest: I used to think numbers like this were crazy. I could barely save $50 a month. How was I going to save half my income? In the decade that I’ve been writing about money, I’ve come to understand that high saving rates aren’t crazy — they’re just rare.

Over the years, I’ve talked with many people who purposefully seek high-paying jobs, find ways to slash costs, or — most often — do both. There are plenty of people who choose to forego the modern American lifestyle in order to achieve something more important. My ex-wife, for instance, has always been a super saver, and is currently setting aside more than one-third of her income. She’ll retire at age 53. I know another fellow who set a goal to retire by 40 — and did so. And I’ve met a few dedicated souls who saved so much so quickly that they achieved financial independence by the time they turned 30.

Related: 10 Best Savings Accounts of 2016

How to Save Half Your Income

According to the aforementioned Retirement Confidence Survey, about 14 percent of workers save one-fifth of their household income for retirement. Four percent of workers save at least half their income. If you believed the doom and gloom in the mass media, you’d think saving half your income was impossible. It’s not.

You probably know a dual-income couple who saves half what they earn, or close to it, by socking away one partner’s paycheck. They live on one income and save the other for the future. If you’d like to boost your saving rate — whether it’s to retire early or to pursue any other financial goal — I recommend a two-pronged attack.

First, minimize spending. Two expenses consume half of the average American budget. Pursue these first — and with greatest vigor:

  • The No. 1 way to cut costs is to pay less for housing. The average American spends one-third of his budget on a place to live. But as you’ve probably noticed, average Americans don’t retire early. I urge folks to spend no more than 25 percent of their income on housing — and less is better. Choose a home in an area with a low cost of living. Reject the advice to buy as much home as you can afford. Buy as little as you need. Take out a small mortgage at a low interest rate. Repay it as quickly as possible. Last, don’t be afraid to rent. Despite what you’ve heard, renting is not throwing your money away. Often it’s a smart move.
  • Transportation is the second-largest expense for the average American. The more you can reduce your use of motor vehicles, the more money you’ll save. Choose to live in a walkable neighborhood. I walk for 80 percent of my errands, which provides added health benefits. If possible, bike to work. Use public transportation. Reject the notion that your car is a status symbol. When you buy, choose a fuel-efficient used model and drive it until it’s dead.

Cutting costs on housing and transportation will have as much impact as everything else you do combined. Big wins are the cornerstone of financial freedom.

Yes, it’s great to clip coupons, to grow a vegetable garden, to shop at thrift stores, and so on. But recognize that these actions net you pennies at a time while tackling the two biggest items in your budget could yield hundreds — or thousands — of dollars in one blow. Many folks frown on this sort of frugality. They view it as sacrifice. They feel like they’re depriving themselves.

I disagree. Saving is not sacrifice. When I save for retirement, that money is still spent. But I’m choosing to spend it on freedom tomorrow instead of fun today.

The second piece of our two-pronged attack is perhaps most important: Maximize your income. It’s great to cut expenses and develop thrifty habits, but there’s only so much fat you can trim from your budget. In theory, there’s no limit to how much you can earn. If you want to retire early, you’ll probably want to make more money.

  • Your job is your most important asset. Treat it as such. Negotiate your salary, learn new skills, connect with colleagues, and actively manage your career.
  • Become better educated. In the U.S., education has a greater impact on lifetime earnings than any other demographic factor. Your age, race, gender, and location all influence what you earn, but nothing matters more than what you know.
  • Sell your stuff. It’ll improve both your mental and financial health.
  • Start a side gig. Make money from your hobby. Take a second job.

Most people who read this article won’t do any of these things. You won’t look for a cheaper place to live, won’t find ways to drive less, won’t increase your income. You want easy, painless shortcuts, and that’s fine. But there are no easy, painless shortcuts to early retirement. If you want to quit working before you’re old, you must boost your saving rate. There are only two ways to do that: earn more or spend less. That’s the basic rule of personal finance.

However, a handful of readers will heed my advice. You’ll make some big changes to create a high saving rate. Once you do, funnel this money into smart investments. Take advantage of employer- and government-sponsored retirement plans first. Route any remaining money into regular investment accounts. Don’t get fancy. Invest in low-cost, diversified mutual funds. I advocate total-market index funds, such as Vanguard’s VTSMX. Ignore the news. Ignore market fluctuations. Ignore everybody. Keep investing during good times and bad. If you follow these steps, you’ll build a wealth snowball that grows faster and faster as you add to it — a snowball that also gains momentum through compounding.

What about debt? If you follow this road map, you don’t have to worry about it. Even if you start the journey owing money on college loans or credit cards, that debt will disappear. Debt reduction is a side effect of boosting your saving rate.

Read: 10 Best CD Accounts of 2016

Your Wealth Snowball

At some point, your wealth snowball will be so large that it can last the rest of your life. You’ll never have to work for money again unless you choose to. At this crossover point, your investment returns produce more than you spend.

Realistically speaking, it’s important to have a margin of safety. To that end, I make the following assumptions when I calculate whether somebody is ready to retire:

  • You’ll spend as much in the future as you do now. About 38 percent of people spend more, 21 percent spend less, and 38 spend the same.
  • If you withdraw about four percent from your savings each year, your wealth snowball will maintain its value against inflation. During market downturns, you might need to withdraw as little as three percent. During flush times, you might allow yourself percent. But around four percent is generally safe.

Based on these assumptions, there’s a quick way to check whether early retirement is within your reach: Multiply your current annual expenses by 25. If the result is less than your savings, you’ve achieved financial independence — you can retire early. If the product is greater than your savings, you still have work to do. If you’re conservative or have low risk tolerance, multiply your annual expenses by 30. If you’re aggressive and/or willing to take on greater risk, multiply by 20.

The numbers behind early retirement really are this basic. But, as I said earlier, just because the math is simple doesn’t mean the goal is easy to reach. Smart money management is more about mastering your personal psychology and emotions than it is about understanding a couple of formulas. To build your wealth snowball, you need to learn to live by your values rather than the values of your friends and family. Or, worse, the values portrayed in the media.

You need to decide what’s important for you. If you remain focused on why you’re choosing to live on less, the “how” becomes easier to see. Yes, you can achieve early retirement. Others have done it, and so can you. The question is: What are you willing to do in order to reach that goal?