The blogosphere is abound with early retirees that have retired in their 30s and 40s. Here's a sampling of blogs I follow or have read in the last year or so comprised of early retirees:
- Mr. Money Mustache, who retired when he was 31
- JL Collins from New Hampshire
- Mad Fientist, also retired in his 30s
- Jeremy from Go Curry Cracker, who also retired in his 30s (or early 40s?) and now travels the world as he pleases, living in low cost of living cities. We had the privilege of meeting Jeremy in San Francisco a few weekends ago
- Joe from RetireBy40. Joe left his engineering career behind to become a stay at home dad/blogger at 38
- Financial Samurai, who makes enough passive income through his popular blog that he doesn't need to go to work anymore
And on and on, the list goes.
And if you look carefully at all these people, what is the most common thread between all these people? It's just one thing — frugality. Frugality isn't just a cool niche thing anymore. It is the only sure fire way to quit your job permanently. The math is extremely in favor of frugal people. The more frugal someone is, the sooner they will be guaranteed to be able to quit their day jobs (i.e. retire). It's a mathematical reality that just can't be argued with. If you have/make $100 and you spend only $40 of that, you're bound to have $60 remaining whereas someone who spends all $100 of it is bound to have $0 left behind.
There's a very conscious reason we decided to include frugal in our blog's domain name. We believe in being frugal in everything we do. Not just with our purchases, but with our food, water, and environmental consumption as well. It turns out that frugality is the silver bullet to so many problems people have. The more frugal we are, the greater our happiness tends to be in the long run.
So when can I actually retire?
The most common misconception in the world today is that retirement happens at a particular age (65?) for everyone. That is not true at all. Retirement instead happens when your finances and savings reach a certain milestone. And that certain point is when your net worth reaches 25x your annual expenses. Past performance isn't a guarantee on future results, but if you had stopped working anytime in the last 100 years with 25x your annual expenses, and invested your savings into a diversified stock portfolio (healthy stock/bond allocation mix), and diligently withdrew no more than 4% of your initial portfolio's value (not the portfolio amount in any given year), you would've have had a 90-96% probability of your money not running out over the next 30 years. But if you worked even a little bit for money during some of those years, especially during the down and bear market years, your probability of success easily shoots up to 100%.
As a result, the only sure-fire way to retire permanently is to be able to amass sufficient savings during your working years. The only way to accelerate that is to save a larger amount of your paycheck year-over-year, especially as you accumulate raises and bonuses at work over the years. Frugality helps with this. It allows you to live a great life on less just by simply tracking and adjusting where your money goes. All you have to focus on is minimizing wastage, and you automatically become frugal. The mathematical reality is the more you save from your paycheck each month, the more money you're going to end up with after 10 years.
Now this is where frugality really outshines itself. It helps you retire early in 2 very special ways. Not only does frugality allow you to increase how much of each paycheck you save, it also permanently reduces your total annual expenses. And this is great, because the number you need to reach to achieve financial independence, aka retirement, is directly tied to your annual ongoing expenses. The lower your ongoing annual expenses, the less you need to save up, since the definition of financial independence aka retirement is 25x your annual ongoing expenses.
Savings Rate as the Ultimate Retirement Hack
This is where the powerful concept of savings rate enters the picture. How do you determine your savings rate? It's simply a ratio of how much money you saved up in a year versus your after-tax income in that same year.
For example, if you made $100k and paid $25k in taxes last year, and spent $50k on housing, travel, food, shopping, kids, gifts, donations, car, gas, insurance, etc. then you'll have saved $100k - $25k - $50k = $25k, and your after-tax income would be $100k - $25k = $75k. Thus your savings rate would be $25k / $75k = 33.3%.
Now here's the kicker: The larger the percentage of your paycheck you save (i.e. your savings rate), the faster you will accumulate savings year-over-year, but at the same time, the lower your annual ongoing expenses. And when your ongoing expenses are lowered permanently, the smaller the nest egg you'll need to retire (25x a smaller number is still a smaller number). In effect, you'll reach a smaller number quicker. Your improved savings rate, achieved through frugality, will therefore turbo-charge your retirement. This is when it gets exciting. The turbo-charging effect isn't quite linear, it's actually exponential. Take a look at this graph of how your savings-rate relates to the number of years to retirement:
How quickly you reach financial independence (FI) is directly related to your savings rate. Assumptions: Starting at net worth of $0, 5% after-inflation returns, 4% withdrawal rate, only gains/appreciation used for income, principal is untouched, no after-inflation increases in spending or income over the years, cost of living is same both before and after retirement.
Let's look at the same data in table form, this time including your age at retirement:
Assume you start working at the age of 22, right after graduation. This table shows how old you'll be by the time you can safely retire with a 4% withdrawal rate at various savings rates.
Based on these calculations, even a 20% after-tax savings rate doesn't seem so amazing now, does it? That only lets you retire after 38 years of working, or when you are 61. You ought to be targeting a savings rate of at least 50%, ideally closer to 70% if you want to retire early. Our own savings rate is currently at 71.2% this year and we diligently monitor this every month. At such a high savings rate, we should be able to retire in just 9.6 years of working, which is before the age of 33 (we both started working at 23). We can retire even sooner if we move to a cheaper cost of living place than where we are now.
The number of years to retirement is therefore very sensitive to small changes in your savings rate. From one end, improving your savings rate increases how much you save each month, and from the other end, it reduces how much total money you'll need saved up to retire safely. The sandwich that this equation forms allows you to optimize just one number in your life, and in return, gain insane reductions to how long you have to work.
