Everybody knows that retirement takes careful planning over many years and is the reward for a life well-lived. What if everybody was wrong? How could you tell? There are several simple but well-respected models for predicting the age of retirement and how much margin (the money you have vs the money you need) is available once you have retired. It’s this margin that directly address the fear you feel when thinking about retirement, particularly early retirement. Financial planners use these models to predict the changes in the outcome when you change the model assumptions (what if you retired 5 years earlier? How about 5 years later?), but they generally fail to give individuals due credit for making cataclysmic life choices. Let’s see what happens when you give people the freedom to make a radical change.
All Models Are Wrong
George Box wrote, “All models are wrong, but some are useful.” Models will not capture all the factors and complexity of real life and they don’t need to. In my first draft of this piece I went on about building simulations and trying to anchor my models with established norms. That didn’t pass Jenn’s nerd filter. We can take up that discussion in the comments if anyone is so inclined. For now, I’ll just state some rules of thumb to see where they go. You can find similar rules of thumb here or here or here.
Rule 1: Save 8-10% of your income
Historically, people have saved 8.36% of their income but the current is 5.30 (link). Many companies match 401K contributions (which is free, easy money folks) with a myriad of schemes that has a net contribution of 8-10% (although some employers now use matching 401k in place of traditional pension plans so you might need a higher pay multiplier, but let’s keep this easy). On the subject of simplification, I am not going to consider the difference between pre-tax and post-tax dollars or percentage of net pay vs take home pay. I feel pretty good about that 8-10% number.
Rule 2: You’ll need 8-12 times your final salary to retire
This is a massive simplification. It accounts for inflation and expected lifespan after retirement. Perhaps most importantly, it accounts for your growing standard of living. People are like goldfish in a bowl. Their needs grow to fill whatever bowl they are placed in. As the wise Eddie Vedder wrote is his song Society:
When you want more than you have
You think you need
And when you think more than you want
Your thoughts begin to bleed
I think I need to find a bigger place
‘cos when you have more than you think
You need more space
Lucky for me, Jenn is entirely on board with simplification over growing needs and expectations. There are exceptions to every rule, and you just might be that exception, but I wouldn’t wait until you retire to find out if your needs grew to fill the bowl you built. Frogs in a pot man. You don’t feel the water heating up until it’s boiling. Your habits are formed and reinforced by your daily events. You will have the life you live.
Rule 3: You’ll get 3-4% raises
3% raises are a good, historical average and, by assuming raises, your model is considering inflation. Spoiler alert, this factor is one of the most powerful factors in the model, but you will not believe its behavior. I wonder if Facebook will penalize me for click bait halfway through my article?
Rule 4: Return on investment of 8%
You’ll need to have your money grow over time or you’ll never be able to retire. 8% is a fairly conservative number that has some support here and here. Historically the market has grown by about 11% since the Great Depression, but experts also recommend a blend of lower risk/return bonds to balance your stock portfolio. Not only am I sticking with 8% I am also not going to play with this number since it is one that you have the least control over.
Rule 5: Starting income of 50K
All of the other rules are relative, so mathematically speaking, you don’t need to know the starting income to predict your age of retirement. The answer will always be the same according to this model. Perhaps we should follow our passions from the get go. Perhaps there are some factors missing. Personally, I have worked 20 years in corporate America. That has to count for something (it will wait for it). Let’s just assume the starting income for this model is 50k, which is the new national average for college grads. It will help the numbers make sense and it will not hurt anything.
The Model Says Retire at 68
All the parameters are set. Turn the crank. Boom! We have an answer. You can retire at 68. That is where you savings line crosses your need line. You start your career with income and no savings. You have needs. Slowly over time, you squirrel money away. That money grows faster than your needs and, eventually after hard work and savings, you can buy your freedom. That is exactly the retirement story you have always heard. Nothing cataclysmic yet. On the bright side, at least the model returned the expected results, so it just feels right. Now, let’s play with the parameters and see what we can do to get you free sooner.
Turning the Knobs
The first knob is for all you go-getters out there. What if you work really hard and make 4% raises? It delays your retirement until 73. I am guessing you are now wondering how this could possibly be correct. Believe it, our model says working hard doesn’t pay off because you will need more. Your needs keep pace your savings. How about saving more or needing less? Saving 10% or needing only 8% of your final income will each let you retire a little earlier. It’s going the right direction, but it’s not a sudden violent upheaval, especially in a political or social context aka- cataclysmic event.
Let’s think outside the box. Let’s turn this box inside out and pour fire and brimstone through the open doors of perception. Maybe I am too excited about modeling. Maybe I have been doing it too long and I am starting to believe. But….Maybe I am onto something. What happens to the statistically normal person if they make a drastic life change? A cataclysmic change that drops their income in half. For arguments sake, they choose to become a travel blogger at age 50? We’ll say their income not only drops in half, but they also stop contributing to their retirement. That might seem like a really bad idea, but our model says otherwise. Take a look at what happens next.
The Next Life
Look at these numbers! The models say the end retirement needs not only change to match the new income, but the built up savings keep compounding. All those hard life choices to resolve debt, balance cash flow, and manage possessions pay off. In fact, they pay off faster than any other factor in our parametric study. Our newly christened blogger can retire in just five years! If they keep working, they’ll develop margin between retirement need and savings faster than any other scenario ran. (i.e. security in retirement) The thing, your thing, that cataclysmic life change doesn’t have to be blogging. It can be any endeavor based on the nonmaterial, or rather a decrease of the material, whatever your passion. Hopefully, if you take money out of the equation, you would pick a job you love. The average American makes seven career changes. Our model says that the last career change might be the most important.
(Feature image by Creative Commons)