Save Yourself


There is no getting around it. If you want to have financial freedom, particularly if you want it early in life, you’re going to have to save a large portion of the money you earn. It doesn’t matter if you make a lot of money or a little money, what matters is the % of your income that you save and invest. The math is actually quite simple. But it still seems surprising. We (humans) have trouble intuitively grasping exponential math, particularly compounding exponential math. Our minds tend to think linearly. This is why running numbers and showing charts can be really helpful to understand and believe how this all works.


There is a great article on this topice over at Mr. Money Mustache.


I recommend taking a look to delve into this further. I love MMM’s writing style and am a big fan….you should check out his other stuff as well.


I should note that what is often neglected in these discussions is the fact that it is much easier to save a large % of your income if you make more money. Based on my own estimates and analyses I’ve read, a basic cost of living for a family in America in most places (excluding the high cost of living areas), is $30,000-$40,000. Upper income retirees spend about $60,000 per year based on data. So if you make enough to afford this type of spending and still save a large fraction of your income, you are in really good shape.

If your income is too low to afford this but you feel this spending level is necessary for you to feel like you’re living an acceptable lifestyle, then you need to focus on making more money (but don’t forget to save most of the increase you achieve!).

On the other side of the argument, there are many examples of people living happily on $20,000 or even less per year if they make less mainstream choices on big cost items like housing, transportation, and even children.  Personally I could probably manage this as a single guy, but if I tried to do this with a family, I would quickly be that single guy 🙂

Generally, most people would be very happy in America with the ~$60,000 spending number as that lets you lead a “nice” life by mainstream standards.  I’m not going to argue if this is needed (it’s not), but the fact is that this is what most people would be happy with.  It also aligns nicely with the happiness studies that show most people are really happy increasing their income up to about $75,000 and then receive a much lower happiness boost beyond that.  Assuming a ~15% tax rate, this means annual spending in the low $60,000 range.  It also matches well with the actual spending data from upper income retirees who spend about $60,000 per year.  It’s important to note that other analyses show these upper income retirees could quite safely spend close to 2x what they actually spend per year.  Some of this is surely from fear and wanting to be conservative but clearly they have made the choice that additional spending doesn’t really make them much happier even though they could afford it.

If you make a good income but feel you can’t possibly save a large portion of it (many Americans seem to fall into this category), then you need to focus on the psychology of why you think you need to spend so much to be happy (hint: all the research says you don’t, despite whatever reasonable-sounding objection is in your mind right now).

I’ll explore some of these items in a future article but for this one, I want to focus on the objective math to show why so many people who achieve early FI, advocate a high savings rate.

Let’s take a few reasonable scenarios to study.

Case 1: Jill the high saver.

Jill just started working and makes $50,000 at her job. She pays a 15% tax rate, and manages to save 50% of the $42,500 remaining. She also is planning for a long life and knows that stocks and real estate have the best long term returns, despite their volatility so she invests all her savings in a diversified mix of small to large US and foreign stocks, plus real estate.   However, investments don’t do that great over the next 20 years and only deliver a 4% real return, or 6% including the 2% inflation that occurs. She does well in her job, managing to stay employed and progressing along the way but only earning an average annualized wage increase 1% above inflation (3% total) for the next 20 years, including the few promotions she received during that time.

Here is what Jill’s numbers look like over 20 years.

Year Income After tax income Savings at 50% Total net worth Spending
1 $50,000 $42,500.00 $21,250.00 $21,250.00 $21,250.00
2 $51,500 $43,775.00 $22,100.00 $44,625.00 $21,675.00
3 $53,045 $45,088.25 $22,979.75 $70,282.25 $22,108.50
4 $54,636 $46,440.90 $23,890.23 $98,389.41 $22,550.67
5 $56,275 $47,834.12 $24,832.44 $129,125.22 $23,001.68
6 $57,964 $49,269.15 $25,807.43 $162,680.16 $23,461.72
7 $59,703 $50,747.22 $26,816.27 $199,257.24 $23,930.95
8 $61,494 $52,269.64 $27,860.07 $239,072.75 $24,409.57
9 $63,339 $53,837.73 $28,939.97 $282,357.08 $24,897.76
10 $65,239 $55,452.86 $30,057.14 $329,355.65 $25,395.72
11 $67,196 $57,116.45 $31,212.81 $380,329.80 $25,903.63
12 $69,212 $58,829.94 $32,408.24 $435,557.82 $26,421.70
13 $71,288 $60,594.84 $33,644.70 $495,335.99 $26,950.14
14 $73,427 $62,412.68 $34,923.54 $559,979.69 $27,489.14
15 $75,629 $64,285.06 $36,246.14 $629,824.61 $28,038.92
16 $77,898 $66,213.62 $37,613.91 $705,228.00 $28,599.70
17 $80,235 $68,200.02 $39,028.33 $786,570.01 $29,171.70
18 $82,642 $70,246.02 $40,490.89 $874,255.11 $29,755.13
19 $85,122 $72,353.41 $42,003.17 $968,713.59 $30,350.23
20 $87,675 $74,524.01 $43,566.77 $1,070,403.17 $30,957.24
Total contributions Total NW Total
$625,671.81 $1,070,403.17 $516,319.11


