Saving for Early Retirement: Why it actually matters in the long run

Of all the ways to achieve Financial Freedom / Early Retirement (Earning, Saving, Investing), Saving is the most important.

Pillars of Financial Independence / Early Retirement

There are only three ways to achieve Financial Independence (FI):

• Earning: Earn more money
• Saving: Spend less money (Save more)
• Investing: Invest the savings wisely

All three pillars are useless without the base of Compounding. Patience enables the benefits from these pillars to accumulate and compound over time.

I think Saving is the most important and transformative of these three pillars. However, Saving also happens to be the least glamorous of the three.

The Three Pillars at a Party

Talk about Earning (your income) at a party, and your friends will listen intently!
Talk about Investing, and your friends and everyone else at the party will listen intently!!
But, talk about Saving, and very soon you will have no one to talk to!!!

Saving for Early Retirement vs. Other Pillars

1. Earning: The Powerful Pillar

Earning is a powerful pillar; there is no upper limit to how much one can make. No matter how large someone’s income is, they can always earn more.

However, just as there is no limit to how much one can earn, there is also no limit to how much one can spend. Time and again, we have seen celebrities, sports personalities, lottery winners, etc., somehow manage to lose all their money.

Also, Earning is one pillar that may not be available after early retirement.

2. Investing: The Glamorous Pillar

This is arguably the pillar that gets the most spotlight. There are numerous articles written on this topic. We all hear stories about how someone made 100 times their money on a stock or cryptocurrency.

There is no shortage of investment guides or experts dishing out the next hot stock tip. I always wonder why someone goes through the trouble of writing a book on how to make millions instead of just using those ideas to make millions themselves:

If stock market experts were so expert, they would be buying stock, not selling advice.
Norman Ralph Augustine

Although one can get lucky through Investing, it is tough to beat the market in the long run.

To invest money, you need first to save money. So Investing is not possible without Saving.

Lastly, Investing suffers from the same drawback as Earning. No matter how good someone is at Investing, they can lose all their money if they cannot manage their Spending.

3. Saving: The Diligent Pillar

This is probably the least glamorous of the three pillars. Nobody gets up in the morning and says I want to save money today (maybe a few FIRE folks do, but overall no one else does).

Saving also goes against the grain of the consumer-driven culture of modern times. So it is probably the most difficult of the three pillars to master. However, once mastered, the rewards can be life-altering.

Saving is also the pillar you have the most control over even after retirement. Every month, we at the Finer household review our expenses to see if we need to make any adjustments. While a monthly review is a bit extreme (and boring), I think a review every 3-6 months is probably a fruitful exercise.

Lastly, Saving is also one of the most important traits of self-made millionaires.

Why Saving is Key for Early Retirement

1. Saving is the Only Thing that Determines Time to Early Retirement

To see the impact of Saving – let us consider a typical family – the Flintstones. Flintstones earn $100,000 in a year and spend $90,000. That means their saving rate is 10% (they save $10,000 out of $100,000).

If you look at the graph below, you will see that it will take Flintstones 51 years to retire, which is more than the average working life. So, in essence, they will not be able to retire early!

As shown in the graph above, as the savings rate increases, the time to retire decreases. It is important to note that time to retirement is dependent on Saving only!

Earning and Investing do not determine how soon you can retire; what matters is how much you are Saving.

Let us consider another family – the Jetsons – who earn $300,000 per year and spend $270,000 (i.e., save $30,000). Both of these families save 10% of their income. That means the time to retirement will be 51 years for both of them! This is true even though the Jetsons make three times more than the Flintstones.

Income does not matter for retiring early; what matters is how much of that income is saved.

In theory, even with a high saving rate of 50% (saving half your income), it will take 17 years to retire early. However, in practice, the time will be less than that due to the magic of compounding.

