It’s a perfectly valid question to ask; especially when you consider how little retirement savings most people actually have.
(Fidelity estimates the average is around $273,600.)
While the major media outlets would have you believe that you need somewhere between $2 and $3 million dollars, you might be pleasantly surprised to learn that you could possibly become financially independent on a whole lot less than that.
In fact, if there’s one thing I’ve learned from reading the success stories of so many real-life early retirees (some of which you’ll meet in a minute), it’s NOT that you need millions of dollars, insider investment knowledge, or even a big-time high-paying job.
The trick is to simply work on reducing your living expenses.
In this post, I’m going to show you how minimizing your lifestyle costs could be the key to retiring on much, much less retirement savings than you think.
We’ll also get into the weeds by focusing on a few select expense categories, examining a few areas where you could be potentially saving more, and then look at how much that could possibly shave off of your nest egg target.
How to Calculate the Minimum Retirement Savings You Need
In its simplest form, figuring out how much money you’ll need in order to retire can be reduced down to the following:
Your living expenses.
Every solid retirement plan starts with asking the individual: When I retire and no longer have employment income, how much money will I actually need to live on?
Close your eyes for a second and imagine what that life will be like. At the core, there will be your basic expenses for things like housing, driving, eating, utilities, taxes, etc. But on top of that there will also be “other” flexible expenses for things like travel, hobbies, and other ways you like to have fun. (… After all, what’s the purpose of retirement if you’re not going to enjoy yourself?)
From just one brief look at this equation, we can quickly observe: The lower your living expenses, the less money you need to save up for retirement! In just a minute, I show you a few examples of some people who leveraged this relationship to make financial independence a reality.
25X (a.k.a. the safe withdrawal rate you choose).
In case you’ve never heard this one before, an easy way to calculate your retirement savings nest egg target is to take your living expenses and simply multiply it by 25. You can read all about why that is at this article here.
25X comes from something called the 4 Percent Rule safe withdrawal rate (SWR). This is a widely accepted rule of thumb in financial planning that says you should be able to safely withdraw 4 percent from your nest egg safely ever year to cover your living expenses for at least 30 years. By the way, if you’re wondering how the two are related, multiplying a number by 25 and dividing it by 4 percent (0.04) is mathematically the same thing.
[On a technical note: There are dozens of factors that could either increase or decrease the safe withdrawal rate you choose. For example, if you plan to retire very young, you may want to drop your safe withdrawal rate down from 4.0% to 3.5% (or 28.6X). Here is some evidence why. Or adversely, if you retire when the investment market is under-valued, you might be able to get away with a higher safe withdrawal rate of 4.5% (or 22.2X). If you really want to know more about the 4 Percent Rule and how to interpret it, feel free to check out this mega-article I wrote here. For the sake of simplicity, throughout the rest of this article we’ll use the 25X or 4 percent safe withdrawal rate in our examples.]
Does This Equation Actually Work – For Real?
Yes! There are lots of examples of early retirees who have reduced their living expenses down and been able to successfully retire early using this simple strategy. Here are a few notable ones:
- Jacob Fisker from Early Retirement Extreme (both the blog and the book) was able to retire in his early 30’s after get his living expenses down to just approximately $7,000 per year. This allowed him to save nearly 75% of his income and accomplish his goal in just 5 years. If we use the 4 Percent Rule to estimate how much his nest egg was at the time, we can conclude that with such low living expenses he only needed approximately $200,000.
- Mr Money Mustache (aka Pete Adeney) famously preaches frugality and claims to only live off of $24,000 per year. This allowed him to retire by age 30 after only saving up $600,000 (25 x $24,000).
- One of my favorite early retirement stories comes from the book “How to Retire Early” by Robert and Robin Charlton. It tells the tale of exactly (in great detail) how the two of them were able to go from almost no savings to $1 million in just 15 years at the age of 43! This provides them with $40,000 per year to travel the world and live freely.
- After a bad day at work, Carl (age 38) made a vow with his wife Mindy that the two of them would retire in 1500 Days (or 5 years). Hence, they became Mr and Mrs 1500 Days from the blog 1500 Days. The goal was to take their current savings and quickly ramp it up to $1 million target. This was based on an estimation that they would need to cover $30,000 per year in living expenses plus a little extra for their children’s college. Through frugality, a lot of saving, and down-sizing their house, they were actually able to accomplish their goal just 3 years later.
- Justin McCurry from Root of Good retired at age 33 after he and his wife reached a savings of just over $1 million. They continue to only spend between $32,000 to $40,000 per year (a little less than 4 percent).
What do we learn from these success stories?
In each of the examples we gave above, do you notice a trend?
= [Saving a lot more]
= [Accelerated early retirement timeline!]
In other words, focusing on reducing your living expenses is almost like a double-ended benefit to helping you to reach financial freedom.
One good thing really does lead to another!
How to Reduce Your Living Expenses
Okay! So if reducing your living expenses really is the key, the next question we should be asking ourselves is:
- How low can we go? What kinds of things could we be doing right now to get our expenses as low as possible so that we would not need so much money for retirement?