There are a few things to point out here. One is the fact that her investments, even with a conservative rate of return, have nearly doubled her net worth after 20 years compared to the money she has put in. This type of exponential math is what Albert Einsten understood when he reportedly said “Compound interest is the the 8th wonder of the world. He who understands it, earns it….he who doesn’t, pays it”.

In addition, as inflation occurs it helps drive her wages up since many people spend their whole income and there would be mass riots across society if wages didn’t at least keep pace with inflation (it’s no coincidence that many people refer to their annual raise as a cost of living adjustment, versus a true increase in compensation).

The doomsayers like to quote that for many jobs in the US, wages haven’t increased once inflation is factored in. I’ve flipped this to a positive here by saying that wages will almost certainly at least keep pace with inflation over time. This has been quite consistent throughout modern history. Also note that these analyses are typically for the same job experience and responsibilities (a fact the media neglects to mention since it makes for a less sensational headline). In reality, people tend to progress in their jobs and gain more responsibility, leading to promotions and higher pay. So even if the pay for those types of positions hasn’t increased beyond inflation, individual workers still tend to see wage increases above inflation, particularly early in their careers.

Regardless, for Jill, since only half her income is spent, only that half feels inflation in prices. The rest of her annual raise gets comfortably added to her growing savings without much mental anguish. In fact, her savings rate actually goes up from 50% to 58% over the 20 years because her wage increases slightly outpace her spending increases due to inflation and she avoided the common challenge of her lifestyle expenses inflating in-line with her growing income.

A next important point is what this growing net worth now does for her. If we assume the typical 4% rule on safe withdrawals, meaning she could withdrawal 4% of her portfolio each year, adjusted for inflation, and likely never run out of money, then we can see how much income her portfolio could provide and compare it to the lifestyle expenses she is used to. The chart below shows this.


After just 17 years of working, Jill is financially free! Her investments provide enough return that she can cover all her lifestyle expenses forever without ever having to earn another $. She can choose to keep working and saving, or start spending more, or start giving money away, or retire, or whatever she chooses. She has now created a massive amount of flexibility and life choice for herself.

Take a look at the shape of the curves as well. You can clearly see the exponential nature of the investment income curve. This is due to the fact that investments, particularly in higher return choices like stocks and real estate, have a compounding return well above inflation. When added to Jill’s high savings rate, where more money is put in as she earns more income above her spending needs, her wealth (and income generated from that wealth), really takes off at a much earlier point than someone who saves a much lower % of their income.

Case 2

Bill the responsible. Let’s use the exact same assumptions as for Jill but change the after tax savings rate from 50% to 20%. This is close to, but still above the general advice of 15% that many financial professionals recommend (and very high above the actual ~5% average savings rate).

I’ll skip showing the numbers this time and jump right to the chart.



Hmmmm. 20 years of hard work, saving relatively “aggressively” like he was told he should do. And yet after 20 years, his savings couldn’t even cover half his expenses if he was fired tomorrow or decided he wanted to make a big change that entailed financial uncertainly like a new career or starting his own business or moving to another country. If he keeps at it, he’ll get there but he still has a ways to go.

There is something interesting that jumped out at me as I ran these two scenarios. Note that Jill is only spending about $31,000 at year 20 vs $50,000 for Bill. If Bill could ratchet his lifestyle down to Jill’s, he is much closer to success already since his investments could provide a little over $20,000 at this point. He still has a ways to go versus Jill but it’s much more feasible.  This helps demonstrate the power of keeping your expenses low.  However, since he is used to spending more, this will be very difficult. We humans get anchored very strongly in lifestyle spending and find it particularly difficult to go down much in spending. Loss aversion is a powerful psychological bias for us.

