One of the most famous posts in the personal finance blogosphere is “The Shockingly Simple Math Behind Early Retirement” by Mr. Money Mustache.
Quite frankly, it deserves to be. It covers a topic that is important, and—for most people—novel. It breaks the ideas down pretty well. And there’s also the fact that it has an A++ headline.
But my question is simple: Does it hold up? Let’s explore it deeper.
What is the “Shockingly Simple” Math?
The post argues that when it comes to the question of how long it will take you to retire, there’s only one factor that really matters: Your savings rate.
Your savings rate is just the percent of your take-home pay that you invest towards becoming financially independent.
So you can think of dividing your take home pay into two categories:
- Spending (including giving)
- Saving (i.e. investing)
Since your savings rate is a percentage of your take-home pay, you can increase it in two different ways:
- Increase your take-home pay
- Decrease your spending
Both of these are powerful, but Mr. Money Mustache points out that decreasing your spending is doubly powerful. This is because if you use the 4% rule (which he’s covered and I’ve covered), you can retire when your portfolio is 25x your annual spending. So spending less increases the amount you can invest towards retirement and decreases the size of the portfolio you need to retire.
Using these principles, Mr. Money Mustache created a chart showing how long it would take to retire at various savings rates (e.g. 66 years at 5%, 28 years at 30%, etc.).
Do His Core Contentions Hold Up?
The short answer is yes.
I’ve ran the numbers myself and re-created the table that is the centerpiece of his post, and the numbers check out. His math does make some assumptions, but they are reasonable.
We’re going to break it all down below in detail, because there are still some insights to be gleaned. As a spoiler, I think the primary observation that he left on the table is that even though cutting spending is twice as powerful, there comes a point where increasing income is the best way to reach your goals.
The Early Retirement Chart
To estimate how many years it would take to reach retirement at various savings rates, Mr. Money Mustache made some assumptions:
- That you could earn 5% adjusted for inflation on your investments
- You would use the 4% rule to determine your retirement spending, with some flexibility for recessions
- You’re starting from a net worth of zero
I re-created his table and reproduced it below. Here’s how the math works (skip if you’re not nerdy enough to care):
- I used a take home pay of $50,000 a year to calculate all scenarios
- Last I checked, the median gross household earnings were close to $60,000 a year, so this number looks pretty good
- In one sense, the number I use doesn’t matter since it’s the percentages that count. But sticking with a particular number gives us the opportunity for further insights which I’ll point out
- Multiplying $50,000 income by the savings rate being analyzed gives you the amount saved per year
- So at $50,000 and a 5% savings rate, you are saving $2,500 a year
- $50,000 – $2,500 = $47,500, therefore this is your yearly spending
- Using the 4% rule, the number you need to retire is 25 * your annual spending
- I then calculated the portfolio growth
- Each year, you add your contribution ($2,500 for the 5% savings rate) to the existing balance ($0 in year one)
- You multiply that number by the rate of return (.05, or 5%) and add the resulting earnings to your total to get your ending balance
- Your ending balance in year one becomes the starting balance in year two
- Drag the formulas down, and your spreadsheet gives you the portfolio growth over time
- Find the year when the portfolio balance exceeds 25x your annual spending and record it on the chart
Here are the results:
|Savings Rate||Working Years Until Retirement|
Mr. Money Mustache’s numbers are nearly identical to mine. A few times we’re off by a year from each other, but that kind of thing happens. He was also more precise in parts, listing 10.5 years for 65% whereas my methodology always rounds up.
One thing that stands out about the chart is that you run into diminishing returns. Going from 5% to 10% shaves 14 years off your career, but going from 90% to 90% shaves off one. I don’t point that out to discourage you from shooting from high savings rate. My point is actually to encourage you that if you haven’t been saving much, every increase makes a huge difference.
Obviously the higher the percentage of your income you’re saving, the harder it is. Something we’ll look at when we cover a few examples below.
Breaking Down a 5% Savings Rate
Here’s what your portfolio growth looks like investing $2,500 a year (5% of the hypothetical $50k income):
Because you need to spend $47,500 a year, your target is over a million bucks.
Having a long time frame is what we don’t want, but at least it gives your savings plenty of time to compound. You’ll notice that virtually all the growth happens at the very end.
