The maths behind retirement is often made very complicated. But, if you look behind all the noise, it is stunningly simple. You can remember the most important things as the 5S:
- Salary: This is obvious. You need to earn money from a job or a business initially to get the money to save, spend and invest. Only then you can think of accumulating enough to stop working for money and retire.
- Spending: We all have to spend for the essential needs. You can retire early if you spend less.
- Saving: If we spend everything and save nothing, we can never retire. It does not matter how much you earn. The lesser we spend, the more we can save. The more we save, the more we can invest and grow the money we save faster and stop working for money.
- Snowballing: Snowballing your saved money means you have to invest it: stocks, bonds, gold, cash deposits, real estate, etc. We have to be careful here not to speculate and lose our money.
- Safe withdrawal: You cannot be a spendthrift once you have accumulated the money you need to live without working. The amount you need is personal but you have to remember that you cannot withdraw a lot a every year. If you do, the chances are that you will have to work for money again.
Since: Saving=Salary-Spending, spending is a key factor. If you spend less, you save more, which you can invest. Obviously, the rate of return is important, but is less important than the amount you spend. This is because, if you spend less:
- You have more money to save and invest.
- You have decreased the amount you need each month for the rest of your life
The rate of return is important, but is not as important. Unless you are Warren Buffett, you are not going to beat the market by 10% each year. Even the best investors usually beat the market by 2-3% each year. The main factor is the ratio of saving to spending. Let us see why:
- If you are an average person and save 10% of your salary each year: Saving/Spending=10/90=11%
- If you are an above average saver and save 25% of your salary each year: Saving/Spending=25/75=33%
- If you are an extreme saver and save 75% of your salary: Saving/Spending=75/25=300%( 9 times more than the above average saver and 27 times more than the average saver)
The 2-3% advantage each year is not going to beat the greater advantage that is got by saving.
If you want to know, how long it will take for you to achieve retirement, then you can use my spreadsheet. The assumptions we are going to use are:
- 4% withdrawal rate, which is generally considered safe
- 5% after-inflation return on your savings
You can view the spreadsheet here. All that you need to key in is:
- Amount spent each year as a percentage of your salary
- Rate of return, which we are keeping as 5%
- Safe withdrawal rate, which we are keeping as 4%
You are ready to retire, when the last column( safe withdrawal rate gives you this percentage of your spending) reaches 100%. Look at the number of years in the first column when that happens and add 1( because we started at year 0). You can retire in so many years.
To simplify things for you, I have created a table with different saving rates and the time to reach retirement. You can see this below:
So you can see where you are and where you want to go from this table.
Remember, that retirement here is not working for money. We all wish to do what we love and not working for money frees our time and energy to do what we like. As the sage of Omaha brilliantly put it:
“There comes a time when you ought to start doing what you want. Take a job that you love. You will jump out of bed in the morning. I think you are out of your mind if you keep taking jobs that you don’t like because you think it will look good on your resume. Isn’t that a little like saving up sex for your old age?” -Warren Buffet