Your savings rate is the single biggest factor that determines when you'll be able to quit your job permanently.
As you can see from the table above, even a modest 5% increase in savings rate can allow you retire several years earlier. For instance, at a 10% savings rate, you would need to work for 53 years, but at a slightly higher 15% savings rate, you only need to work for 45 years! That's a massive difference of 8 years by simply adjusting your savings rate by 5%! The funny thing is that a 5% savings rate boost can so easily be attained by taking control of very simple things in your life like your groceries and your Starbucks/coffee/breakfast expenses. Are these simple changes not easily worth 8 years of your life? Most people would probably say they are.
Enter frugality, the magic pill that solves all your financial problems
And how exactly do you increase your savings rate? There's only way and it's by being frugal AF. Learn how to maximize your savings rate by following our pro frugal hacking tips. The general strategy is to monitor/track your expenses very closely in a spreadsheet, and start cutting out expenses that don't matter one by one. That morning Starbucks latte? Cut it out. Those gym memberships that you never use? Cancel them. For each expense you encounter, you have to ask yourself the following 4 questions:
- Do I derive sufficient value from this expense?
- Can I negotiate/bargain this price down somehow?
- Can I delay this purchase somehow?
- Can I acquire this same product/service for cheaper or free somehow?
You probably don't need a product or service this very minute, so you lose nothing by delaying the purchase. You may find that you didn't really need the product after a few days. Many people have been able to reduce their internet, cable, and cell phone bills by just calling and asking, or by threatening to cancel their service and jump ship to a competitor. Cheaper alternatives for products can be acquired by renting instead of buying. You can also ask to borrow from your friends, coworkers, or neighbors.
Now in reality, frugality isn't so easy to achieve unless you were raised in a frugal environment to begin with. We find that it comes quite naturally to us, but we got lucky because our parents were forced to be frugal, and so we adopted the frugal mindset along with some good strategies to be frugal directly from them. But if you've never been exposed to frugality in the past, it can be hard at first. But it's not impossible.
The wonderful thing is you have plenty of time to learn to become hyper-frugal. You can even take years to get there if you want, as long as you do get there eventually. Every time you fail, you don't lose anything. You just pick up and try again the next month. If you would rather rip the bandaid off quickly, you can try to become frugal in just 3-6 short months. Just make sure it's sustainable though. I generally recommend spreading out lifestyle changes over 1 to 1.5 years so you can be sure they are sustainable habits that can be implemented long term, and in our case, your entire life.
i'm sold, but how do I be frugal?
The truth is once you believe in frugality and its potential to improve your finances dramatically, your own creativity will allow you to manufacture new ways to be frugal in everything you do. Your motivation should be to retire from your regular day job as early as possible. After all, who wouldn't love to retire in their 30s or 40s? Or would you prefer you retire in your 50s, 60s, or heavens forbid, your 70s? There are plenty of people in North America following this recipe to financial success. The ultimate career success is to not need to have one in the first place.
Reducing your consumption of toilet paper is probably not going to have a big-enough impact on your savings rate. But there are some real changes that can make a big dent to your annual expenses. Here's a small sample of them that we ourselves follow religiously in our daily lives:
Basic Improvements
- Stop trying to impress other people with money or status symbols — it doesn't work, and even if it does, it doesn't last
- Don't ever go "shopping", buy only what you need
- Live within your means, don't try to be lavish
- Minimize wastage in your life. If you buy stuff that you don't find yourself using often, that's wastage. If you're throwing out groceries at the end of each week, that's wastage too
Killer Improvements
- Don't pay a single dollar in credit card interest. Shred your credit cards and only use your debit card if this is a problem for you
- Pay off your student loans quickly so you save money on interest
- Reduce your square footage (aka downsize)
- Share your space with roommates and/or on AirBnB.
- Try to bike to places or take public transit, rather than drive or cab everywhere
- Buy used instead of new, especially true for cars and houses
- Invest in your health and body early to minimize health-care costs
- Use the public library for books and tools rather than buying new on Amazon
- Protect your belongings by engaging in regular maintenance
- Give away your pets for free. Cats and dogs are more expensive than you think
Advanced Improvements
- Don't throw stuff away until something is close to the end of its life
- Stop buying expenses brand-name products (like handbags, cars, foodstuffs). Same with groceries: stick with store brands or private label items which are often significantly cheaper than their name-brand counterparts
- Reduce your restaurant and eating out expenses. Cook more at home instead
- Build a DIY habit rather than getting outsiders to do stuff for you
- Ask yourself if there's cheaper/free ways to acquire stuff. Can you meet your needs different? Can you bargain the price down? Can you rent instead of buy? Can you borrow/barter?
- Watch how much you eat, don't over-eat, and reduce your consumption of gourmet food products such as gourmet coffee, wine, chocolate, milk, etc.
- Don't opt for fancy foreign vacations, you can have as much fun within your own town or county
- Keep gifting, tipping, and donating, to a reasonable level. Do not tip more than 15% for anything unless you've bought your own financial independence first
In summary, the less money you spend by being frugal, the more you keep for yourself. The more you keep and invest for yourself, the more free (i.e. passive) money it generates via stock market growth over the years, like it does in your 401(k) account. The more free money you generate, the sooner you can quit your job permanently, since you'll be able to live off the passive income alone eventually.
So ladies and gentlemen, are you ready to retire early by embracing frugality to its fullest extent possible?
