Early Retirement is all about Spending Less, Not Earning More

That’s an odd assertion to make, and illogical to boot, no? If you need to save £10000 a year, and you’re breaking even at the moment, then you could either spent £10,000 less, or carry on spending at the same rate, and earn £10000 more?

Not so fast. For a start if you earn £10000 more you’ll get to lose £3000 to £4000 to the taxman, so you do in fact have to earn even more. However, there are added ‘soft’ issues. You may have to spend more time at the office or commute further, so your domestic ocsts may rise as you favour convenience over DIY. More subtly, there may be lifestyle inflation pressures.

For instance, when I go to Canary Wharf I stick out as a slob – I’m the guy in the T shirt and no-label trousers where all around me are designer shirts and well-cut suits. I’ve just looked at what engineering jobs pay there it appears that I earn similar to some of these folks or even a little more, however I don’t need to spend the money on the designer gear 🙂 That’s average engineering jobs – obviously if you’re network admin for a big bank I’m going to be way down in the salary stakes!

Mr Money Mustache’s courageous outline of the history of his increasing net worth (‘Stash) reminded me of this. When I first looked at it I thought blimey, I haven’t got anywhere near that figure (USD800,000 ≈ £500,000) so either I am outrageously necky even thinking about early retirement or life in the UK is a lot cheaper. Monevator has a pretty similar value for his baseline reference, though unlike MMM his example income replacement portfolio is pure financial assets. However, digging deeper MMM considers his house part of his net worth, and this is a total 360 degree net worth calculation. I’ve never calculated that because of my income focus, and I have a greater diversity of ‘Stash than MMM, accumulated over three times the amount of time, so I’ve never seen a large amount of it in one place. He did me a favour in getting me to tot this diverse mess up. It’s probably at least in the same ballpark, despite the fact that I personally have never seen a single financial transaction or single asset purchase for more than £60,000 in my life. Ever.

It’s the Spending, not the Earning

More interesting, however, is how he got there. I built my net worth largely on my own (I was single for longer than most people) so he had the edge with having two people bringing in money to the household, and MMM earned significantly more than I have ever done, so he got there in 10 years whereas I have been working for nearly 30.

However, it wasn’t that MMM’s household income was higher than mine. It was that they saved a far higher proportion of their income than I did prior to 2009, and invested it. The so called magic of compound interest hasn’t made a large difference to his wealth, this is pure saving. Apart from the value of my pension, which presumably the Trustees invest and use compounding, I don’t think much of mine is due to compounding either, indeed unlike many I don’t rate compounding as a way to make things easier over a working life, Yes, pension contributions you make in your twenties do appreciate numerically, however they better had do, because inflation means the value of £1 then will be a lot more than the value of £1 when you retire. The differential once inflation is taken out is not huge.

Compound interest ain’t as magical as they say

I experimented with the Motley Fool’s compound interest calculator. Say I invest £1 a month for my working life of 30 years. Without inflation I would have 30*12=£360 at the end of it.

Now if I was in an inflationary environment and scaled my annual savings and got interest to match inflation in real terms I’d still have the equivalent of £360. So if I’d started in 1980 and opened my pot in 2010 I would have £1200 in there, but it would have been worth the same as the £360 in 1980.

Let’s say I’m a savvy investor and get a return of 3% above inflation, I’d be sitting on a pot worth £580 in 1980 pounds. It’s a 61% increase, so worthwhile, but not a total game changer.

money is drawn to money so if you have money it’s easier to save

I started my savings from a standing start in 2009, after three years I have savings of twice my gross salary. The heavy lifting here is done the same way as MMM – spending less than I earn, aided by some investment appreciation, some dividend income and a lot of stopping the Government thieving half of it in tax. It really is remarkable how much you can reduce taxation if you don’t need to spend most of your income…

Unlike MMM, my investment income is pretty poor at the moment, as my ISA is small, and tax-free pension savings are in accumulation mode. Young early retirees need to make their investments pay a decent income quickly, there is the same pattern in MMM and ERE. Mine are operating in the traditional form  of being in accumulation mode right up until they are drawn.

I have the challenge of trying to bring the post-tax investment income up to service my basic living costs between retiring and drawing my pension, a gap of about three years. Because it’s a near-term requirement unsuited to the ravages of the stock market, I have three years running costs as cash, which is galling because this is about half of my post-tax savings. Cash earns no real income, whereas at least my ISA is achieving its nominal 5% dividend  return. I could double that dividend return by committing the cash to it, but the maths doesn’t work out. A 5% dividend return means you need a stake of 20 times the desired income, and I haven’t got that yet.

