Reduce Spending or Increase Income?

If you are interested in early retirement then you will have invariably thought about whether it is better to focus your energy on increasing your income from work or to reduce spending. For most people the answer is normally to reduce spending, and I will discuss why that is true for most people during today’s article.

For some people, notably single income families, those without work, students and people at the beginning of their careers, it is worth focusing on increasing income compared to reducing spending. The exciting thing about reducing spending is that it usually can be done without affecting your ability to earn an income. Reducing spending can rapidly decrease the time it takes to retire early by increasing the amount you can save and more importantly, by permanently reducing the amount needed to retire.

For example, if you can reduce spending to a seriously trim $10,000 per year, then you can retire on a measly $300,000! This uses the conventional wisdom that you need approximately 30 years worth of expenses to retire without ever exhausting your early retirement nest egg. This is normally easier to achieve than to increase your annual income such that you can accrue, say $3,600,000 to ensure an annual income of $120,000 in retirement.

Jacob Fisker in Early Retirement Extreme discusses in quite extraordinary detail the mechanisms involved in early retirement, and the amazing effect a high savings rate can have. For example, imagine that you earn $100,000 after tax and you manage to live on 10% of your income. Every year that you live this way, you are by necessity, saving 9 years worth of living expenses assuming that you continue to live on $10,000 in retirement. This means that in 3 years, you will have saved the equivalent of 27 years of living expenses – right in the middle of the recommended 25 to 33 years of living expenses necessary to retire.

With this level of savings accrued, it is hypothesized that the total demise of the nest egg is highly unlikely to be extinguished using a 3 to 4% withdrawal rate. To continue with the example, the nest egg of $270,000 will produce $10,800 every year assuming you can obtain a 4% return on your investment. Assuming that you can obtain a 7% return from the share market then theoretically your investment size will always keep pace with inflation and will always be able to keep yielding the $10,000 necessary to retire. This further assumes 3% inflation, and 4% to live on. See for a truly amazing calculator that will compute the likelihood of retirement success based on various nest eggs and returns using over decades of actual US share market returns.

Why would I give up my job and reduce spending to retire on a pittance?

Some of the most common criticisms of early retirement are:

  1. But I like my job and would be bored if I didn’t work
  2. What am I supposed to do all day if I don’t work?
  3. What if I want to return to work but can’t because of a gap in my résumé?
  4. How can I live on 10-25% of my salary?
  5. I don’t want to be a dirty hippy

The first thing to say about all of that is that there is nothing stopping you from quitting work as soon as you are financially independent and able to quit work. The longer you are willing and able to continue to work after you reach the magical point of financial independence the bigger your buffer against unexpected market performance and unexpected inflation. It also allows for a larger withdrawal rate if it is desired. Commonly people who decide to explore early retirement will find that as you reduce spending, the desire to consume decreases. That joy is obtained by doing it yourself, cooking for yourself and unplugging from the typical consumer hive-mind.

Time can be spent doing things that we are now taught to outsource, like raising children, fixing our broken possessions and growing food. These tasks take on a form of work from which you can derive great satisfaction, firstly by reducing spending thus speeding or prolonging retirement and by beating the system which is carefully managed to produce maximum consumption. Hopefully this blog will teach you that living from a small percentage of your wage will be not only relatively easy but also immensely satisfying.

Even using a modest saving rate like 25%, 30 years of living expenses can be saved in 10 years. This is the aspirational target that I suggest everyone focus on at the beginning of their quest – reduce spending to this amount and you will be free in ten years. Doing this is normally much easier than increasing your income by double or quadruple, but of course, any increase in income should not be avoided unless it detracts even to a small degree your ability to enjoy yourself.

This is fundamental to the point of early retirement – paid work is simply a mechanism by which we can obtain money which we then use to purchase things which we cannot obtain ourselves. If paid work becomes the end rather than the means, then we either love our job and would do it even if money was not an obstacle or we have fundamentally missed the point of life.

In my opinion, life should be about fostering good relationships, creating a sense of community and being happy. Work plays an important role in producing happiness, but it does not have to be paid employment, and it should not interfere unnecessarily with living life. Traditional paid work in normal western countries provides an amazing opportunity to accrue a ridiculous fortune compared with most other periods of life on earth or compared to developing nations – this mode should be exploited so that it can then be ignored, freeing us to do what we please.

Set a target and make all reasonable attempts to reduce spending to this level, from there you can set a target for how far away your retirement will be. Then set a date and work hard towards reaching the dream of retiring early, while others continue to dream rather than act – and get out of bed at 6am to go to work.

Reduce spending for an early retirement:

10% of income = free in 3 years

15% of income = free in 5 years

20% of income = free in 7.5 years

25% of income = free in 10 years

Keep tuning in for tips on how to reduce spending without sacrificing on your quality of living to allow you to be free from work while you are still fit and young and able to live life, not one in an old-person’s home!

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Reduce Spending or Increase Income? — 1 Comment

  1. Pingback: How to Retire in Ten Years, Regardless of Your Age | Eyes on the Dollar

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