One of the most spirited debates within the early retirement community revolves around the influence that a high level of savings (as well as income) has on a person’s ability to retire early. I have argued in the past that although a high income can help, an aggressive savings schedule is a far better measure to determine a person’s fitness for early retirement.
My rationale was simple: it is a person’s lifestyle that ultimately determines how long he or she can survive without a full time job post-retirement. Meaning, a more frugal lifestyle will generally enable earlier retirement than a less frugal lifestyle, regardless of income.
But yet, I would be remiss if I did not address the obvious monkey in the room.
It only makes sense that the more money a person makes, the more money a person can save. Clearly, a person who socks away $250,000 a year could certainly retire before a person who is only able to save $25,000 a year. Most likely, a savings rate of $250,000 a year is due to a very high level of income, and a savings rate of $25,000 is due to an income far less.
Based on the numbers alone, I think we can all agree that the person who saves $250k a year CAN retire before a person who saves $25k a year…but only with the appropriate lifestyle.
Early retirement comes down to…
In the first paragraph, I talked about a person’s fitness for early retirement. A person’s “fitness” is his or her ability to retire based on savings and spending post-retirement. Savings will include all accessible retirement accounts like brokerage accounts, IRAs and 401ks and their associated capital gains, as well as social security or other sources of income from side businesses, rental properties or anything else that generates cash.
Spending is the biggest factor in our post-retirement lifestyles. For most, our spending level post-retirement is directly related to the amount of capital we have saved and continue to earn, along with an estimated rate of investment return – typically around 4%, but can vary.
Early retirement comes down to our ability to live out the rest of our lives by withdrawing from our investments at a rate that will never completely deplete our savings. If we spend too much, we risk running out of retirement savings.
For example, an annual withdrawal rate of 3 to 4% of our total investment capital is common – meaning, with $1m in investments, a 3% rate of withdrawal amounts to living off of $30,000 a year, while 4% allows $40,000 a year.
The appropriate lifestyle
Let’s revisit the scenario above, comparing a person who saves $250,000 a year with a person who saves just $25,000. It is only natural to look at both scenarios and give the nod to the higher income person saving $250Gs. Clearly, this person’s level of savings has better prepared him or her to retire much sooner.
The problem is a person’s level of savings is only half of the early retirement equation. The other half is dictated by our spending and how quickly we use our savings after we finally decide to retire. Lifestyle is a big factor in completing this equation.
Here is the rub: If the person who saved at a rate of 10-times the amount of someone else also spends at a rate of 10-times the amount of someone else, that’s person’s high spending rate, enabled by a high level of income, has reduced that person’s ability to retire earlier than the lower income person.
They might still be able to retire sooner than the lower income person, but the gap has closed significantly. Imagine that after retirement, your neighbor spends $200,000 a year (to include mortgage, cars, etc), while you only spend $25 or $30k. Sure, your neighbor probably does have a higher level of savings than you, but that neighbor also needs a higher level of savings just to maintain an expensive lifestyle.
From a percentage standpoint of savings to spending, that person may not be “better off” than you.
This phenomenon is what I like to call post-retirement lifestyle stability.
Investments that increase in total value post-retirement due to capital gains (and any other side income) above and beyond a person’s spending rate indicates a high level of stability. And naturally, if a person’s level of spending exceeds capital gains and income, that situation implies an unstable lifestyle.
The important element to remember in this debate is income, savings and spending ALONE are relatively meaningless.
What truly matters is how all of these elements play together and how they affect our overall level of post-retirement lifestyle stability. These elements are crucial to our ability to retire early, and the less money that we spend (both before and after retirement), the easier this whole early retirement thing will ultimately be – regardless of your income or savings.
Can a high level of income and savings make it easier to retire early? Yes, absolutely – with one crucially important caveat. One’s level of investment savings and side income must exceed one’s spending. Otherwise, we might find ourselves looking for part-time work, and our income that we enjoyed pre-retirement won’t matter.
If spending is too high, investments will run dry. -> See, that rhymes, and anything that rhymes has got to be true.
What are you doing NOW to ensure your high level of post-retirement lifestyle stability?