One way to improve my situation would be to reduce my outgoings. The poster child for how to do this in the UK would have to be Macs, who has managed to get his running costs down to £5k p.a. which is a damn sight less than mine. Interestingly enough, much of the difference would be reduced if I didn’t run a car. On the downside neither estimation accounts for the ~1% of house value you should allocate for maintenace and repairs. As owner occupiers we are probably way less hard on the fixtures and fittings, and yet over the last 5 years I have spent over 1% of the house value on repairs and improvements.

My career profile was much more conventional in that my earnings peak was much, much later in my working career, about 20 years in. However, the common takeaway with MMM and ERE is that you only build up enough capital to get a decent income if you spend much less than you earn – and that much less needs to be about 50% if you want to do something very different to the normal pattern of working.

For me the savings pattern isn’t anywhere  near as different from the norm as those guys. It’s much closer to Salis Grano, who sums it up in this post titled Where Did It All Go Right. I am insanely jealous of course, as I haven’t got there yet. Unlike MMM who retired after 10 years, thus shaving 20-30 years off his working life, my aim is taking a more modest 10-12 years off my working life, I have already been working three times as long as he has.

It is one of those ironies of life that saving money is easier once you have money, when of course the people that really need to save money are those that are in debt. It’s how capitalism keeps most of us debt slaves, particularly those who acquire debt young and warm to the lifestyle.



14 thoughts on “Early Retirement is all about Spending Less, Not Earning More”

  1. Nice roundup of some familiar faces, and I appreciate being included.

    Regarding investment returns, according to the Barclays Capital Equity-Gilt study, the average real return per annum on the UK market is 5.4% a year, which is significantly above your 3% rate for a ‘savvy’ investor – in fact it’d take your sum closer to £900.

    Knowing your macro view, you might say 5.4% from UK equities is unrealistic, but we’re undoubtedly on low valuations so that’s tilted in your favour, plus there’s also the rest of the world.

    What’s more, a savvy investor might add some small caps or value to the mix, tilting the return above the 5.4% in return for taking on more risk (i.e. what we’re having to suffer right now).

    Cars are a wealth destroyer, if you can live without one do so. Do you have zipcar near you?

    I think restructuring to enable walking/cycling, zipcar, public transport, taxis and the occasional long distance hire will be pretty profitable for most people.

    Easy if you buy your house with this in mind at the start, admittedly!

    Finally, if I may indulge, I have a compound interest calculator with a nice graph if you’ve not seen it! 😉



  2. Thanks for the kudos, ermine, ‘poster child’, eh? 😉

    You’re right about cars. I still have my (t)rusty old VW which is knocking me back about £700 this year, roughly £220 tax, £250 insurance, £150 MoT/maintenance and £80 fuel. Mileage is very low and I can’t even remember which month it was I last filled up 🙂 Still, it allows me to get extra work, and that pays enough to subsidise some personal luxury usage!

    On the other hand property maintenance was way below the 1% mark, about £350 spent on re-felting the garage roof. Having the time to do it myself was worth a lot though, as I’m sure getting ‘professionals’ in to do it WOULD have cost me that 1%!

    These are both quite ‘big ticket’ issues that are easily overlooked, though the real elephant of course is buying into consumer culture. That’s the big difference I see between me and my friends – I suppose we all know someone who is ‘struggling’ whilst complaining about having to pay higher-rate tax…. For my part, I have never even earnt median wage, and yet still seem to be better off. Maybe because I don’t fritter it all away on fripperies and frivolities.


  3. @ermine
    I very much appreciate the perspective of someone who has been toiling longer than MMM or ERE. I respect their paths, but am beyond the point of strict emulation. I’m approaching 50 y.o. in less than a month; and were I more courageous about driving down expenses, I’d be in a position to tender my resignation immediately. I didn’t start saving in earnest until I was 40. Since then I’ve managed to save about 45% of my yearly gross. The choppy investment climate for the past decade means that very little of my current net worth is due to anything other than having saved it in the first place. The one last hurdle for me, shared by most older Americans, is the cost of health insurance premiums until Medicare kicks in at 65 (at least under the shaky rules governing the system at present).

    Nevertheless, your post has encouraged me to engage in a little end-of-year reflection on my outgoings to see if further reductions can be managed.


  4. Yes, you can never rely on an investment strategy as such. Saving hard is going to be the only way for most people or, as in my case, saving steadily and having some financial luck, althuogh I am not an early retiree compared to some.

