Just for fun this morning I googled “How much should I save for retirement?” and saw the following graphic as the top result:
This is right in line with the traditional retirement advice you’ll receive from most financial advisors: save 10 to 15% of your income each year and start as early as possible. I agree with starting early but the idea that you only need to save 10 to 15% of your income has a few obvious flaws.
Flaw #1: Lifestyle Inflation
The first flaw of traditional retirement advice is the subtle encouragement of lifestyle inflation.
Consider Tony, a student fresh out of college earning a salary of $40,000 (let’s assume all number used from here on are after-tax). Tony considers himself financially astute and decides to save 10% of his income, which amounts to $4,000 in his first year. But what if Tony receives a $4,000 salary increase after his first year? Traditional retirement advice suggests that Tony save 10% of that increase, which means he’ll put away an additional $400 every year…and find a way to spend the remaining $3,600.
This is the first flaw of saving a fixed percentage of income each year: as Tony advances through his career and gains promotions and salary increases, he is told that he should only save 10-15% of each increase and use the rest to….you guessed it, inflate his lifestyle! This mindset is the exact reason most people find it so difficult to get ahead financially. Spending naturally tends to increase in parallel with income.
Now pretend Tony has a friend named Mark who realizes the absurdity of this traditional retirement advice and decides to buck the trend. When Mark receives promotions and pay increases, he dutifully keeps living on the same amount of income each year while Tony slowly inflates his lifestyle. Mark recognizes that he can live comfortably spending $36,000 his first year out of college and decides to keep living on this amount for the next few years, despite pay increases. Let’s see how these two guys compare financially after only being out of college for five years:
Mark has more than doubled Tony’s net worth in only five years! This was all due to one simple decision: to live on a fixed amount each year and resist the urge to increase spending when his income increased. This decision is one that has enormous financial impacts, especially fresh out of college.
There seems to be a common mindset among college students who land decent paying jobs right after graduation that they “deserve” to inflate their lifestyle and “have earned the right” to start spending ridiculous amounts of money. This common belief that one should “treat themselves” after working so hard to graduate is the exact belief that leads to slow and stead lifestyle inflation and a perfect recipe for a long working life.
By opting to continue living like a college student for only a few more years after college, it’s possible to get an incredible and life-changing jump on the financial game.
Flaw #2: Low Savings Rate
Traditional retirement advice has another obvious flaw: saving 10-15% is still such a low savings rate that it encourages a long working life. In the personal finance community, the 4% rule is the widely accepted rule that states one must have around 25 times annual expenses to retire and live off 4% of one’s portfolio without ever running out of money. Using this rule, I headed on over to Networthify to find out just how long of a working life was necessary with a 10% and 15% savings rate.
With a 10% savings rate, starting at a net worth of $0, one must work over 51 years to reach retirement:
Keep in mind, that’s not saying you can retire at age 51, it’s saying you can retire 51 years after you reach a net worth of $0 and start working full time. For most college graduates, student loan debts linger around for many years and it can take a considerable amount of time just to get to a net worth of $0. Even in the most optimistic case for someone who graduates college at age 22 and has no debt, a 10% annual savings rate puts them on track to retire at age 73.
Now let’s have a look at someone who manages to save 15% of their income each year:
Even with a 15% savings rate, one must work nearly 43 years to have enough money for retirement. For the 22 year old college grad with no debt, that translates to a retirement age of 65.
Please Don’t Follow Traditional Retirement Advice
By following traditional retirement advice, one can retire between the ages of 65 and 73.
It’s both concerning and absurd how we perceive this as normal.
The greatest financial problem our society faces is the fact that most people don’t even think about retirement until it’s too late. But even for the lucky ones who do realize they need to save for retirement, they’re met with this advice: save 10 to 15% of your income and work for the next 40-50 years to reach retirement by age 70.
If you find yourself thinking there has to be a better way to approach this problem, I bring good news. There is a way to throw off the shackles of a long working life and find freedom far before you turn 65.
At the core of obtaining financial freedom is a simple idea: save a large percentage of your income for several years. This is much easier said than done. The typical consumer that has been trained faithfully for many years by the media, television, and the marketing industry doesn’t want to spend less money, but instead they want to spend more. They want to buy more stuff. More gadgets, houses with more square footage, more cars, more toys. This is what we have been told is the way to gain happiness and live a life of true joy.
But I believe it’s possible for anyone to buck the typical consumerist norms and reach a place of financial independence, early retirement, or at least financial flexibility far before age 65. We simply have to recognize that saving 10 to 15% of our income simply won’t cut it. To truly gain financial freedom, we have to save a significant portion of our income. Check out my early retirement grid for an idea of how long you’ll have to work to reach retirement at various income and spending levels.
If you hope to live a life of financial freedom, please don’t follow traditional early retirement advice. It leads to lifestyle inflation and a long, unnecessary working life.
Here are some great resources for further reading and ideas on how to increase your savings rate:
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