A recent Business Insider article did a kick-ass job of explaining the power of compounding interest for young people. It made some great points about how saving and investing even small amounts when you’re young is so much better than trying to catch up when you’re older, but it’s adherence to the limits of conventional financial wisdom infuriated me!
The article is all about how you shouldn’t wait to start investing in retirement accounts. It’s does a surprisingly good job of demonstrating the huge effect compounding interest has for people who start investing in their 20’s instead of their 30’s. Once you hit 65, that amount you invested in your 20’s has had time to double three or four times. It’s a curious thing, the human brain has trouble extrapolating the results of compounding interest and exponential growth.
So here’s the example in the article. Person A starts saving $200/month when she’s 25, and person B starts saving $200/month when she’s 35. Person A ends up with $400,000 when she hits 65 while person B has just $200,000. It’s a powerful example, but I think it’s missing the point because both person A and person B are thinking too small.
My beef with conventional personal finance
That’s where my praise of this article ends. My beef is not with this author, instead I’ve got a beef with most money/personal finance writers and how they frame their questions.
Why do we expect so little of our citizens? Why is it always a stretch to assume that our citizens can manage to save and invest $200/month ($2,400/year)? Posts like this one anchor our opinions of what a reasonable savings level should be. This leads to Americans failing to even consider what might happen if they invested just a little more.
What if we weren’t so entrenched in their small-minded personal finance philosophies? What if we decided how much to save based on how we want to live when we retire? And what if we chose when we want to retire, instead of just accepting age 65 (or later)?
A new way to consider retirement
In the Business Insider article person A (who saves $200/month starting at 25) ends up with $400,000 at age 65. If we apply the 4% withdrawal rule, that means she’ll be living on $16,000/year (without considering pensions or social security).
Person B would be doing even worse (saving $200/month starting at 35). She’d earn only $8,000/year. She’d better have other sources of retirement income or else she’ll run out of money quite quickly.
Instead of considering such sad examples, why don’t we consider a more reasonable spender who’s decided to approach life a little differently. Person C makes about $50,000 at age 25, but since she’s frugal and money-savvy, she only spends about $35,000/year (much more than I spend). Even if she never makes more money as she grows older (a silly assumption) she should be able to save at least $600 every month. She’s easily able to save triple her friends A and B because she’s somewhat conscious about how much she spends. At age 65 she’ll have $1.2M to retire on*. This will provide an annual income of $47,000/year which sounds quite a bit nicer than $16,000 or $8,000.
Person D is a little more aggressive when it comes to saving money. She makes $50,000/year like person C, but she only spends $25,000/year (more than I’ve spent in either of the last two years). She’s able to $1,500/month because of her frugal focus on life. Instead of worrying about how much money she’s got at age 65 ($3M), person D gets to decide for herself when she wants to retire. She just has to determine how much money she wants to bring in passively each year. Since she only really needs $30,000/year in income, she gets to quit working at 45 instead of 65*.
Why doesn’t everyone customize their retirement?
Why doesn’t the mainstream media include examples like person C and person D in their articles? Why not expand the possibilities of the readers?
I guess the answer is simply that mainstream financial articles have to cater to the lowest common denominator in order to maximize their ad revenue. But imagine for a moment what might happen if these authors took a risk that might piss of their editors. What if they showed examples like people C or D? It might just help a few more average people (read: American over-consumer) to question their beliefs about what level of spending and saving is normal.
If there’s one thing I want you to take away from my blog it’s this. Just because your friends, family, and coworkers tell you that a certain expensive hobby, luxury brand of car, or classy bar is “normal”, you don’t have to listen to them.
Normal means so many things to so many different people. You’ve got to realize that there’s no such thing as normal. You can design your life to be exactly how you want it. Stop thinking small when it comes to saving and investing. Start thinking bigger and decide when and how you want to retire on your own terms.
*Obviously these are quite conservative assumptions in order to make a point. These numbers don’t even account for raises our heroes will almost certainly earn throughout their lives.