Keep in mind that even amounts as low as $500-$1000 per month could translate into hundreds of thousands of dollars less that you need. Here’s a chart you can use to follow:
Therefore, to figure out where we can squeeze, let’s run through some of the typical expense categories and see where we can optimize and improve.
Killing off your mortgage is one of the ultimate goals you can achieve in the personal finance community.
Why? Because not only have you eliminated one of your largest monthly expense, but you also get to declare freedom from the mortgage lender. The house is finally all yours!
So what’s the best way to pay down your mortgage?
- Send in an extra $100 or $200 per month on top of your principal. Just that little bit extra can knock 5 to 10 years off the typical U.S. mortgage. Use this calculator to find out exactly how many years it could knock off of yours.
- Refinance your house from a 30 year to 15 year fixed mortgage. You’ll save a TON in interest and greatly accelerate your payment timeline. I refinanced after one year and saved almost $100 per month.
- Fight your property taxes. If they start to creep beyond a reasonable level, challenge them! I did and WON!
- Move to some place with lower property costs. I live two county’s away from an area where a house the size of mine could easily cost double what I’m paying right now. Hence why I don’t live there!
Of course keep in mind that your housing costs never truly go down to zero. Even if you do accomplish that wonderful goal of paying off your mortgage, you still have to pay your property taxes and home owners insurance every year.
Like them or not, vehicles are one of the fastest depreciating things we own. The only real way to win financially when it comes to cars is to:
- Buy them with cash (or at least finance a portion of them for as little as possible)
- If financed, pay them off quickly
- Don’t lease
- Keep up on the maintenance so that they don’t develop bigger, more costly problems
- Shop around every two years or so for the best and most affordable auto insurance.
Our family loves to travel! And we used to pay between $4,000 – $5,000 to do so … but not anymore!
In 2016, I entered into the world of travel hacking and absolutely can not believe how many deals are out there for regular people like you and me to scoop up. To date, we’ve saved over $4,000+ on travel in just the past year, and my gears are already turning for the next one.
This is the tricky one. It seems like every time you turn on the news there is always some new debate about how and when medical care coverage will change.
Regardless, there will most likely be some cost associated with this topic. But remember: If you’re 65 or older, you can file for Medicare. If you’re younger than that, then check out this page for ideas on where to find good coverage.
Power / Heating:
Keeping an eye on the thermostat and not running the air conditioner all the time are your best bets here. Moving to a smaller house doesn’t hurt either!
An inexpensive family cell phone plan can be purchased these days for less than $100 per month. It can be even lower than that if you don’t upgrade your phone every time a new one comes out.
If you really want to get frugal, FaceTime Video / Audio and other WiFi calling options are free over your Internet connection.
TV / Internet:
Cable is nice, but you don’t really need a full cable TV package. Hook yourself up with a TV that connects to your WiFi and you’ll find a TON of things to watch via Netflix, Amazon Prime, YouTube, or any number of cool apps.
When it comes to groceries, the key here is planning. If you throw things away every week, then something is wrong. Sit down and make a list of all the meals you’re going to make. Then go out and buy only those items that you need.
As for eating out, keep it to once per week. Set a limit for yourself; such as no more than $15 per person.
Being entertained doesn’t always have to mean spending money. Some of my favorite times are when we go for walks, play a sport with the kids, exercise, or do a local activity within our community.
Is There Another Way to Retire for Even Less?
Yes! One more aspect to the equation I presented above is that if you have other income coming in from other places, then it reduces your retirement savings needs down even further.
Here are a few examples how:
Are you expecting to receive Social Security right around the time you plan to retire? If so, let’s say that you plan to need $4,000 per month for living expenses and $1,000 per month will come from Social Security. In that case, your retirement savings only needs to produce $4,000 – $1,000 = $3,000 each month (or $36,000 per year). That drops our retirement savings target down from $120,000 to $900,000; a reduction of $300,000!
Other ways to make money on the side:
Additional retirement income could come from any number of legitimate sources. Another common example are folks who own rental properties. Again: $500 in net rental income could equal out to $150,000 LESS that you need to save for retirement!
We’ve got a ton of other cool ways you could be earning money on the side on this page here. Check them out for yourself and find one that suits you the best!
If you’d like to explore any of these topics more thoroughly, then please check out my book “How Much Money Do I Really Need to Retire & Achieve Financial Independence?”, available in both digital and paperback.
In this book, we cover the topic of retirement planning from a variety of angles. We’ll look at everything from reducing your living expenses to how safe withdrawal rates can be leveraged to help you need less savings.
Regardless, the take-away should be clear. If you truly want to be financially independent, don’t chase after the illusions of earning as much as a VP or becoming some kind of investment wizard. These are talents acquired by only a very select minority of the population.
For the majority, there is a much, much more attainable goal sitting right in front of you. If you learn how to do more with less, then financial freedom is an option at any income level. The math works out the same whether you are a high income or low income earner.
The challenge, however, is all in how you get there. Just like taking care of our bodies and becoming more healthy, exercising some discipline when it comes to our spending is the first step to a successful path towards financial independence. Master this and you will have overcome the hardest part of the journey!
Readers – What’s the least amount of money you believe you could comfortably live off of? How much does this reduce your retirement savings goal by?
Featured image adapted from Flickr – Frankieleon