In the first part of this article we saw an example of planning for retirement. Teresa spent the same for many years and retired around age 55.
What if I don’t want to keep my expenses constant?
We said that Teresa spent the same throughout her life. In theory, the last years she would have to live quite tight to maintain the same expense level.
We are going to change the perspective. Instead of talking about total spending we will talk about savings rate. So expenses will go up with income. This may be more or less realistic depending on your specific life plans.
Teresa decides that living alone in an studio is quite a luxury . She will share a flat and cut back on restaurants and leisure.
- Rent: 425 euros. Shared apartment including utilities (water, gas, electricity, etc.)
- Transport: 60 euros. Approximately the price of a monthly pass in Madrid or Barcelona.
- Everything else: 340 euros. Food, gym, restaurants, etc.
- Total: 825 euros
Savings rate: 45% (675 savings from 1,500 of total income). She still plans to spend 2k a month in retirement, so her FI number is still 600k.
With these assumptions we have more or less reached the same result as in the first part. Teresa could retire at 54:
If she retired at 55, she could follow the 4% rule and spend about 4,000 euros per month. Or she could be more conservative and spend about 3,000 (3% rule).
What happens if we modify other variables?
It’s interesting to see the impact that the different variables have on the time that would take Teresa to reach financial independence.
How much more could I spend in retirement if I keep working for a few more years after I reach FI?
Calculating with the same assumptions we get this table:
So if you stay working for 5 more years you could spend an additional 2,100 euros per month during retirement. The last years are probably the ones with the highest income (and savings) so working a few more years has a great impact.
How am I impacted by inflation and investment returns?
Two of the most difficult things to estimate are returns and inflation. Besides being impossible or very difficult to control or act on. So I think it makes sense to look at the combined impact of these two variables.
I think this table shows how inflation can eat up your money if it is not (well) invested. An inflation of more than 3% is not crazy at all. In fact, in Spain it was more than 3% in 2011 for example.
The lesson that I draw is that having all your money in a cash account is a sure way to melt it away and makes it practically impossible to be financially independent in a reasonable time.
How am I impacted by returns and savings rate?
A high savings rate protects you from bad returns. However, if your savings rate is low, you pretty much depend on the returns of your portfolio
What I find very interesting is that the more you save, the less impact it has (marginally). For example, moving from 55% to 65% allows you to retire 2-3 years earlier. However, moving from 25% to 35% saves you 4-10 years! Although it is an increase of 10% in both cases. Also, it seems easier to cut expenses when you save 35% than when you save 55%.
Looking at it from another angle, if you save more than 55% and you think your expenses are already optimized, perhaps you should concentrate on increasing your income instead of reducing your expenses. You are already doing a great job in cutting your costs and may require a great sacrifice to cut even more. So maybe it makes sense to see if you can improve the other variables (income and profitability). In any case, saving more than 55% is a great to position to be in in the path for FI so it makes sense to not obsess about further optimizing this.