On the flip side, if Jill doesn’t stop at year 17 and works just 3 more years, her investments will now kick off $45,000 instead of $30,000 and more than 2X the $20,000 that Bill can generate. This is pretty close to Bill’s current higher spending level, even though she doesn’t need it.  It seems really nice to be Jill at this point. This late ramp up of investment gains is partly why the “just one more year” syndrome is common. A few more years of working can make a big difference as you go beyond the minimum net worth you feel is needed to retire, especially when you are saving a lot each year.  I can’t say I am immune to this myself when I see the financial benefit of working “just” a few more years.  I am still working to make sure my family is exposed to minimal financial risk when we do say goodbye to a high income.  Depending on the amount you are saving and your current net worth, it may not take long to go from a 4% withdrawal rate to 3% or even 2%.  It’s ultimately a personal choice but you should run the numbers so you walk into it with eyes open.

For our last case, let’s take a look Mike, the average American who saves 5% of his income and just doesn’t see how he could do much better since life is expensive and there always seem to be bills to pay and emergencies like car repairs or doctor visits that happen. Plus, retirement is far away and certainly isn’t something to spend much time thinking about. He likes his job and isn’t sure what he’d do if he didn’t have to work anyway.  It’s also not something that comes up in conversations with friends or family since they are doing the same thing as he is.

Here is Mike’s situation after 20 years.




Ouch!  Looks to me like Mike is in trouble. I hope he still is just as passionate about his job now 20 years later (unfortunately the probability of that is low). In fact, I hope he will like his job for a very long time to come because otherwise he will be miserable. I hope he isn’t fired. I hope he doesn’t have a major health problem that prevents him from working as long as he needs to.  I hope he doesn’t read the data that shows almost half of people retire earlier than they wanted/planned as they are forced out through downsizing or health problems.

Hope is not a strategy. Please don’t rely on it for your life plans.  Your life is too important.

Some further comments:

Note that I used conservative estimates on many assumptions here.

Actual (not marginal) tax rates on this income (in retirement) should be well below 15%, especially if tax advantaged plans like a 401K is used. I also assume no matching contribution in such a plan for savings. I assume a real return of 4% from stocks and real estate vs the last many decade average of 8% and a consensus estimate of 5-6% going forward (US numbers). I also assume wage increases only 1% above inflation. However, most people progress through their career over time, developing expertise, getting promoted to more responsibility, and gaining wage increases. For many people, wage increases have greatly exceeded inflation early in their careers. When I say greatly, I mean by a few percent each year. For exponential math, this is a significant difference over time even though it feels minor in a given year.

For the blog readers who don’t like these assumptions, you can run numbers with your own assumptions. You can change investment rates of return, wage increases, inflation, etc. What you will find is that the key conclusion remains… far the most important variable in your personal finance equation is the % of your income that you save each year. Everything else, like a high rate of return on investments because you are a rare investing savant, will only move the time to FI in each of these scenarios by a few years (i.e. about 10%).

This means that if Jill gets relatively poor investment returns for most of her working life, she will still reach FI in 20 years or less.

If the markets do really well, Jill will shorten her time by a few years, Bill will shorten his time as well but will still be working for long after Jill. Mike is in big trouble no matter what.

Things like investment returns simply don’t matter until you already have a large investment portfolio built up. It’s the way the math works. In this case, 20 years is a relatively short time and only a few of these years include a substantial portfolio relative to spending.

For those just starting out, don’t worry about advanced investing knowledge. It simply doesn’t matter when you are starting out. The key is to focus on establishing a good savings rate and to begin investing. I recommend starting with a low cost total market fund from Vanguard, which will serve you well for many years as you start to learn more. In fact, many people have successfully retired by doing exactly this……no sophisticated investment management is needed.

A fair criticism is that Jill was forced to spend quite a bit less than most people, including Bill, on the same average salary. This is of course true. You can’t get standout financial results by doing the same thing as everyone else.

If you can do it, a best case scenario is to earn an above average income so you can afford to spend enough for a “typical” nice lifestyle and painlessly save a large portion of your income. But it’s certainly not the only path.

Find your own path but make sure you understand where that path is leading you so that you are going in with your eyes open.  Good luck!

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