Mind the gap.
Everyone in the personal finance world has some version of this sentiment, including the folks that run the London Underground. There are hyper savers and Uber earners. There are some that are cool with both. I definitely fall into the third category. I don’t really care how you build a gap between your income and expenses; just make it as big of a gap as possible!
I would like to use this post to explore why it is so important.
A friend shared this savings curve from the awesome team of Winnie and Jeremy over at gocurrycracker. I did some additional tracing, and Mr. Money Moustache has a similar post. He also linked to networthify (not https) which may be the original source for this set of bloggers. So, let’s dig into this a bit more. First, the graphic itself.
The idea is that if you save x % of your gross income every year (and maintain your current expenses indefinitely), after y years, you will achieve Financial Independence.
- Mr. and Mrs. Money Mustache completed their journey to financial independence in about 9 years by saving 66%+ (and making a few mis-steps along the way)
- Jeremy and Winnie completed theirs in 10 years and a day by saving north of 75% of their take home pay (and making some pretty big oopsies of their own)
This was eye-opening for me! I fancy myself pretty good with money. Let’s see how we’re doing by this standard. Here’s our 2016 expenses Paretoed out into big buckets.
And the answer to how well we’re doing is: pretty crappy! …although, not relative to the average US person, actually. Turns out on average, Americans only save ~6% of their after tax income. We’re putting away just over 30% (with a 1 yr old).
Relative to how we were doing pre-kid and compared to other extreme early retirement bloggers, we’re not socking away as much as I would like. And, you know what? That’s OK. We’re parents. And, this early retirement thing is just creeping into our consciousness.
For another post, I’ll have to dig into what our numbers were leading up to the purchase of the rental property. Speaking of the rental property, I’m actually a bit more bullish on our ability to retire early because of our real-estate portfolio. Let’s quote George Box again, “All models are wrong. Some are useful.” These models strictly look at investments as having a fixed percent (5%) growth. They also assume a fixed 4% withdrawal rate in retirement based on your current expenses. Both are conservative and your expenses may vary quite a bit…I hope we’re not still paying for child care when we retire!
Last thing before I sign off: see how the relationship between savings and time is curved? That’s because of two basic factors:
- Compound growth
- Constant expenses
The more you can do to save early, the more your best savings tool gets to work for you. By the way, it’s the tool that anyone selling you something doesn’t mention: time. In case you missed it from school, compound growth follows an exponential growth curve. Practically, that means the more time you give your money to grow, the more it works for you. Here’s $1000 invested for 20 years at 7% (compounding monthly).
Point two is where this gets exciting. If your investment grows at an exponential rate and you withdraw at a constant rate, your investment will continue to grow even as it supports your retirement. There’s some caveats to that, but at it’s core, that’s why the 4% withdrawal rate is such a nice way to plan for retirement.
Think on that for a while. Then, think about what structural changes you might be willing to make in order to bring retirement closer to today.