By Chris Mamula
Everyone knows they should start saving for retirement as soon as possible. What people know they “should” do and what people actually do is not the same thing. According to AARP , nearly half of American households headed by someone age 55 or older have no retirement savings.
What is someone far behind on retirement savings to do? Can they learn anything from the FIRE (financial independence, retire early) community?
The “simple math” of FIRE allows people who start saving aggressively in their 20s to achieve financial independence in 10-15 years and be financially independent by their 30s to early 40s. The math is identical if you start saving in your 50s to reach financial independence at traditional retirement age.
It’s hard to drastically change decades old behaviors if you haven’t saved earlier in adulthood. That’s fair.
I want to share a counterpoint to give hope if you’re getting a late start saving for retirement. It is possible to apply these FIRE principles later in life. In fact, late savers have several key advantages that early savers do not.
Achieving financial independence quickly is primarily a function of your savings rate. The greater your savings rate, the faster you become financially independent.
Many people erroneously think achieving financial independence requires great investing prowess. The shorter your journey to financial independence is, the less time investments have to compound during this process.
This is not to trivialize investing. It will play a vital role in making your money last while supporting spending needs after achieving financial independence. Investing just needs to be placed in its proper place.
Savings rate is what you must focus on if you want to achieve financial independence quickly. Your savings rate is simply the amount of money you save divided by the amount you earn.
In equation form this looks like:
Savings rate = Savings/Earnings
Savings rate = (Earnings – Spending)/Earnings
Only two things really matter if you want to achieve financial independence quickly… how much you earn and how much you spend. Many people who begin saving later in life have several big advantages over younger savers in these two domains
One of the two factors that go into creating a high savings rate is your income. So it should be easier to save when you earn more. Earnings peak for most workers in their 40s and 50s . This creates a clear advantage for people who are saving for retirement later in life.
In our household, we reached financial independence quickly by saving roughly 50% of our household income. We lived on Kim’s income. My income was used to pay off debt quickly. Then we invested it.
The simple math worked, but it wasn’t easy. We started this system of paying off debt when Kim was starting out with a salary of about $35,000. I was earning $10-$12/hour working part-time while in graduate school. This required a frugal lifestyle.
Things got much easier when I began collecting a professional salary as a physical therapist. It became easier still when we both grew our salaries over the ensuing decade.
Still, we started cutting back our income just as we were approaching our peak earning years. Kim cut back to part-time work when she was in her mid-30s after our daughter was born. I completely left my career at the age of 41.
Applying FIRE principles early in life means saving a large percentage of your income before reaching your peak earning years. Early retirement results in leaving a lot of career earnings on the table. Late savers, on average, have a clear advantage of saving during higher-earning years.
Earning is only half of the savings rate equation. Spending is the other key factor. Late savers may have key advantages here as well.
One of the biggest expenses many of us have is raising children. Younger savers have to figure out how to save for their own financial independence while also figuring out how to support children — from buying diapers and safety accessories in the early years, to supporting expensive hobbies and filling bottomless stomachs that characterize the teen years, to preparing for the massive expense of college education.
For many people in their 50s, their children are out of the house. For others, kids are in their teen years. Many expenses are in the rearview mirror, and there is some certainty on what the next phase of life looks like. As your children get older, this creates several advantages to earn more and spend less.
As children become adults, the expenses of their food, utilities, and clothing go away. Some parents save for their children’s college education over many years . Others cash-flow it from income when the time comes. In either case, once that phase ends it frees up substantial cash flow that can be redirected to your own retirement savings without sacrificing lifestyle.
Children growing up does more than free up cash flow. It frees up time. Tim Urban’s blog post The Tail End points out that by the time a child graduates high school, they’ve spent 93% of the in person time that they will ever spend with their parents in their lifetime.
The Tail End is a powerful read. It provides a graphic reminder to be careful how you spend your precious time.
This idea can be a little depressing. But it highlights a key advantage that allows late savers to catch up. You can use that freed-up time to increase your earnings.
The idea that we “needed” bigger houses in the first place is mostly a function of marketing. Many households could downsize at any time and still live comfortably.
Dave at Accidental FIRE analyzed housing trends . He found that in 1951 the average American household contained 3.34 people and the average new home construction was 874 square feet. By 2017 the average household size decreased to 2.54 people while the average new construction size increased to 2,660 square feet. Over the past 70 years, we have more than tripled the square footage per person in the average American household!
Downsizing housing expenses is one of the most impactful levers we can pull to drastically reduce spending. All things being equal, smaller houses tend to be less expensive, have lower property taxes, and cost less to heat and cool.
As our children get older and move out, it provides a great opportunity to downsize. That is another advantage for those who need to catch up on retirement savings compared to younger savers whose household size is stable or growing.
We all realize that housing is a big expense. A rent or mortgage payment leaving your checking account every month is a stark reminder.
For many households, an even bigger expense is income taxes. This is easier not to notice for most of us because we don’t write this check every month. It is automatically deducted from our paycheck before we receive it.
Many people don’t even think about income taxes because they think they are inevitable and out of their control. In reality, we have a lot of control over how much income tax we pay.