2. Impact of Saving on Bottom Line

Every dollar saved goes to the bottom line. The same cannot be said for the other pillars. Every dollar earned through Earning or Investing is taxed. So, in the end, a dollar earned through Earning or Investing is really worth 80 cents (assuming a 20% tax rate). On the other hand, a dollar saved is really worth a dollar – because there is no tax on the Saving.

If the saying ‘A penny saved is a penny earned’ were to be modified for the above situation, it would read ‘A penny earned or invested is only about 80% valuable as compared to a penny saved”. Not exactly concise, but still important to remember.

3. Saving is Recurring

Once you find a way to save, the benefits continue to accumulate over time. When the Finer family switched our cell phone service from a large cell phone company to a no-frills carrier, we saved $80 / month (believe it or not, we were paying $110 / month before).

Although it was a one-time hassle to switch, the amount we saved ($80) gets saved every month. This means we will end up saving about $50,000 in our lifetime because of this one small change!

Saving also reduces the money needed for FI. The smaller your spending, the less money you will need to retire early. Typically one needs 25 times the annual expense to retire. So if they are saving more, that means their yearly expenses are less. That means they will need less money to retire early.

4. Saving and Compounding

Saving enables you to take advantage of compounding. Compounding is when an asset’s earnings are reinvested to generate additional earnings over time.

Let us assume you own shares in Apple company. These Apple shares give you some money (dividends) every quarter. These dividends from Apple shares are reinvested to buy more of those shares. This results in you now owning more Apple shares (in addition to the original shares, you also now have the new shares purchased using the dividends).

This leads to more dividends (because you own more shares now), which leads to more share ownership, which generates more dividend income, and so on. All this while the price of the asset also is hopefully going up.

Compound interest is the eighth wonder of the world.
Albert Einstein

5. Other Benefits of Saving

The habit of Saving has a lot of other benefits. Although these are not financial benefits, they are still important.

Having money saved can help to reduce stress. It can also help in dealing with emergencies or a job loss. The habit of Saving also leads to building up wealth – which can provide more options in work and in life.

Saving also leads to a more sustainable life. Spending less on things reduces waste – the things I buy now are what I need or value.

Related Article: The Real Cost of Buying Something

The Other Side: Not Saving for Early Retirement

While considering all the benefits of Saving listed above, it is worth noting that Not Saving is doubly bad. It leads to debt, essentially reversing the effect of compounding – instead of working for you, now compounding works against you. The debt prevents you from Saving and Investing – in essence, you cannot take advantage of compounding.

Every day that compounding is not working for you; it is working against you.

For example, if Flintstones are too busy paying off their debt, they are not Saving and Investing (compounding their wealth). Prices of most items keep going higher while their wealth is not growing – in essence, compounding (inflation) is working against them.

As you can see from the chart below, prices for most items (apart from electronics) increase every year. And some of them (like healthcare and education) grow at a very high rate.

When to Start Saving for Early Retirement!

With all these great benefits of Saving, it is essential to start saving early in life. The graph below shows how much money a person will have at age 65 if they save $500 a month (assuming a 10% annual growth rate). If they start at age 25, they will end up with close to $3 million!

Starting 10 years later (age 35), they will have $1.1 million. And if they start at age 45, they will end up with less than $400,000.

What happens if they start late (at age 45) and want to catch up and still have $3 million by age 65. In that case, they will have to put in $3,800 per month (instead of $500 per month if they started at age 25). It is tough to catch up later in life; starting as early as possible makes sense.

On the other hand – what happens if they start even earlier? Let us say they begin saving $500 at age 20 instead of 25. Well, then they end up with $4.75 million (instead of $3 million)! That is a nice increase for only 5 more years of savings.

In Conclusion

All three pillars were important on my FI journey. However, the Saving pillar has been the most transformative. It helped reach FI quicker. But more importantly, it also enabled me to embrace a more frugal and sustainable lifestyle.

We buy things we don’t need, with money we don’t have, to impress people we don’t like.
Will Rogers

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TACTICS: Transportation, Health Insurance, Groceries, Utilities, Tracking Spending

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