If you’re hoping to retire sooner rather than later, then there’s more to be gained from saving more and spending less than you might realize at first.
On the surface, everyone can recognize that saving a larger proportion of your income does exactly what you think it will do: Help you stock-pile more money more rapidly, and reach your nest egg target quicker.
But another benefit that sometimes gets lost is the way in which our habits react. Spending less doesn’t JUST mean having more money to set aside. It requires learning how to forego that lost additional income, and adjusting your standard of living. This, in turn, and completely affect what our target nest egg is ultimately. Hence, spending less and saving more could really be thought of as a double-ended approach to achieving an early retirement!
To better illustrate this point, let’s create a simple example of how this information sometimes gets lost in translation.
Example: Let’s say you earn $60,000 per year now and you’d like to continue to live off of 80% of this amount during retirement. Instead of contributing 10% to your 401(k) like most people recommend, you decide to really go for it and bump your contribution up to 20% instead.
Just as you guessed, this nice increase in contribution will certainly reduce the amount of time it will take for you to reach financial independence. The original timeline of 44 years at the 10% contribution rate turns into 33.4 years with the 20% contribution (assuming you started at $0 saved).
But in reality, is this really the only benefit? – Not at all!
When we save more, we don’t just decrease the amount of time it will take to reach our goal, but we’re also inadvertently making our goal even lower. Let me explain this a bit further …
How Saving More and Spending Less Really Benefits You
If you earn $60,000, then all you ever know is how to live off of $60,000 (net of taxes, of course).
When we start saving our money towards some goal (retirement, a new house, etc.), then we learn to modify our spending habits to adjust to this new level.
- If it’s 10%, then you’re really living off of $54,000.
- If it’s 20%, then you’d adjust to living off of $48,000.
In other words, we learn to treat this money as if it never even existed.
While that may not seem very relevant, this simple modification in our spending habits plays a huge role in determining how much money you truly need to save up in order to retire.
Remember that by conventional standards, your target nest egg amount is 25X times your expense needs. So if your expense needs are always decreasing, then your target nest egg is too!
So in our previous two examples:
- $54,000 of annual target income becomes a target nest egg of $1,350,000.
- $48,000 of annual target income becomes a target nest egg of $1,200,000.
Here’s how this relationship works across all savings rates:
The more we save, the less we live off of, the lower our needs become, and the lower our target nest egg adjusts too.
To put it another way, not only are we saving more to run towards our target sooner, but our target is also effectively approaching closer and closer towards us. By working both sides of the equation to spend less and save more, we reach financial independence that much sooner.
Examples Where Spending Less = Early Retirement Opportunity
This phenomenon is something that is often under-appreciated by most people when they are trying to come up with their plan. However, if you look at any early retirement case study, you’ll likely find some aspect of this situation used in their strategy.
One extreme example that comes to mind is Jacob Fisker from Early Retirement Extreme. Jacob was an extreme saver; putting as much as 90% of his income into his retirement savings. He was able to do this by keeping his expenses low and only needing roughly $10,000 for his living expenses.
But at the same time, this low-expense lifestyle did something else to help him reach his goal sooner. With such a low standard of living, his target nest egg was only $250,000; significantly less than what most people think they need.
So as you might guess, by saving almost 90% of his income and having such a low target, he was able to hit his goal very quickly and retire by his early 30’s.
Mr. Money Mustache is another famous example. Though not quite as extreme as Jacob, MMM discovered that he would only need roughly $600,000 to cover his $2,000 per month lifestyle expenses. Again, this powerful combination of saving big and lower spending allowed him to become retired in his early 30’s too.
How You Can Save More
If you’re looking for ways to work down your spending, I highly recommend tracking (or back-tracking) your spending habits for 1-2 months. Try using a free program like Personal Capital or Mint. Even grabbing your last few credit card statements and firing up Microsoft Excel will be fine.
When you dive into your spending, it forces you to see the magnitude of certain purchases and how they can stack up over time. If you live in a household with a spouse, then it might also help you to learn a little bit about their spending habits as well.
Once you do this, you’ll be sure to discover several areas where your spending could be cut back. Are you spending too much at the mall? Grocery stores? Restaurants? Home Depot? There are literally thousands of ways you could be saving more money!
Whatever the heavy-hitters may be, challenge yourself (and your spouse) to keep your spending under a set limit. That way you can take the difference and apply it towards the savings goal you’d rather see it go to.
Readers – What are some of the unforeseen benefits you’ve discovered to saving more and spending less? In what ways have you seen one action play into another, and ultimately bring you closer to achieving your financial goals?
Featured image courtesy of Flickr