Key takeaways
- Numbers thrown up by retirement calculators can look scary & unachievable at times
- In response, many try to get aggressive by investing in schemes that promise high returns. But this is most often a mistake since it also increases risk
- A safe way to get aggressive with planning for retirement is to reduce your expenses
- Expense reduction is one of the few things in your investment journey that is truly within your control
- Note that your INCOME has NO bearing on how soon you can retire
- Only your savings rate has a bearing on how soon you can retire
- Increasing your savings by just 10% most often has a more than 20% impact on reducing years to retirement
- Increasing your savings rate has a triple sided benefit on your retirement plans as explained in the article
- If the numbers for your retirement look unachievable or scary, start tracking essential expenses & plug that number in instead
- If the numbers still look too high, you’ll have to find a way to make changes to your lifestyle, reduce expenses from now so you can live off less in retirement
Introduction
In an earlier article, I explained how you can calculate the target amount you need to be able to retire. In yet another article, I explained how you can calculate how much you need to invest each month to get to that retirement target number.
In this article , I explain how to use a tool to figure out how many years it will take for you to retire.
I also demonstrate the significant reduction in years to retire based on increasing your savings and what to do if initial numbers look scary or unachievable.
The typical way some people try to accelerate time to retirement
Most of us start saving & investing later than we should have. We realise it a bit late and when we start to look at making retirement calculations, the amount we need to invest each month or the number of years to achieve retirement looks scary or unachievable.
When this happens, the temptation is to get aggressive with one’s investments. One path that people feel tempted to take is to look for investments with exceptionally high returns. For example they may fall prey to real estate schemes, start investing heavily in small cap mutual funds, stocks, crypto etc. But most often than not this is a mistake. Because the rule with investments is that the higher the returns, the higher the risk. There is no such thing as high returns with low risk. If any company is promising higher than average returns with low risk it’s most probably a scam.
One of the safe ways to get aggressive with investing is to SAVE more aggressively. In this article we show the impact of doing that.
Expenses: One of the few things we CAN control in our investment journey
As I mentioned in my earlier article on the topic of asset allocation, there are very few things one can truly control in one’s investment journey. Asset allocation is one of them and your expenses are another one. This article shows you how dramatically controlling your expenses (and consequently increasing your savings rate) can accelerate your retirement.
What is a savings rate?
Your savings rate is your savings divided by your income expressed as a percentage
i.e. (Income minus Expenses) / Income X 100
Example calculations of years to retire based on savings rate
Networthify is the well-known & widely accepted tool that I’ve used to make the sample calculations below.
Here are the assumptions / inputs I provided for the results below:
- Income of 1 lakh per month
- REAL (i.e. post inflation) 3% rate of return
- 3% safe withdrawal rate in retirement has been assumed based on research done by Ravi Saraogi.
- A starting net worth of portfolio of Rs. 1 crore
Surprise Surprise ! Your income has no bearing on how soon you can retire
If you play around with the numbers on Networthify, you will notice one very interesting fact if you look carefully. Your income makes no difference on the number of years it will take for you to retire. The only things that make a difference are:
1. Your savings rate
2. The expected returns you input
3. The safe withdrawal rate
4. Your current portfolio value
Of the above 3 factors, your savings rate is the only thing that you can control during the years you are preparing for retirement. However, by controlling that savings rate, your withdrawal rate in retirement can also likely be controlled. In addition, your current portfolio value, your investment prowess aside, is probably in any case strongly tied to your savings rate. So 3 out of 4 factors can be controlled significantly through a high savings rate.
This effectively means that if a billionaire and you have the same savings rate, it will take both of you the same amount of time to reach retirement ! Alternately, if you have a higher savings rate than the billionaire, you can retire before the billionaire ! 😊
Percentage reduction in years to retire with every 10 percent increase in savings
Here’s some data that shows you the impact that every 10% reduction in expenses can have on your years to retirement.
