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Savings Rate: The Secret To Early Retirement

For years, I’ve been interested in the subject of personal finance.  I’ve read many books, listened to many podcasts and more.  I thought I had a a basic idea of what I needed to do in order to retire.  However, I recently discovered a secret.  That is, there is a distinct relationship between your Savings Rate and early retirement.  By dramatically increasing my savings rate, I’ll be able to significantly boost my dividend portfolio and be well on my way to early retirement. There’s much to discuss, so let’s dive in.

The Problem

A lot of the financial materials out there rightly focuses on retirement.  However, the problem is that much of the focus is on retiring around the traditional retirement age of about 60 or 65.  The assumption is that an individual would start out at age 20, work 40 years, and then retire at age 60.  But who wants to spend 40 years of their life working because they have to?  I know I don’t.  But, I didn’t know better and so for the longest while, I was following that mantra.

I listened to many different financial gurus and took the advice I thought was relevant to my situation.  For example, I came across David Bach.  He has written many books, but perhaps one of his most famous is The Automatic Millionaire.  One of the things that David Bach teaches is the concept of paying yourself first.  What many people do is after they get paid, they first pay their bills. So, they might pay their mortgage, their credit cards, utilities, etc. Then, after all the bills are paid, they try to save what’s left.  Rather, David Bach suggests that as soon as you get paid, you immediately save a portion towards retirement. That makes perfect sense, and I’ve tried to adopt that in my own financial plans.

Financial Gurus

David Bach is not the only one.  There’s also Ric Edelman.  Ric Edelman has his own financial advisement firm that gives everyday Americans access to certified financial advisers.  He also runs a weekly podcast which I listen to regularly.  Ric Edelman also has written many books, and perhaps, one of his most famous is The Truth About Money.  One of the principles I take away from Ric Edelman’s advice is the importance of having a well diversified portfolio.  Truthfully, my dividend portfolio wouldn’t meet Ric’s definition of well diversified.  But, my investments in my Roth 401K and Roth IRA are more diversified because I’m invested in various funds, including index funds.  So, I try to keep his principles in mind when I invest.

Of course, there’s also Dave Ramsey.  He has his 7 baby steps, of which I try to follow the first 3.  Dave recommends in baby step 1 to first save $1000 in a starter emergency fund.  I am still working on saving my $1000.  In baby step 2, Dave recommends that you get out of debt using the snowball method.  Using the debt snowball method, you would pay off your debt from smallest to largest (except the house). He then recommends in baby step 3 to build your emergency fund to 3 to 6 months of your expenses.  For me, I’m working on baby step 2 and will be finished with it by October when I pay off my student loans.  Visit my debt tracker to follow my progress.

But Wait There’s More

There are other financial gurus that I’ve listened to over the years.  These include Ramit Sethi who wrote I Will Teach You To Be Rich and has a blog by the same name.  My biggest take away from Ramit is his concept of Conscientious Spending which I wrote about two years ago in my Conscious Spending Plan post. I’ve also listened to Suze Orman and others.  So, why did I go through citing all these financial gurus?

The point is that even after listening to all the names mentioned, reading all their books, looking at all their fancy charts about compound interest, etc, I never really grasped the fundamental relationship between having a high savings rate and retiring early.  It’s certainly possible that one or more of the financial gurus did mention the importance of having a high savings rate.  It’s certainly possible that I might have missed it. Or that I did read it, but it didn’t sink in.  Maybe I was too young, or immature, or naive, or stupid to have understood what they were saying before.  I don’t know, but I feel duped.

Too Motivated To Feel Sad

I don’t blame the gurus.  In fact, I will continue to listen to them and take the advice I feel is relevant for my situation.  But now, I also understand that a lot of their advice is for folks who will have a traditional retirement and I just have to tailor their advice accordingly.  Before I go on, I want to emphasize that I am neither recommending nor disparaging any of the financial gurus listed.  I’m only saying that in all my time listening to them, there was always something missing to give me the confidence to believe that I too can have a successful retirement. Well, I’ve recently discovered the missing link and now wish to share it with the whole world (or at least the 100 or so readers who read my blog everyday).

The Intrigue

About a year or two ago, I kept hearing about FIRE. FIRE is an acronym that stands for Financial Independence Retire Early.  Honestly, I didn’t pay much attention to it because it was usually used in association with a discussion about Millennials.  As I am not a Millennial, I mostly ignored the topic.  That was dumb!

Had I paid more attention, I probably would have discovered the secret to early retirement earlier, but I didn’t.  However, as I am learning more about FIRE, I started to change my thinking.  Rather than just focusing on the traditional retirement age, is it possible for me to retire early?

