Retire Early by Living Below Your Means
Some people think you need to win the lottery to retire early. Others think you need to cash in on stock options at a high-tech company, or found a successful business. Still others think the road to early retirement hinges on getting a professional degree and starting a medical or law practice. In reality, virtually anyone can retire early by following only one simple rule: “Live well below your means”.
Take the case of Mr. Lawyer and Ms. Paralegal. Mr. Lawyer is 45 years old, and works as a partner in a downtown law firm. Including his annual bonus, he earns a robust $240,000 per year. Ms. Paralegal is also 45 years old, and works in the same law firm where she often helps Mr. Lawyer prepare his cases. She earns $60,000 per year. Both Mr. Lawyer and Ms. Paralegal dream about retiring early, at age 55.
Who is more likely to be able to retire early: Mr. Lawyer or Ms. Paralegal?
At first glance, Mr. Lawyer seems more likely to reach his dream of retiring early at age 55. He earns four times more than Ms. Paralegal. Ms. Paralegal would need to get a 300% raise to match Mr. Lawyer’s income, which will not happen. So Mr. Lawyer has a clear advantage.
A casual observer would also think Mr. Lawyer is more likely to be able to retire early. If Mr. Lawyer acts like his peers, he possesses the signs of high-income earners. He went to a prestigious law school. He lives in a five-bedroom house in an executive neighborhood. He drives his BMW sedan to work and parks in the nearby covered garage. He frequents popular eateries. He spends weekends at his lakeshore cottage. He goes skiing in Colorado each winter and hits the beach in Aruba each summer. He seems to be living the American dream.
In contrast, Ms. Paralegal lives a middle-class life. She earned her paralegal degree at the local community college. She lives in a two-bedroom condominium near the local Walmart store. She takes the bus to work and drives her six-year old Honda Civic when she goes shopping. She brings her lunch to work except Fridays, when she joins some co-workers for a soup-and-salad special. She takes bike rides on the weekend, and travels to Ft. Lauderdale each Fall to visit her retired parents. Clearly, the casual observer would consider her lifestyle to be a few notches below that of Mr. Lawyer.
But in determining who is more likely to reach their early-retirement dream, the answer can be surprising. Ms. Paralegal may be in a better position to achieve her dream because she follows one simple rule: she lives below her means while Mr. Lawyer does not live below his.
While Mr. Lawyer makes $20,000 per month, he spends most of it: $6,000 per month (30%) on income taxes; $800 to repay student loans; $3500 on the mortgage on his main house; $2000 on the mortgage for his cottage; $1500 for property taxes; $600 for his car payment; $200 for parking; an average of $1000 per month for his vacations; $250 for his lunches; and $3000 for everything else. He puts the remaining $1150 per month into his retirement account. Thus, Mr. Lawyer saves 5.75% of his income.
In contrast, Ms. Paralegal makes $5,000 per month, but spends only about 50% of it: $500 per month (10%) on income taxes; $700 on the mortgage on her condominium; $250 for property taxes; $60 for bus fare; an average of $30 per month for her annual airline ticket to Ft. Lauderdale; $20 for her lunches; and $1000 for everything else. She puts the remaining $2440 per month into her retirement savings accounts. Thus, Ms. Paralegal saves 48.8% of her income by living a less-opulent lifestyle.
While Mr. Lawyer should be able to retire comfortably at his normal retirement age of 65, he is unlikely to reach his dream of retiring early at age 55 because his 5.75% savings rate will not provide enough of a nest egg to support the lifestyle to which he has become accustomed. He is living approximately at his means, rather than below his means. In contrast, Ms. Paralegal should be able to reach her dream of early retirement because her 48.8% savings rate will easily provide a nest egg large enough to support her modest lifestyle. In other words, by following the simple rule of living well below her means, Ms. Paralegal will be able to live the life she desires rather than the life she’s expected to live by others.