The double impact of savings on retirement acceleration
Notice from the above data that a 10% reduction in expenses or a 10% increase in savings rate always seems to have more than a double impact (i.e. 20% or more) in terms of reducing the number of years it will take for you to retire.
This is because increasing your savings, has two effects: It increases the amount you invest but most importantly, because all retirement calculation target goal amounts are based on your monthly expenses, your retirement target also comes down substantially. So in effect, you are reducing your target and at the same time increasing the investment contributions you make towards your target.
This is a very important point to note and so I’m restating it again in a different form. When you increase your savings rate say from 20% to 30%, what you are in effect doing is finding a way to live off only 70% of your income instead of 80% of your income. This means you have learnt to change your lifestyle to live off less money per month and this reduces your retirement target amount drastically and you’re investing more each month. This has a 3rd massive impact as well: Once you learn to live off less money per month, It will likely reduce the amount you need withdraw during retirement and that makes you safer as well.
What to do if savings rate or years to retire look unrealistically high
1. Essential / non-negotiable expenses to the rescue
To determine our maximum possible savings rate, we need to know accurately how much our monthly expenses are.
Tracking ALL your expenses every month is an extremely good financial habit to create & a great starting point. I do this by downloading my bank statements from every account I have and adding up each & every expense.
When I started this exercise, I can honestly tell you, I was SHOCKED to see how much I was spending. In fact, shocked is a gross understatement 😊 My mental guesstimate of how much I was spending on average every month was waaay below what it was in reality.
From the point of figuring out how many years more for you to retire though, there is one other angle that would be very useful to track or analyse about your expenses. That is what percentage of your expenses are essential / non-negotiable / mandatory and what percentage of your expenses are nice to have or non-essential / negotiable. i.e. what you could do without if push came to shove. I do this simply by marking each expense on my spreadsheet either as Essential or non-essential.
Once you know what your essential expenses are you can enter that into the tool and you are likely to get a more realistic & achievable “years to retire” number.
2. Impact of reduction of expenses in retirement
If one realistically believes that one’s expenses in retirement will or can be reduced, one could consider that while planning for retirement. Below I show a simple chart from Valueresearch that shows mow much of an impact reducing one’s expenses in retirement can have.
Now calculate YOUR years to retirement
All retirement calculations are EXTREMELY sensitive to the values we assume for things like returns, inflation etc. what this means is that if you make even a 1% error in any of your assumptions, the number of years to retire could go up or down drastically
So before you plug values into Networthify make sure you know how to accurately calculate what your historical investment returns (i.e. returns BEFORE accounting for inflation) have been in the past.
Note that it is also critical to calculate your personal inflation rate before you can know what your REAL (post inflation) returns are.
To get a really accurate result on years to retire, the REAL returns that you should enter on Networthify are = Your historical returns minus Your personal inflation rate.
You can now use the Networthify to calculate how many years you would need to retire. Make sure you click on “Show more Options” to be able to edit the expected REAL (post inflation) rate of return as well as your Safe Withdrawal Rate. I would suggest using a safe withdrawal rate of 3% based on Ravi Saraogi’s research for India.
Disclaimer: I am not a financial advisor. My articles are meant for people who are not savvy or well versed with personal finance and investing and find it difficult to grasp all the jargon typically used when discussing such topics. I hope to be able to demystify investing and make it as simple as possible for everyone. I’ve invested in Mutual funds for approx. 24 years. I’ve also been a diligent student of the subject of investing over the past 24 years learning & applying the writings of luminaries in the field. In these articles I’m merely sharing my experience & learning from that investing journey and the books of luminaries in the field in the hope that it might help others in some way. I am in no way directly or indirectly claiming to be a hot shot investor who has generated exceptional or even above average returns during my investment journey. However, I am quite confident that even if all you do is learn from my mistakes, educate yourself on sound investment principles & develop good financial habits you will benefit greatly. Please ensure that you consult a financial advisor before taking any decisions or actions concerning your personal finances or investments. I shall not be liable.