Early Retirement Lesson #2: Earn More vs. Spend Less

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Here’s more of my “old man wisdom” about early retirement. I call it that because the lessons that I learned may or may not fully apply to you, but they worked for me and that is why I’m sharing them. Last time I talked about savings rates and how you need to save between 30-50% of your income in order to retire early. That’s a lot, and it leads to another long-running debate: Should you spend your energy trying to earn more money, or spend less money?

The “Earn More” or Capitalist argument is that you can’t save your way to being financially free. You need more money. You need a positive attitude, the willingness to work hard, and a desire to be rich. Capitalists tend to talk about things like entrepreneurialism, multiple streams of income, passive income, leverage, real estate opportunities, and occasionally some sort of multi-level marketing program like Amway or Herbalife.

The “Spend Less” or Frugalist argument is that unnecessary spending is the core problem. You don’t need all that stuff. You just need more spending discipline. Most American households have an amazing, luxurious lifestyle with huge houses, more than one car per person, and enough calories to feed a football team. People who earn more, just spend more. It is amazingly common to earn $250,000 a year and still live paycheck-to-paycheck. Look at athletes like Antoine Walker and Vince Young who have each earned over $100 million and $30 million respectively but still filed for bankruptcy shortly after they lost their jobs.

The easy answer – which I have used myself – is to do both. What a cop-out answer! 🙂 Let’s try harder.

Studies have found that happiness is doesn’t go up after $60-$75k of annual income. Why is that? Perhaps it is because $60k will get you all the you need to be physically and socially comfortable. A house that isn’t embarrassing, reliable transportation, the ability to enjoy a dinner at Applebee’s with friends, the ability to travel occasionally. The median household income in the U.S. is roughly $51,000 a year. $60,000 is roughly 20% higher than that, making you “above average”. If you were to upgrade to a gated community, a Bentley, eating at 3-star Michelin restaurants, flying only on full-fare business class tickets, that won’t get you any better-quality friends. If you already make $200k and aren’t happy, then making $400k or $800k won’t make much difference.

Back to that 50% savings rate. If you’re happy with spending $60k (on average people spend 97% of their income), then you’d need to earn roughly $120k in order to save half. That seems like a good upper bound. If I already earned $120k or more, I’d probably focus on adjusting my spending to the 60k level instead of trying to make more.

On the flip side, as your income drops far below the median you start feeling the pinch more and more. A family of three that earns under $25,000 a year can be eligible for food stamps and other government subsidies. Earning $50k and saving 50% of that means living on $25k a year without being eligible for most government subsidies. Now, some people do live on less than 25k, but is rarely by choice (extreme counterexample). If I earned $50k and really wanted financial freedom, I would focus my energy on earning more money.

Now these numbers should probably be adjusted for the cost-of-living in your area. Look up the median income in your city or county; start here and here).

If your household income is less than 150% of the median income in your area, I would focus on earning more money. Start your own business. Invest in yourself through career advancement or a job change. For example if it is $60k, I would try to get to a household income of at least $90k. (That could be two people earning $45k each.) You could do a little frugalizing and spend $45k to get to a 50% savings rate.

If your household income is more than 200% of the median income in your area, I would focus on managing your expenses. If median income is $75k and your household income is $150k, then try and see if you can get to the spending level of a $75k household. Examine all of your expenses one-by-one. You will need to prioritize and probably cut back on areas that are less important to you. Early retirement is a big goal; you might need to make some big changes like moving to cheaper housing or dropping a car payment.

If you are in between 150% and 200% of the median income in your area, that is more of a gray area, and you may just need to do a little of both.

You can argue about the exact percentage cutoffs, but the basic idea is that I want a rule of thumb that accounts for the tendency of most people to maintain their social relationships (which are closely linked to happiness). At very low spending levels, it gets harder to maintain your social relationships and the self-discipline and energy needed can be better spent making more money. At a certain point, spending more money does not improve your relationships.

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  1. I love the way you are looking what which side of the equation to focus on based on median income in the area. I think that is a very logical approach, and where the “most bang for your buck’ will be found when trying to increase the delta between earnings and expenses.

  2. Excellent approach! We seem to love making all issues black and white when in reality gray is much better. Making more AND spending less are equally important. A hybrid approach that I personally follow is to simply concentrate on your savings rate. Shoot for at least 50% savings no matter how much you make, invest the savings and financial independence is within reach!

    • I agree, there is no single answer for everyone.

    • There is definitely a tipping point. If you live a $50k/year lifestyle but you make $100k/year, then saving 50% of your income is simple. If you instead only make $55k/year, then you’ll probably starve before reaching a 50% savings rate. Depending on the cost of living in your area vs your income, you may only need to cut back unnecessary spending to achieve a satisfactory savings rate, in other cases you may need to boost your income.

  3. Controlling expenses is much easier than creating more wealth by expand income capabilities, especially considering that to earn more, you will have to take on more risks: to start a business that you could fail, to get a better degree where you need to borrow more debt first. The probability of negative risk is proportionate to the gain you are hoping to get, which means you can fail and further delay your financial freedom goals.