Sometimes, believing that something is possible is a key ingredient to achieving your goal.  I never really gave early retirement a second thought because I never thought it would be possible for me.  I’m close to being 40 and kicking myself everyday for not starting earlier.  In my head, I figure that I still have a good 20 to 25 years of compounding growth in the stock market.  I hoped that would be enough time to allow me to have a respectable retirement.  I don’t want to live on beans and rice during retirement.  Unless I win the lottery or marry rich, I won’t be sailing around the world in my yacht during retirement.  But, I hoped that I would live in a nice house, and if I wanted something nice, I could buy it without calling Suze Orman asking if I can afford it.

I’m On FIRE

But, I started to pay more attention to FIRE.  A lot of the gurus talk about being financially independent.  But, now I am paying more attention to the possibility of me retiring early.  You heard that right!  For the first time, I truly believe that it is possible that I can retire early.  I have set a realistic target date of age 55.  Not quite as young as 45, but not quite as old as 65.  I think that if I am able to retire at the age of 55, I would still be in reasonable good health (hopefully) and be able to enjoy my retirement more.  I might still work (maybe as a bartender or at Starbucks), but only because I want to; not because I have to.  Much of the literature on this topic suggests that to be financially independent, it is necessary to save at least 25 times your expenses.  This is consistent with the 4% withdrawal rate that we keep hearing so much about.  I plan to do just or more.

So, what’s the secret to an early retirement?  Your savings rate!

The Solution

The solution is remarkably simple to understand, but difficult to execute. If you want to retire early, one way to do that is to increase your savings rate.  More specifically, if you can increase your savings rate to an amount away higher than the typical 10% to 20% that the gurus recommend, you can be well on your way to early retirement.

One person who has championed this idea is someone you have probably heard of.  That is Mr. Money Mustache and he runs a famous blog by the same name.  In 2012, he wrote an article entitled The Shockingly Simple Math Behind Early Retirement.  If you haven’t already, I highly recommend you read it. The information below comes from that article.  I will try to provide some of the important points mentioned in the post.

Let’s Talk Math

Mr. Money Mustache makes several assumptions. They are that you:

  • “Can earn 5% investment returns after inflation during your saving years”
  • “Will live off the 4% safe withdrawal rate after retirement”
  • “Want your stash to last forever”

Mr. Money Mustache posted a table that shows the relationship between your savings rate and the number of years you would have to work towards retirement.  Based on his calculations, if you have a savings rate of 10%, you can expect to retire in about 51 years, given the above assumptions.  Increase your savings rate to 25% and you reduce the number of years to 32.

The math starts to get exciting at reaching a 50% savings rate.  Then, it would only take you about 17 years to retire.  And, what’s really exciting is that if you can increase your savings rate to 75%, then you can retire in a whopping 7 years!!!

Wow.  Mindset is key.  Don’t think there’s no way you can get your savings rate up to 50% and beyond. Try to figure out how you can do it.  Nothing changes if nothing changes.

The Concerns

Admittedly, there is no perfect system or magic pill that’s going to get you to early retirement. There are drawbacks or things to be aware of with any approach.  Let’s look at some things to be aware of with this approach.

First, it’s important to decide what you are going to do with your savings.  If you save 50% of your income and put it in a checking account, you probably aren’t going to be making enough money in interest to follow this strategy.  So, the savings should actually be put into investments.  I’m a fan of stock market, but I’m also comfortable with the risks involved.

Perhaps one of the biggest concerns there is with the approach is that it relies heavily on the performance of the stock market.  If the market severely drops in the couple of years before you retire, it might not work out so well.  Also, the impact of taxes should be accounted for.  So, it’s probably not a bad idea to have contingency plans and a safety buffer just in case. There’s also no substitute for a detailed plan for your retirement. But, with dedication, consistency and perseverance, I think this approach can work for some people.  I know for sure that I’m going to give it a try.

Conclusion

I finally found the secret to retiring early.  I realize that it’s not really a secret and that there is much information out there on the topic. However, I never discovered it until now. By increasing my savings rate to 50% and beyond, I will have more money to invest in my divided portfolio and other retirement savings. I am confident that by focusing on my savings rate, I will be able to achieve my new target retirement age at 55.  So, you can expect monthly postings about my savings rate.

As always, I a not a financial adviser and you should do your own research before deciding the best approach for you.  However, I hope you found this information useful.  Let me know your thoughts by commenting below.

The post Savings Rate: The Secret To Early Retirement appeared first on Dividend Portfolio.



This post first appeared on Dividend Portfolio, please read the originial post: here

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Savings Rate: The Secret To Early Retirement

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