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How To Retire Early: A Critique of A Widely Shared Article

Recently, an article has been floating around the internet that presented a simple strategy to retire early.  It seemed too good to be true.  The gist of it is  “Even by simply upping your savings rate from 10% to 20%, you could shave off over 14 years from your retirement timetable.”  But what really caught my eye was the a simple chart that accompanied the quote suggesting the more aggressive you saved, the earlier you could retire:

If interested, you can read the full article here.

I couldn’t find enough details on how these figures were determined.  There was no complete list of assumptions used to arrive at these calculations.  Was Social Security factored into these calculations?  What about inflation? How did they define success?  I decided to do my own analysis and critique the findings on either end of the chart.

 

Save 10% for 51 Years

For the analysis that follows, I assume a 21 year old saves about $10k a year (10% of a $100k income) and does so for 51 years. And then in retirement, he would live off $100k. Social Security is not factored into this equation.  When we model this scenario, the results are very underwhelming.

The Result:

This scenario is not promising.  There is an extremely high chance that the portfolio would last for only about 12 years in retirement.  When we run through a 1000 market simulations, only 9% of the time will the portfolio last until age 95.

A Modification to Consider:

Let’s add social security to see how this affects the probability. Assuming social security of $30k per year, we can see that probability has jumped from 9% to 74%.  That means that in 74% of the 1000 market simulations, the portfolio lasted at least until age 95.  By leaning on social security to partially fund retirement, the investor doesn’t have to take as much from his savings.

We are getting closer to success, but I would not be comfortable with this plan.  I want to see a confidence level in the 90% range.  To get to a confidence level that I would feel comfortable with, I see three options to consider doing in addition to factoring in social security:

  • Increase savings to $1000/mo
  • Retire three years later
  • Live off $1000/mo less in retirements.

An Even Better Approach:

Let’s go back to our original scenario (without factoring in social security).  Let’s assume that the investor would increase the amount he saved each year by the rate of inflation.  In year one, he saves $10,000, but by year 5 he is saving $10,510.  Now this produces an interesting result:

That small change of saving a little more than the previous year had a profound impact when spread over five decades.  And the best part is that social security is icing on the cake.

Conclusion:

With modifying the assumptions a little bit, this scenario is very realistic.  This closely matches a lot of rules of thumb out there, so I’m not surprised that this scenario is workable.

Save 70% for Nine Years:

Let’s move to the other end of the spectrum and see how we can make the more aggressive goal possible.  Here is a hint: it’s a real stretch.

The obvious issue:  A client earning $100k per year would save $70k in this scenario leaving $30k for taxes and living expenses. That’s simply not enough to live on and pay taxes upon.  Under normal circumstances, I’d stop right there in my analysis. But to make this scenario at least plausible, let’s assume that he works for a company that provides food and that he camps in the parking lot.  You may be laughing, but it does happen. Basically, he has no living expenses and that $30k is used to pay taxes.

Result:

If we take the same client situation as we outlined in the previous example and accelerate retirement to begin in 9 years, the client has absolutely no chance of having the portfolio last through our planned life expectancy of age 95.  I’d be happy if the portfolio lasted for 10 years.

 

A Modification to Consider:

To make this scenario even remotely possible, the investor would need to slash his retirement income to about $1900 per month if he wants to have a good probability of retiring in 9 years and living off his portfolio until age 95.

Conclusion:

We may find it comical to consider the premise of only working for 9 years and saving the rest, but if this hypothetical person had an extremely modest lifestyle, this modified scenario could be considered.  The author of the chart referenced at the beginning of this post is a proponent of these kinds of retirement strategies and has even retired early himself.  His blog captures his thoughts and strategies and a few months back, I even wrote about this growing extreme retirement trend.

 

Effects of Saving an Extra $20 Each Week

Saving just a little bit extra each year can have a profound impact over the long term.  Investor’s Business Daily ran some pretty interesting numbers showing the impact on one’s retirement if an extra $20 is saved every week.  Here is some of the findings based on certain age ranges:

Recent College Grad: invest $20/wk earning 6% and by retirement, that pot of money will be about $330,000.

