How a penny saved is worth more than a penny earned
A penny saved is a penny earned? Sorry, Ben Franklin, I have to disagree with you. A dollar cut from your expenses actually has a larger impact on your retirement goals than an extra dollar earned.
This seems mathematically impossible. A dollar is a dollar. But in this article, I will prove how this is magically correct.
To begin, you may have heard about the FIRE movement. It stands for Financially Independent Retire Early.
The FIRE method is based on the 4% rule. The 4% rule is a rule of thumb used to estimate a savings amount needed to continue your lifestyle in retirement. Many financial experts consider 4% to be the sustainable annual withdrawal rate.
Let’s jump into the math. How do you calculate your retirement savings goal?
But, please keep in mind that expenses, such as health care, will likely rise as you age. This is an important factor to consider as you determine if the 4% rule is enough for you to comfortably retire.
Now, let’s use an example to illustrate the importance of cutting expenses.
Meet friends, Ben and Jerry.
Ben earns an income of $65k and currently spends every cent. But great news! Ben is offered a promotion and receives a $25k raise. He saves all $25k towards his retirement goals.
Now let’s look at Jerry. Jerry earns $65k. Sadly, Jerry was passed over for a promotion. Before you feel sorry for him, Jerry finds ways to reduce his spending to achieve his retirement goals. He also saves $25k a year.
How much do they need to retire?
Wow! That’s a 7-year difference! Despite saving the same amount, Jerry is 7 years closer to financial independence.
As you can see from the example, a dollar saved has a double effect. Not only is the dollar being saved for retirement, but because you no longer need that dollar to sustain your lifestyle, you have a smaller savings goal.
To put it another way, for every $10k you cut from your expenses, you need $250k less to be financially independent.
The way to build your savings is by spending less each month. — Suzy Orman
Conclusion
Although earning more is important, spending less is more powerful.
Look to your big-ticket items first. Do you really need your expensive car? Can you live in a smaller home? Find sustainable ways to save and reach financial independence sooner by spending less.
