Most people think million dollars is enough savings for you to retire. Personally, when I reach my first million, I will pack my bags and leave for a new adventure. Others say a million is not enough. To them, you need more, 2 million, 5 million or 10 million to be able to say bye bye to your job. They may also say that it also depends on how old you are. But I think we can all agree that 1 million dollar is a large amount of money, and if you are not stupid, it can do a lot of things and may even buy you financial freedom. In fact, I will have long said adios to the rat race by the time I reach a million dollar mark.
How much is a million dollar? It is widely accepted that if you have a savings of 25 times your expenditure, you can retire from working at that point. It assumes that you invest that amount with a modest 8% return. 8% is the historical average on index fund investing. Basically, it assumes that you can expect 8% return in the long run on your investment. From this 8%, you can withdraw 4% for your expenses and keep 4% invested in the market. This way your investment will keep growing, and will also beat inflation which is assumed to be less than 4% in the long run based on historical average as well. Of course, no one can correctly predict the future and past indicators do not mean the future will be the same but you need certain metrics to plan for retirement. 4% withdrawal rate is considered as a conservative plan and is widely accepted in the investment community.
So let us look at the real numbers. What happens when you accumulate a million dollar in your investment account? At 8% rate of return, you will profit 80K a year. At the withdrawal rate of 4%, you can withdraw 40K from it. The other 40K stays in your investment account and adds to your principal. So next year, you will gain interest on 1 million 40 thousand ($1,040,000) which will be $83,200 out of which you will be able to withdraw $41,600 for your expenses. In 10 years, you will have $1,480,244 in the investment account and you can withdraw $59,209 for that year. In 20 years, you will have more than two million ($2,191,123) in your investment account and you can withdraw $87,644 for that year’s expenses. If you retire in the 30s and live for 50 more years, in your 90s, you will have more than seven million in your investment account and will allow you to withdraw $284,267 that year. So basically, you will never run out of money, both your wealth and investment income keeps growing each year.
So if you have a million dollar in your savings and you can live on 40K per year on expenses, you can retire. If your expenses will be higher than that, you will need more savings to retire. You can also do it on a lower amount if you have expenses lower than 40K. 40K may not be a lot of money for a lot of people in the US, especially you spend like a typical middle-class family. But that will put me among the highest wage earners in Nepal, above 95% of the population if not more. Do you see why I want to retire in my 30s and go back to Nepal? Actually, 40K can buy you a good living even in the US. But you need to come out of typical middle-class spending. You can read Mr. Money Mustache’s blogs on how to do it. My two people household had less than 25K of expenses last year and we went on vacations a lot more than an average American family. If you are still not convinced, sorry, I will try harder next time. But this is also not for everyone.
You may have noticed that I left taxes out of the discussion. There is a way you can legally avoid all or most of the taxes in retirement at these withdrawal rates. I will talk about these in a different post but you can research 401k, IRA, HSA, Roth IRA, Roth Conversion if you cannot wait.
But you probably do not have a million dollar in your bank account or investment account now. You are not alone and I do not have it either. But if you have a job like I do, you can get there soon. If you have a tech job like a lot of immigrants and if you are married, with two wage earners in the family, you most likely make more than 100K a year in wages. If you both have tech jobs you may be around or more than 200K. But let’s say you just make a modest 100K a year. If you are not in tech and/or have a lower income, please forgive me, but you can still do it. It may take you a little longer or may require more hard work or a combination of both, but it is still possible. It is easier to talk about someone in my own situation, that is why I am choosing 100K as an example.
If you can invest 57K now and add 57K each year to it, it will take you 10 years to reach a million with 8% annual rate of return. So if you start at the age of 25, you can retire by the time you reach 35 years old. If you are as aggressive saver as I am, this is possible. But if you think that is too much and you can only save 40K a year, it will still only take you 12.7 years to reach there. If you start at the age of 25, you will still be in your 30s when you reach there. What if you can only save a modest 25K a year, you can still reach a million dollar mark in 17 years or when you are 42 years old. That is still very young. In fact, 20 years younger than a normal retirement age of 62.
What if you had no idea about any of this when you were 25 years old or you are already older, you can still do it. You just need to add 10, 12 or 17 years from today. You just need to start saving and investing now if you have not already.
How do you maximize your savings?
1. Earn more and spend less: This is the simplest way. The difference between your income and expenses is the savings. So increasing your income and cutting down on expenditure is the first and foremost step. You can ask for a raise, switch jobs for higher income, take a part-time job or do a side hustle.