Someone in their mid-40s:  invest $20/wk earning 6% and by retirement, that pot of money will be about $40,000.

Someone in their mid-50s:  invest $20/wk earning 6% and by retirement, that pot of money will be about $14,000.

The results are pretty clear – consistently investing over many decades can have exponential benefits on your financial situation.  Even small amounts can add up to have a big impact when time is on your side.

 

 

Critiquing a Financial Plan

The following article examines five young people and their financial plan (more like their lack of planning).  They are then offered some preliminary advice about how to improve their situation.  Unfortunately, in every case I found the advice to be overly simplified.  Here’s the article

And here are some overarching strategies that apply to all the case studies:

1)      Emergency fund.  Start here first and make it a priority to build an emergency fund that can cover non-discretionary expenses for 3-6 months.

2)      Save more.  If you can’t save more now, earmark any future raise toward saving.  When asked about a rule of thumb for how much to save, I’ll often respond with “Save as much as you can”.  Young people and millennials are unlikely to have pensions and with the questionable future of Social Security, the burden to save is placed on their shoulders much more than previous generations.

3)      Automate.  Make sure any savings are set to occur automatically.  The mental anguish of writing a check every month or year to a retirement account can be surprisingly difficult.  Many times it is our own biases that create obstacles to reaching our own goal and simple processes like automating our savings can have a huge impact.

4)      Disability.  Life insurance is commonly discussed when a couple has children.  But disability insurance is rarely brought up.  What’s odd is that people are more likely to file a claim for disability insurance than life insurance.  And it doesn’t apply just to physical injuries, either.  We’ve had several clients and prospects tell us about their long term disability that affects their ability to do a desk job as a result of a bad car crash.

 

Using The Money Management Tool: Connecting Accounts

Recently we introduced The Money Management Tool to help clients better organize their financial lives. The tool has lots of features and we will occasional explain how some of the features are being used by our clients (or should be used) to help them reach their financial goals.

This post will deal with a prospective client who has many accounts and struggles to keep track of where they are located.

Situation: A prospective client approached us looking for help managing his investments. He had about 10 different accounts – multiple checking and savings accounts and a several different retirement accounts from current and previous employers. These accounts were held with several different financial organizations.

Problem: He struggled to keep track of all the accounts. He was constantly forgetting passwords used to view his balances online. He was spending hours trying to stay organized and reading the statements. The inconvenience grew to the point where he just ignored his accounts.

Solution: The Money Management Tool could be used to connect all the accounts together. After establishing the connections between the tool and his accounts, he would be able to see daily account balances for all the accounts from a single account. No more trying to remember multiple passwords or trying to read different statements each month.

new account

If you or someone you know needs help getting their financial house in order, this tool can help.

Contact us today to get started.

Do It Yourself Investors May Be Hurting Themselves Without Knowing It

The last time I changed the oil on my car, I inadvertently drained the power steering fluid thinking it was engine oil.  Then I added engine oil and thought I was all set.  I proceeded to drive a car around town with no steering fluid and twice as much engine oil as I should have.  It didn’t take long before I realized I really screwed up my car.  It was an expensive mistake but I learned that maintaining my car should be done by the experts.

This same concept applies to investing as well.  These two articles capture some of the biggest issues we come across when we talk with prospective clients:

Financial Illiteracy May Have Cost Investors 200 Billion Over 20 Years

20 Common Investing Mistakes

15 Mistakes People Make In Retirement

Mistakes in retirement can be costly and unfortunately very common. Money magazine’s recent article captures 15 examples.

While I have seen every one of these 15 mistakes actually happen, the most common issue I’ve seen this year is Number 7 on the list: Not knowing how much to withdraw.

This has become more pronounced as a result of the flat market. Investors who saw an 8-10% rate of return on their account could take out about 8-10% each year and end up with an account balance close to what it was at the start of the year. But with the markets flat to down slightly, investors who continue to take out 8-10% each year are seeing their account down by that amount.

The general rule of thumb is to take 4% per year. Take out more on a regular basis and you run the risk of depleting the account.