Your Savings Rate Does Not Determine When You Can Retire

I’ve read a number of articles around from good sources stating that the number one figure that determines how quickly you can retire is your savings rate. You can even play around with an online early retirement calculator built around the concept. It’s a simple but powerful concept. I like to think of using the savings rate tables as a good motivator to increase my savings and decrease my expenses. It gives you a great idea as to the rough timeline for retirement and is a nice barometer. Reading about it for the first time reminded me of the first time I read about compound interest – it motivated me to save more.

Here’s the problem: Technically, it’s wrong. Or at least I find it lacking for my own projections.

We’ve already discussed calculating your savings rate at length. Suffice it to say, many people are using differing methods to come up with their savings rate, possibly choosing the most attractive (and highest) one to use. That’s one reason why it’s shaky to use savings rate as the major determination for when you can retire. But the real problem is that your expenses matter most.

My expenses today are not the same as they were five years ago, and they won’t be the same in another five years. Five years ago, I owned a duplex and had a single mortgage with more than half of it being paid by my renter downstairs. Today I have three mortgages and three renters. Five years ago I was single. Now I’m married and have a baby boy – A very hungry baby boy who drinks a lot of formula (we weren’t able to do breastfeeding).

The reality is that your expenses will change over time as your life changes, and that while this number may be hard to predict it is more useful to analyze the expenses and savings separately to get a better picture of your projected retirement than to try and project out using savings rate. Taking today’s savings rate without factoring in your existing savings or accounting for long term debt commitments that will eventually end is a shortsighted practice.

You should really take a step back and look at the breakdown of your expense to see what realistically would differ over time, particularly in retirement. For me, that means I’d take the mortgage principal and interest payments out of the equation. Once the mortgages are paid off, those are two expenses I won’t have. You certainly can try to account for mortgage principal by including it as savings when calculating your savings rate, but interest on loans and debts is a thornier issue. It’s not really savings, but it’s ideally an expense that will eventually just disappear – and the timing of that is determined by your mortgage term (30 year? 15 year?) and whether you expect to pay it off early. Because I chose to become a landlord, my obligations for mortgage debt trump a good portion of my retirement planning. The payments  inflate my expenses which gives a skewed number necessary for financial independence. I need to react by projecting out the mortgage end date, the breakdown of the payments (escrow, principal and interest) and also account for pre-payment of the loan. There are two major limiting factors on when I could retire: When I reach the nest egg necessary to cover my expenses, and when I get the mortgages paid off.

Another major determinant in future expenses is family. You can project out roughly how many years you have left to retire and try and extrapolate how many children and how old they’d be. Then you can try to estimate how much they’ll contribute to expenses over time based on rough age. But this is pretty slippery stuff here. You can’t be sure how many children you may actually end up wanting, or exactly how old they’ll be. Will second and third children be cheaper since they’ll use more hand-me-downs? What if they’re not the same sex? Plus, how can you really estimate expenses given age if you’ve never had children of that age yet? We certainly can’t use the ridiculous calculators and estimates that get published every year – we’re frugal and don’t expect to spend anywhere near that amount (which they like to inflate by assuming you’ll buy a much bigger house and bigger or more cars, and add that to every year’s total).

I say when in doubt, use your current expenses for future projections – which is what using your savings rate is doing. But if you know very well that you’ll have paid off your mortgages, or some other loans – estimate using a adjusted expense total. And then calculate backwards from there by using the 4% withdrawal rate to determine the necessary nest egg to cover expenses. At that point you can use a compound interest calculator to see how long it may take to reach that number. If you’re like me, you’ll also likely need to use a mortgage amortization and pre-payment calculator and match those timelines up. It may very well be the case that you reach your nest egg number assuming the mortgage is paid off, but the mortgage wouldn’t yet be paid off on that date!


5 thoughts on “Your Savings Rate Does Not Determine When You Can Retire

  1. Hi Christopher, I totally agree! Understanding your savings rate is just the beginning. The reason I love using your % savings rate to talk about the road to financial freedom is because it makes it easy to understand what it takes to get there. Easy to understand what levers need to be pulled and how hard. It’s also motivating to see how even small changes in your savings rate can have a huge impact! But this concept is definitely only the beginning! Thanks for including me in your post!

    • Happy to see you here, I enjoy your blog!

      Yes, the savings rate tables make for a shocking and mind-blowing revelation that making small strides in turning around your expense to savings ratio can make a huge difference in your net worth and financial freedom. I think it’s a great introduction to the concept and a major motivator. I just worry that so many focus so narrowly on what their savings rate is today that they can’t see the forest for the trees. A great number of us have homes to pay off and a whole lot of unexpected occurrences along the road, as well as a pretty wide variance in rates of return over time.

      I’m just lobbying that we urge people to take a deeper dive and consider the timing of their debts as well. I can already see that you’re pretty focused on that yourself:

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  4. Great reminder! I’m continually trying to both reduce my expenses and increase my savings, but it’s hard to predict how things are going to change over the next ten years. Your points are all good things to keep in mind.

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