Save Like a Tortoise

Q: Who wants to be financially independent? A: Who doesn't?

Becoming truly financially independent means you have accumulated enough wealth to maintain your lifestyle utilizing only the growth of your investments. Many studies suggest a moderate annual withdrawal rate for a retiree is 5% of the portfolio. So as a rule of thumb, if you live on $100,000 a year, your financially independent breakpoint is when you have amassed $2,000,000 or more in invested assets.

OK, so how do you obtain such wealth? Well, there are two ways this is accomplished. The first is something extraordinary happens for you. You are extremely talented and have a really high paying job; you win the lottery; your wealthy grandmother just passed away and left you everything, or you were the first person to have hot coffee burn you and the cup didn't have a warning telling you that coffee is hot. Cha-ching! The second way is for the remaining 99.5% of us. The answer is save like a tortoise.

Let's take a 30 year old making $100,000 a year and growing at 4% year over their career. They have nothing, meaning $0, saved for retirement so far. Today they start to save 10% of their income and split it up among their 401k and IRA. Their employer has a typical match of 3% of their pay. So, starting now they have the equivalent of 13% of their income being saved for retirement. This person has taken the time to educate themselves on Modern Portfolio Theory and Efficient Markets, so they construct a passively managed, globally diversified portfolio with 80% in stocks and 20% in bonds. This is an aggressive strategy, but this tortoise investor has confidence in the long-run and knows that 35 year's time is on their side. From 1973 thru 2007 this type of investment strategy produced an annualized return of 13.6%. Once you take out any advisor fees, custody & transaction costs, and a reduction in return for performance that is unlikely to repeat, it is reasonable to assume this tortoise investor will receive an annual return of 10.6% given the riskiness of their portfolio.

Given all of these assumptions, this 30 year old investor starting at $0 would retire at 65 with almost $6.6 million in the bank. To put this into perspective, we reduce this amount for inflation, 3.1% a year, and it would be the equivalent of just under $2.4 million in today's dollars. This person would have the option to retire financially independent at age 63 if they so desire, or they can wait until 65 and retire knowing that they'll have more than enough.

The key here is to start early. If this same investor started at 40 instead of 30, they wouldn't become financially independent until age 73 at a 13% savings rate. To retire at 65 with enough, they would have to save upwards of 20% of their income.

Each of the assumptions above are linear. Obviously, life does not work in a straight line, but this type of analysis can be a helpful guide and should be updated once a year to reflect the changes in your circumstances.

One wrinkle in your plan an investor might not expect is a large increase in income later in their career. Let's say an investor goes from making $100,000 a year to $150,000 a year at age 50. This investor should not get used to a $150,000 lifestyle....they haven't prepared for it the last 20 years. This investor will still experience a bump in lifestyle due to the pay increase, but it will be muted a bit by the lower income they have spent the last two decades preparing to replace.

Today is a wonderful time for the educated and disciplined. Each of us have more control on our retirement future than the generations before us. We've been provided 80 years of in-depth market history, computers to help make sense of all the data, portable tax-advantaged vehicles to invest and grow our wealth.

We have all the tools we need. But do we have the self-control and patience required to save like a tortoise?