    So I think everyone should focus on the savings first. It is easier to attend and negative risk is minimum. Once you are in a good practice, savings is becoming a habit, then focus on achieving your dream of being the next Steve Jobs…

    • If you can’t moderate your expenses, you’ll never gain financial independence, that is for sure. I agree tou definitely need that muscle. I would encourage though the idea of making the commitment to go back to school or training to switch jobs, like going from a cashier at Walgreens to a pharmacy tech, or a pharmacy tech to a pharmacist.

    • I feel you. To date, every attempt that I’ve made to create an additional source of income has failed, barring working a 2nd job. That hasn’t been an option for a while since my full time job has me on standby 24/7, so I literally need to be able to stop what I am doing immediately and address the issue that caused work to call me. Needless to say, no employer will like you walking off the job during your scheduled hours.

      I’ve tried working to myself, and that financially ruined me. Being good at providing a service and being good at running a business ( staying competitive in price and service level ) are 2 different things. I learned that lesson the hard way!

  4. Thanks for a refreshingly simple and pragmatic view on this age-old and thorny issue. I would like to add that you can use savings to increase immediate income rather than retirement income only. This is kind of a “double-hybrid” approach to the issue. I agree btw that income chase beyond your goals is not a worthwhile goal. Hopefully this year I can reach my final income goal and then we can sail the family ship smoothly along. A combo of active and passive income sure is also a better diversification, although realistically can only be achieved with higher income or inherited / gifted money.

  5. I love your thoughts on this and the way you are able to articulate it – I think it accurately reflects on my own thoughts on the subject.

  6. Jonathan,

    You leave out two key considerations in this assessment – pre-tax vs. post tax and inflation when you mention about saving 50% . 50% saved today will erode by 3% each year, so it womt be the same when you retire unless there is a real return that you receive by investing those savings. Also when you make 50k you cannot save 25k after tax money. Same applies if you make 120 – you cant save 60k when your post tax income is 84k

    • 50% saving rate is just a rough guideline, but ideally based on after-tax numbers (after-tax income, after-tax spending). I know that some of the numbers are conflated in this second post but calculating after-tax numbers for everything would have been a mess.

      • Jonathan, can you clarify your 50% savings rate, are you saying that saving 50% of your take home or 50% of MAGI, or pre-tax etc. My wife and I bring home about 134k yearly and save roughly 80k yearly in pre-tax accounts

        • For the most part, it’s easier to keep everything post-tax when doing calculations, both the savings and income. But I would worry more about the big picture and it seems like y’all have a very healthy savings rate either way. 🙂

    • Saagar, I agree. Uncle Sam mucks up a lot of what is written here. Also need to consider that there is a difference between simply saving money and actually saving money for retirement. I try to save as much as I can each month, but it’s going into a lot of different buckets – retirement, college accounts for kids, home improvements, car replacement, vacation/travel funds, etc.

  7. @Jonathan, I agree, but I would still like to see a post which gives an overview with a rough estimation of taxes and inflation accounted. When someone talks about earning 120k, more often than not, it is annual income which is pre-tax

  8. @Scott, That is another key consideration, savings for short term goals need to be accounted for, too. When you save 60k but buy 30k car every 3 years with cash, you won’t have much left for retirement. When you start including all these, it starts becoming s mathematical model. No wonder, personal finance is so complicated 🙂

  9. Awesome post! Love the psychological approach to this!

  10. Great post, very informative. We currently save 15% toward retirement, 10% in emergency savings, 5% general, 32% toward debt and the remaining toward bills. Our minimum debt payments are actually 15% of our income, but we are aggressively paying it off and our current plan is to pay it off in 2 1/2 years. At that point, we will start saving about 30% of our income. We are currently 26 and 28 and would love to retire by 50, so our hope is to continue to increase our savings rate over time.

  11. I definitely agree with your suggestion that if you are earning 200% of the median to focus on expense reduction (rather than income increase). But I’d suggest there is a more powerful justification for doing so: once you are earning $120k or $150k or something like that, earning additional income takes an even bigger toll on your life and time. In short, you maximize your overall advancement toward early retirement and your happiness along the way if you earn big (but not too big!) and spend little (but not too little!).

  12. Don’t forget if salary is 120k versus 60k, the 120k person pays multiple times more income tax and 2x more SS/FICA tax (which is over 7%). Basically living off the husband’s (preferably) or wife’s salary and saving the other person’s is a good way to go roughly, so when the wife stays home a few years with the kids, you aren’t forced to go back to work due to lack of funds. Plan ahead – buy your first house with that in mind so you can’t later claim your wife “has to work”.
    In NYS, it is very hard to live on one salary – taxes on a 3 bedroom 2000 sq ft house ($200k) is 6-7k…yet is below average in my town (compared to weekly sales which probably has new large houses in the average). We somewhat managed to do so with a 15 year 6.4% $120k mortgage (wife stayed home some years, worked some years part time, some years full time when kids were young). Mortgage and taxes were about $1500 per month and I only was making $50k.

  13. Thank you for putting your time and effort into this post. I learned a lot and it is just nice to read about unique ways to make more money and save more money.

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