Saving for early retirement: the point of diminishing returns

[Silhan]

I finally understand a point that has been made before on these forums, which is that extreme scrimping and saving in order to retire earlier might not be worth the discomfort it causes along the way.

For example, if by living below my means I could save $50,000/yr at a 7% average annual real rate of return, I would have approximately $1,200,000 after 15 years.  (All amounts are in 2006 dollars.)  However, if I could increase my savings rate by 1% by saving an additional $500/yr (for a total of $50,500/yr), then after 15 years I would have approximately $1,212,000, or 1% more.

Now suppose I could retire with $1,200,000, and suppose that my current income is $100,000/yr.  Saving that additional $500/yr would allow me to retire only a few months earlier, at best.

Would the possibility of retiring a few months earlier in 15 years be worth giving up what that $500/yr would buy me along the way?  Because my current budget is already pretty lean, I've concluded that it's just not worth it; I've reached the point of diminishing returns, especially considering that there's always the possibility that I might never reach retirement due to accident or illness.  So for now, I'm trying to enjoy the journey more and to think about the destination less.

 

[doushioukanaa]

First, congrats on saving $50K per year!

One thing I noticed about your math is that you assume a lump savings of $50,000 at the end of the year when you would probably more likely have monthly savings of $4,167 per month, and with the benefit of compounding you would end up with more like $1,334,000 at the end of 15 years. It's true that if you increased your savings to $50,500 per year or $4,208 per month, you would only be able to retire one month earlier.  You would need to either improve your returns or increase your savings further to have a significant impact you your FIRE date.

Everybody implicitly makes the trade off between saving and spending, but few bother to model it and make an explicit decision about it in the way you have. What it comes down to is your savings is quite high, so the extra $500 doesn't have a whole lot of impact. For somebody who saves a lot less, the extra $500 would have a larger impact. So for those reading, only take this as license to spend that additional $500 if you already have a very good rate of savings...if not, the "latte factor" should be taken into account. http://www.wordspy.com/words/lattefactor.asp

 

[CybrMike]

sounds like your trying to justify a purchase of something that is $500 per year. LOL.

 

[Silhan]

sounds like your trying to justify a purchase of something that is $500 per year. LOL.

Nothing in particular.  I just feel like I'd enjoy that $500/yr more now than I would the extra few months of retirement in 15 years.

 

[Silhan]

First, congrats on saving $50K per year!

One thing I noticed about your math is that you assume a lump savings of $50,000 at the end of the year when you would probably more likely have monthly savings of $4,167 per month, and with the benefit of compounding you would end up with more like $1,334,000 at the end of 15 years. It's true that if you increased your savings to $50,500 per year or $4,208 per month, you would only be able to retire one month earlier.  You would need to either improve your returns or increase your savings further to have a significant impact you your FIRE date.

Yup. My main realization was that increasing my savings rate by a relatively small amount wouldn't have very much effect on when I could retire, so I've decided not to worry about how to squeeze that last $500/yr out of my current budget.

 

[AFloat]

You have to find a spending amount where you are comfortable and save the income above that amount. Our comfortable level was around $70K per year so we saved all the income above that. As independent computer consultants our income would vary from year to year but it was always above $70K so our savings would vary year to year. We had 4 very good years, earnings above $350K, so we were able to save a lot during that period. My point is that when our income increased our savings increased not our spending. Many of our friends would spend any pay increase, not save it. If they got a $5K salary raise they would use that to buy a new $50K car. The difference is that we’re ER and their still working.

You need to find your own spending comfort level and resist spending income above that level. It’s different for each person.

 

[preben]

Well - reading the thread you would have $134k more at retirement - that could buy quite a lot of $500 treats (or car/boat Etc.) then!  

That said - you seem to have a good balance between saving and current gratification and I fully agree that that is the way to go.

Cheers!

 

[wabmester]

Well - reading the thread you would have $134k more at retirement - that could buy quite a lot of $500 treats (or car/boat Etc.) then!  

Ben, I think you slipped a decimal point.   Should be $13K more.

So, your choice would be 15 $500 treats now or 26 $500 treats later.

 

[preben]

Quote: you would end up with more like $1,334,000 at the end of 15 years Unquote
I did not do the math, doushioukanaa did - Oh well - anyway; enjoy that cash NOW - we can not take it with us!

Cheers!

 

[retire@40]

If you reverse-engineer your endgame, you will know how much you will need to save to get to the promiseland.

So, if you want to have $1,200,000 in 15 years, then you know what you need to save on a monthly basis to get to that point.

With the extra $500, you can make a choice:

Do I save it in case I don't get the X% rate of return I need to get to the final amount or if I'm concerned I may not be able to make all the minimum required monthly contributions to my savings?

Or, do I spend it knowing even if my concerns above occur, I will just extend my timeframe beyond the 15 years if need be, or make any other necessary adjustments to bring me back in line to achieve my goals.

 

[perinova]

very good conclusion. assuming that you are talking about a 1% max in savings change from 50%. the diminishing return is real but with market return mutliplies this in the early years.

however don't do this too many times.
I checked my own rule of thumb ( time_month=1200/savings_rate )
going from 50% to 49% I would loose 5 months (only.. I guess )
going from 50% to 40% I would loose 60 months (5 years - no way)

since you are part of few savers that did this computation you are adjusting your budget to your personal retirement goal. you will be OK. congrats with that

 

[Rich_by_the_Bay]

The operative phrase here is "worth it."

Whenever you see that, you are referring to personal value systems and preferences. So, you will never find a number or income or lifestyle which is "right." It's a personal play - "diminishing returns" for one person might be just what is needed to make ER income "worth it" for another.

 

[tryan]

Rather than set savings some end-game number (1.2M) we determined what annual spending allowed us to live comfortably (60k for us); then everything beyond that was candidate savings/investing.

End game saving goals are nice but life has a way of turning these goals into fantasy (especially with kids). For us it was better to set an easy-living budget/spending and be able to smell the flowers while saving.

 

[laurence]

Exactly, set a goal. What monthly income do you need? What nest egg is needed to generate it? What age do you want to retire? How much time does that give you to save that nest egg? What's that work out to in monthly contributions to your retirement account?

At that point, cut the check, and enjoy the rest, it's later than you think!

 

[Silhan]

Rather than set savings some end-game number (1.2M) we determined what annual spending allowed us to live comfortably (60k for us); then everything beyond that was candidate savings/investing.

End game saving goals are nice but life has a way of turning these goals into fantasy (especially with kids).  For us it was better to set an easy-living budget/spending and be able to smell the flowers while saving.

That's basically the approach I've taken.  However, every so often (typically after a hard day at work) I wonder if I could possibly tighten my belt a little more in order to retire a little earlier.  This was one of those times.  But as I've already mentioned, after going through the math, I finally realized that enough is enough.

 

[perinova]

One point I want to make that might be important.
The diminishing return is for the money side of it. 15 years seems a long way to go now but... In 15 years you may be "sick and tired of being sick and tired" (got this from the REHP) and so ready for . The last year of work 1 month will feel like an eternity!!!!

I am not at this point but from some postings in the forum it seems that it can be the case.

 

[laurence]

Having never experienced it, I'm only guessing, but I would attribute a lot of what you see on this board to "short timer's disease".

 

[HFWR]

Look what you could have done with that $500...

http://money.cnn.com/2006/04/11/magazines/fortune/f500_dollars_fortune_041706/index.htm