This is the easiest savings rate to pull off, but the 65 years to retirement is nuts. We’ve gotta do better than that.
Breaking Down a 10% Savings Rate
Compared to the last chart, spending went down, savings went up, the target went down, and the number of years to retirement went way down.
Breaking Down a 25% Savings Rate
A few things stand out here:
- Your contributions are now making up a noticeable percentage of your portfolio (look at all that blue on the graph)
- This is the first example where you’ve needed less than a million dollars to walk away from work
- You’re spending is tighter, but doable for a frugal person (especially one without kids)
Breaking Down a 50% Savings Rate
- Your contributions now make up a clear majority of your portfolio balance at retirement
- $25k yearly savings is great, $25k spending is starting to get tough
- For reference, Mr. Money Mustache himself is known for being very frugal and lived off $20k-$25k a year
Breaking Down a 95% Savings Rate
Okay, the reason I’m showing you this one is to illustrate a point: There’s no way you’re going to cut your spending to $2,500 a year.
The Case For Increasing Your Income
Here’s the short version: The only way to achieve a really high savings rate is with a really high income.
To be fair, although MMM passes over this point in his post, his blog as a whole indicates that his primary audience is professionals with decently high salaries who spend obscene amounts of money. Fair enough.
But it’s really hard to cut your spending below $25k a year, and if you have a family, you’ll reach the reasonable limits of frugality much higher than that.
Once you hit your reasonable frugality limit, the only way to increase your savings rate is to increase your income.
For reference, here’s how much income you would need to support a 95% savings rate at various spending levels:
|Annual Spending||Income Needed|
Last I checked, the top 1% make somewhere between $400k-$500k a year. So you’d need to be a 1%’er by income to save 95% of your salary if you spend a mere $25,000 a year.
This is similar to the strategy I outline in the core post of this blog: Personal Finance in Less Than 10 Words
Things Could Be Better
One assumption that I mentioned quickly and never revisited was the concept of 5% returns after inflation. The fact is, we don’t know what the long term rate of return will be.
Sure, it could be lower, but it could also be higher.
The market goes up and down, but it goes up far more often than it goes down.
Historically, the market has produced a rate of return that works out to around 10% per year. Adjust down 2-3% for inflation. and you get a 7% real yearly return.
Just changing the expected returns from 5% to 7% is enough to shave our working career from 51 years to 41 years:
It’s also worth pointing out a few hidden assumptions we’ve snuck in:
- We assume that in retirement, you are completely retired and never make another penny
- I haven’t said anything about social security or inheritances
- These models all keep your spending constant, but most people spend less as they age
If any of these assumptions don’t hold, you might be better off than any of my fancy graphs and charts give you credit for.
Are You Starting Above Or Below Zero?
We’ve been assuming this whole time that you have a net worth of zero. You’ve invested nothing in the stock market, and you have no debt.
Of course, if you’ve already started investing, you’re closer to freedom than these numbers would indicate.
If you’re net worth is less than zero however, you’re closer to bondage than freedom.
If you’ve gotten caught in the debt trap, you owe it to yourself to get out so that you can get to the point where your money works for you instead of you working for your money and to service your debt.
Related Post: The Debt Trap: How Smart People Get Snared
Everything Hinges on the 4% Rule
Here’s a reality you’re going to have to make peace with: You can’t predict the future.
The future is unknown and in many cases, unknowable. Investing (in anything) will always carry risks because no one knows exactly what’s going to happen.
That being said, the 4% rule has held up very well when it has been studied historically. The future won’t be exactly like the past, but the past provided some tough challenges. The great depression, wars (including two World Wars), massive inflation, major stock market crashes in 2002 and 2008.
The fact is, you’ll never know for certain if your portfolio will survive a lifetime of spending and market fluctuations. But portfolios with a sensible allocation between stocks and bonds is surprisingly resilient. It gets even more resilient if you are flexible and creative.
Although his claims seem unbelievable and his headline (while admittedly great) is borderline clickbait, the cold hard fact is that Mr. Money Mustache retired in his early 30’s.
His methodology worked for him, and the math indicates that the principles are sound in general. They rely on some assumptions, but every single retirement plan relies on assumptions without exception.
Work to spend less, earn more, and invest the difference and you will hasten the day when you never have to work again.