This question comes up more often than it should despite it being pretty simple math, so I figured I might as well do a quick post on it.
When it comes to out-of-whack budgets, there are always two ways to get them solvent: the subject can either cut their spending or they can make more money.
And yes, that is an inclusive or because you can and should try to do both.
BUT! Suppose for a second that you were forced to pick just one of the two with the explicit intent of retiring sooner. Which should you go with?
Suppose you’re 25 years old and will live through the age of 80, at the end of which you will promptly die (so it goes).
In regard to income and expenses, you currently make $40,000 per year and spend $35,000 per year. This means you’re putting away $5,000 or 12.5% of your income, for retirement. Not bad!
Suppose you have two options to increase your savings by $5,000 per year, that first year:
- Make $5,000 more, for an income of $45,000 per year (with the $35,000 in spending held constant)
- Spend $5,000 less, for spending of $30,000 per year (with the $40,000 in income held constant)
And just to finish setting this up, let’s suppose macroeconomic conditions are such that inflation, affecting both your spending and income, is constant at 2% and your retirement savings grow at a constant nominal rate of 6% (net of all taxes).
A little math
In order to figure this out, I put the above numbers into a spreadsheet, and calculated how long you’d have to work so as to not outlive your money.
In the baseline scenario, you have to work until age 64 (To be more precise, you have to work 7% of the year after you turn 64).
Then, switching up the numbers, in the Make More scenario, you have to work nine years less, until age 55. That’s quite a drop!
But! If you instead spent $5,000 less per year in the Spend Less scenario, you can work 11 years less, until age 53 — an even bigger drop!
(For those curious, if you did this by ratio — e.g. a 10% pay increase vs. a 10% spending cut — spending less still wins, but by a smaller margin)
Wait, so why is this even happening?
Think about it this way: Sure making more money is great (it really is!), but it only helps you during the working part of your life, and presumably, you don’t want to work until you’re dead. On the other hand, spending less helps you save more of your paycheck while you’re working AND helps your money last longer once you’ve retired; it’s basically the double rainbow of budget tips!
Now, of course, there are a ton of other factors at play, but it looks like this “quick post” ended up pretty normal-sized so I won’t go into those.
Who else has interesting math stories to share?