Last time we saw Christy Shen and her husband, Bryce, living one version of a radical retirement: they retired in 2014 (Christy was 31 years old) after only a few years of work. Each year while working they saved more than half of their earnings. Can anyone do that, or were they just lucky to invest when returns were high?
Investment returns were high when Christy was investing for retirement. We don’t know Christy’s exact investments, nor her precise investing years. She says they now have a roughly 60/40 split between stocks and bonds, but it’s not clear they had that during their saving years. Most of their saving period occurred after the 2007-2008 recession when returns were high. From the end of 2008 through 2014, a six-year period, the compound annual return from an investment in Vanguard’s Total Stock Market Index Fund was 17.8%. Bonds didn’t rise as much, but the Vanguard Total Bond Market Index Fund averaged a compound annual return of 4.6% from the end of 2008 through 2014. These two funds are good examples of returns to U.S. stocks and bonds. So it’s clear Christy and Bryce were lucky.
A good question still lingers: in periods of more normal investment returns, how many years of work and saving are necessary to build a portfolio that will support a person through the rest of life?
To study that question, I built a spreadsheet model (see below for a brief description of a spreadsheet) of savings and investments during working years and recorded the number of years it takes to accumulate a portfolio that will support an indefinite retirement. The model includes a “4%-rule:” a portfolio is large enough when retirees can live in the first year of retirement on 4% of it. Christy and Bryce were living on about $40,000 per year from their salaries, and they saved the rest. Therefore, when they had saved $1 million, they had a enough—4% of a million is $40,000. At that point their portfolio could support them in the style they were used to, and they didn’t have to work.
The full results are in the table below. People who save 60% of their incomes (they live on only 40% of income), like Christy and Bryce, can expect to retire after 11 or 12 years of work. That’s longer than Christy because the portfolio is earning 6% to 8% instead of the outsized returns of the years before 2014. Nevertheless, that is a very short career by modern standards. Radical savings offers a radical retirement.
People who save half (50%) of their income can expect to retire in 15 years. People who save 40% of their income can expect to retire in 18 to 20 years. (Again, earning 6% to 8% on investments.)
The results in the table also show that a more conventional savings rate corresponds to a more conventional career: saving 10% to 20% of salary, at long-run growth rates of 6% to 8%, will require 28 to 46 years of work before a retirement portfolio will support a person indefinitely.
Finally, the table shows the working years associated with saving rates between 20% and 60%. People who push saving to 30% of income will accumulate enough between 20 and 26 years. If a person starts at age 25, she will be ready to retire by age 45 to 51.
Very high investment returns (above 10%) shave years off a required career, but it’s foolish to count on them—15 year periods during which investments averaged 0.16 (16%) per year are rare. And of course these career forecasts aren’t promises—if investment returns are lower than the 6% to 8% range, then people would have to work longer.
The assumptions underlying the analysis are these:
- Workers must save enough to replace their spending during working years. Retirement spending equals pre-retirement spending. (We are ignoring for Social Security or pensions, as well as periodic salary increases during a career.)
- Experience with retirees, and a large collection of research articles, show that once retired, people can occasionally increase their annual spending to offset rising prices in the economy, maintaining a relatively constant real standard of living. And if stocks or bonds fall sharply, people should delay any planned increases in withdrawals.
Employer pensions are disappearing, which means that individuals must save on their own for retirement. Most reports on this issue conclude that Americans are saving very little and that we are heading into a retirement crisis. At the other extreme, some Americans, and some Canadians (Christy and Bryce), are saving huge amounts of their incomes. They are learning to live on small amounts of spending while preparing for greater wealth in their later years. More of our working people could usefully follow that example.
We’ll continue exploring this subject for one or two more posts.
A spreadsheet is a computer application that presents itself as a table in which each cell is programmable. In one column I put income from work, then programmed the next column to save part of that income, then programmed another column to accumulate the savings as stock and bond investments year by year. The accumulated investments could then be compared with the amount needed to finance retirement. Once that amount was reached, I recorded the number of years. I ran the spreadsheet at different investment growth rates and saving ratios, and recorded the results in the table above.