Part I: Opportunity Cost
I know I’ve talked about this before, but recently I’ve been thinking about the best way to help people visualize it.
This chart show the percentage of your retirement remaining at each age. It assumes you start savings at 25 and retire at 55, contributing the same amount every month and earning a 7% real return. Inflation would be canceled out by inflating your contribution amount, so we don’t worry about it.
Even though this chart shows some pretty compelling things, like:
- the first 10 years matter more than the following 20
- delaying savings by 5 years destroys 33% of retirement money (which meal will you be skipping in retirement?)
- The first half of your career accounts for 75% of your retirement nest egg
I want to make it more concrete by adding the aged faces below the chart so that people can more easily identify how screwed they are. Basically, if you look middle aged, there’s only one quarter left in the game, and you need to haul some serious ass to salvage any kind of good deal for yourself. You can still do it, but to be successful you’re going to have to get weird.
I need to make direct connections between ages and retirement outcome.
Starting at 25 is steak. Starting at 30 is ground beef. Starting at 35 is SPAM.
Starting at 25 is exotic, sandy beaches. Starting at 30 is cheap Florida. Starting at 35 is your cat’s litter box.
Starting at 25 is a house. Starting at 30 is a condo. Starting at 35 is your kid’s condo.
Part II: Savings Rate
How much will you need for retirement? The Trinity Study (https://en.wikipedia.org/wiki/Trinity_study) suggests you need enough such that you can live on 4% of your invested assets.
Roughly, if your assets earn 7% every year on average, and inflation is 3%, then you’ll get to spend 4% and reinvest 3% so the invested assets keep up with inflation.
Starting from 0, we’ll need to invest a percentage over 30 years such that our savings is 25X our annual spending. For a 30 year timeline, that savings rate is about 27%. This is a percentage of your take home pay. If you spend $2000 a month, your nest egg will be $24k / year * 25 = $600k.
But say you don’t have 30 years. We all would like to believe we’ll be able to work forever, but the reality is that many of us will encounter health problems that ruin our plans. We pick a cutoff age – let’s say 65. So if you’re 45 and you’re reading this, you only have 20 years left. What will you do?
You’ll save 50% instead of 27%. That’s less fun than saving 27%, but being broke in old age is less fun than spending less while you’re still able bodied with the dignity of a career.
A 10 year retirement plan will require savings of 66%.
The 27% plan allows for a more comfortable retirement plan than the 50% plan, and the 50% plan is more comfortable than the 66% plan.
Part III: Happiness
Part I tells us to start now, and Part II tell us how to calculate the minimum we must save. These numbers are daunting if you haven’t started yet, and many people will have to make dramatic changes in their lifestyle to get on track.
Furthermore, many of the implied changes can be a big emotional shock. What do you mean my salary doesn’t matter? I’m a successful person – I make over $100k a year!
Learning that you can’t afford your house can feel like a person is saying you haven’t worked hard, that you don’t deserve the American dream. You’ll have to be very honest with yourself when these feelings come up. Building wealth, especially if you’re paying off debt aggressively, can feel lonely and boring. This is because it’s very easy in America to purchase novelty with money rather than thinking critically about how you can get it for free. People moving from a low savings rate to a high savings rate must understand that they’ll need to study new ways to spend their time happily that don’t cost money.
Spending time with friends and family rather than buying stuff is a big part of the answer, but you’ll need to figure out your own ways to replace costs around things like exercise, food, and transportation.
Understanding how much happiness you get per dollar spent. Understanding your own psychology, and understanding what longitudinal studies say about happiness and adult develop is a big part of the answer (https://www.theatlantic.com/magazine/archive/2013/05/thanks-mom/309287/).
You’ll need to set aside time for the rest of your life to study and develop these idea in the context of your own life.