    Probably 1% for annual maintenance is a little high for London, although I reckon I have spent that over the years but only because the figure includes some building work.

    I would definitely not assume anything over 3% for real returns on equities going forward. With my current capital mix of roughly 2/3 cash and 1/3 shares I use just 1% in my long term projection overall.


  5. Excellent post that sums it up nicely. I completely agree that any/all early retirement plans are primarily driven by savings rate (and not so much by investment return rate)

    I am trying to get *very* aggressive with my savings rate to put this thought into practice.


  6. @Monevator my 3% figure is more pessimistic because I believe the myth of growth is breaking down, and I’m generally of a more nervous disposition. One factual change is that nowadays company managers are looting a lot more of company profits in pay and benefits at the top than was historically the case, so I’d be loath of extrapolate the results of 1950-1990 into the future unless we can do something about that.

    Agreed with the car. After experiencing a 1.5 hour commute when I lived in London I always made sure to live closer to work, and having been lucky enough not to have to switch jobs too often that strategy has worked for me. I save some money by cycling in the spring and summer, but the fixed costs are now higher than the variable costs.

    @Macs, I’m even more in awe is your £5k includes £1k car spend 🙂 Poster child indeed!
    I think the 1% figure is what professional landlords assume, and owner-occupiers have the advantage of being more careful with the fixtures and deferring some big items in necessary.

    @Maus the difference in our ages can be counted on the fingers of one hand 🙂 You do have a very serious problem in the US with the cost of healthcare. It is probably true that if you can afford it the best of US healthcare is a lot better than we have, however, that seems to cause a lot of stress for Americans. I am happy with the level of service provided by the NHS, inasmuch as I don’t plan to use it but it is there if I need it.

    You have a good start on me saving for 10years. I save quite a bit more than 45%, but I have been at it for a shorter time. Next April I will have been saving for three years. I am fortunate enough to have a good company pension with over 2/3 accrued.

    @SG yes, that’s the inconvenient truth; for most people an investment strategy won’t cut it. For early retirees who have sold a business or otherwise got a larger than normal cash sum early in life it might.
    Although the 1% includes building work in your case, in mine it includes some improvements too which sort of speaks for keeping the estimation at that value. It’s a pity there isn’t a way to scale that to the value rather than the price of the hose since London prices are skewed up, so you can probably get away with a lower factor at the moment. Perhaps that target should be 1% of your original purchase price, scaled by inflation 🙂

    @burntout, good luck with your savings! One thing which striked me in your plans are you are targeting networth. I found this stressful with a large equity component, which makes your net worth very volatile. When I switched to targeting income I found it easier to live with the volatility of equities, because the dividend income is a lot less volatile. And it is income that you need to make your way in the world. Income is what pays the rent and puts food on the plate. I’d rather have enough income and a net worth of 0 than a net worth of £1,000,000 and no income !


  7. “whereas at least my ISA is achieving its nominal 5% dividend  return”

    Hi Ermine,

    You made the above quote in your article and I’m wondering if you were referring to a Cash ISA or a Stocks & Shares ISA?

    The reason I ask is because I have just transferred my Cash ISA to Northern Rock which is paying 3.05%. That was the best rate I could find. If you are getting more can you tell me where?


  8. @yabusame

    My stocks and shares ISA. This is the dividend yield on purchase price, the overall portfolio value varies at the moment about +/- 4% on purchase price depending on what day you value it. I expect when the Euro blows for the portfolio value to fall and recover from that sort of event over the next couple of years.

    A Cash ISA performs a different job that a S&S ISA IMO – although I also have a Cash ISA most of my cash savings are with N&SI in index-linked savings certificates because of the RPI guarantee, tax-free status and relative security. We would be living in desperate times when N&SI are on the skids, though it may come to pass one day…

    I hold the Cash ISA because I took it out a couple of years ago at the start of my savings run when I thought I would get hoofed out of work in months, not years. It paid me 3.02% last year, which is a 2% loss because of inflation. I keep it because it is nice to have as cash but in the event of a Euro collapse or other stock market meltdown I may convert it to S&S to fly into the storm…

    Cash investments are unlikely to preserve wealth across decades, so they’re not usually considered suitable for retirement planning.


  9. Hi Ermine,

    Thanks for the informative reply. I assumed you were talking of the S&S ISA but I just wanted to be sure.

    I do hold my emergency fund in a Cash ISA, and I like your idea of putting it in NS&I Index-Linked Savings Certificates. I looked at these a little earlier in the year and I’ve just checked again but there are no issues on sale at the moment, so I’ll just have to keep hold of my Cash ISA for now.


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