Before I started thinking about early retirement, I thought about the logical progression of my savings program. I currently spend about 50% of my paycheque and I save and invest the other 50% (including mortgage payment). The reason for spending relatively little is that I was brought up to be restrained, and not that I lack the imagination. I’d like to spend more, but I don’t want to be in a situation where I’m living month-to-month, even if my monthly spending were double what it is now.
Early on, I spent most of what I earned. As my earnings increased, my spending remained relatively consistent. When considering spending more, I felt that I would rather save and invest, so that I would have more financial stability. Finally, I realised that I was progressing toward the ability to meet monthly spending needs with investment income, which is another way of saying financial independence.
Wouldn’t it be great if my spending were sustainable? Suppose I spend $3000 a month. As soon as my investments produce $3000 a month of spendable income, my spending is sustainable. I no longer need to work to maintain my spending. On top of that, as I continue working, I can increase my sustainable spending amount. It is difficult to conceptualise a concrete plan using this approach because it has so many variables. Salary often increases over time. Investments may pay dividends, which are fairly consistent, or they may grow in market value, which is volatile. Spending can also fluctuate from month to month. But the main idea remains to increase spending only as investment returns make it sustainable.
Here is an example of how this might work. For our example, we’ll use a single man, John, who never marries or has children (to keep it simple). John starts out earning $30,000 per year (after tax). He spends $20,000 and is able to save $10,000. We will assume that dividend-paying stocks pay a consistent 5% (re-invested) and we’ll ignore market growth. After 10 years, John has $125,778.92 in investments, producing $6,289 in dividends in a year. John’s spending has increased (with inflation) to $22,000 per year, but he’s gotten a couple of raises at work and now earns $40,000, saving $18,000. At the end of another 10 years, the investments are worth $431,282.68 and they produce $21,564.13 in dividends. John is basically financially independent after 20 years.
Now John can really start to increase his spending. Let’s suppose he gets a raise of 3% per year. The next year, he’ll earn $41,200; the investments will increase by $21,564.13 just from dividends; if he were to spend the same $22,000 and save the rest, his investments would increase by another $19,200. The total increase for the year ($21,564.13 + $19,200) is $40,764.13, which can produce $2038.20 in dividends. John should spend ($22,000 + $2038.20) about $24,000 this year. The following year, John earns $42,436 and his investments (at $470,046.81) earn $23,502.34. For this year, John can increase his spending by $2,075 (using the same approach as above), or $26,000. The last year in our example, John’s investments (at $509,985.15) produce $25,500 in dividends. He’s not living the high life yet, but his spending is increasing and it is sustainable. The market value is unimportant, since his income is from dividends, and losing his job or taking a year off wouldn’t affect how much he could spend, only his rate of increase. He’ll never have to go back to spending less. He can continue to increase his spending as long as he continues working.
If a person is disciplined with their spending, they should be able to reach financial independence relatively early. Once their spending is matched by their investment income, continuing to save allows them to increase their spending in a way that is sustainable. As such, the risks of not being able to work are totally mitigated and they will never have to return to spending less money.
Does this plan seem practical to you? Is this a viable alternative for people who could retire early, but who love their jobs?