2. Reduce your taxes: Taxes are the highest expenses for most people. Most people do not think about taxes when thinking about savings but you can save a significant amount if you can utilize some tax savings strategies. Maxing on 401K, IRA, and HSA are the simplest way to save on taxes. In 2018, you can contribute up to $18,500 individually on 401K, $5,500 on traditional IRA and $3,450 of HSA. That is $27,450 per individual and if you have a two-person household like mine it will be $54,900 total. If you have an employee match on 401K, that can add another few thousand on top of that. Say your employee match amounts to 3K (3% match rate), your total tax-deductible savings for the year will be 57.9K, just above the 10-year savings plan I had discussed earlier. This also means significant tax saving (more than 10K in my situation).
3. Housing: Housing is another big expense. It depends on how big your house is. Most people think that your house is an asset. But actually, it is a big liability for most people. It is also the biggest trap that keeps you in the rat race forever. You should read “Rich Dad Poor Dad” book by Robert Kiyosaki if you want to know why your house is a liability and not an asset. So a smart way to save is by keeping a low mortgage or a low rent. We live in an apartment and pay rent around $700 monthly including utilities. If you live in an expensive city, this is probably not possible, but I am assuming you are making more in wages to compensate that. If you are not, then you should consider moving to the Midwest and lower your housing cost.
4. Food: You can save a significant amount if you do meal prepping and cook your own food. It will save your health as well as your wallet. Occasional eating out is fun but it is not for every day. You should invest in kitchen appliances like a slow cooker (crockpot) or a modern pressure cooker (instant pot) if you are lazy and bad at cooking like me.
5. Car: You should get rid of your expensive cars loans. I drive my Honda I had bought 5 years ago with cash. We also have a second car which we bought from craigslist for cheap, and helps when we need two cars. I am actually thinking of getting rid of the second car since I started walking to work which is less than a mile from my apartment.
6. Clothes/Furniture/Essentials: I stopped accumulating a lot of crap. Consumer society of today’s world makes us feel like more stuff you accumulate, happier you are. I found that it is actually the opposite. I do not spend a lot in clothes, furniture, and other crap. I only buy what I need and when I need them. You probably already have too many clothes in your closet like I do, so there is no need accumulate more like crazy.
7. Travel: This is our weakness (not really). We like to travel a lot, who do not, right? So we spend some dollars on plane tickets, car rentals, restaurant foods and other travel expenses. But we are also frugal travelers and we mostly do outdoor things like sight-seeing, hiking, spending time on the beach etc, which does not cost much. We also buy our tickets in advance, use points and deals when possible, and go to cheaper destinations. If you like to travel, there are many ways to save on your travel expenses.
8. Alcohol: I quit cigarette and coffee four years ago and have cut-down on drinking significantly but I enjoy a beer or wine and enjoy drinking with good friends occasionally. It has saved both my wallet and my health. You can always cut down on your booze, especially if you like to go to bars and order drinks at restaurants. It costs a lot less if you drink at home instead.
9. Miscellaneous: There are always miscellaneous expenses. Some are big and some are small. It is always best to evaluate if they are something you truly need or are they just your wants. Living a frugal life helps to cut down expenses and maximize your savings. Keeping a budget and tracking your expenses helps you save. Saving is also a mindset, the more you think about it, the more you do it. You can read about personal finance, FIRE etc. Reading will help you learn more from other people.
Good luck in your pursuit of Financial Independence/ Early Retirement (FIRE). If you have not already, you can still contribute to your 2017 IRA until April 2018. Sooner the better, as it will start working for you sooner. Million dollars may or may not be enough for you to retire, but you can use the same strategies to accumulate more.
If you know a little about retirement accounts like IRA and 401K, you probably know that you have to pay a penalty to withdraw your money early, or before reaching a “normal” retirement age. But there are ways to avoid the penalties and avoid/minimize paying taxes on that amount. In fact, using these retirement savings options, you can put your money tax-free, let it grow tax-free, and withdraw tax-free. I will write about that in a different post but you can research about Roth conversion if you want to know more about it yourself. HSA can only be used for eligible health-related expenses. But I am assuming you will get sick someday and will need to pay for medical expenses. You can also pay for your expenses that occurred outside of United States.
You may be worried about unknown health costs in the future like most people. I do not blame you and no one knows how much you may need to spend on your health in the future. But that is still the same if you were working. Best way to protect against that is through health insurance, although that still leaves you with a lot of unknowns. But you can pay your health insurance premiums with your HSA.
Good luck on your pursuit towards a million dollar savings and/or financial independence.