How long do you need to work to retire? Fifty years? Forty? On the contrary, you may actually be able to retire in only five years.
This is the message of Jacob Lund Fisker, who wrote the book, Early Retirement Extreme (ERE). His self-styled movement began back in 2007, and some of its followers are already beginning to retire. It is an interesting concept – but not everyone buys into it. Before you start preparing for your early retirement, it’s important to understand the concept, the pros, and the cons.
Early Retirement Extreme: The Concept
Although Jacob has recently said he regrets using the term “early retirement extreme,” his ideas are truly extreme from the perspective of most people. The idea is that anyone earning virtually any level of income in the developed world can retire in just a few years if they follow three simple concepts:
1. Cut Down on Spending
While many people can be called “frugal,” Jacob is on a different level, living on only $7,000 per year. How? He never eats out at restaurants, lives in a very inexpensive home, and splits the expenses evenly with his wife. Additionally, he grows some of his own food using a home garden, makes some of his own furniture, and is addicted to getting free stuff from sources like Freecycle.
Jacob recommends other ways of cutting down costs, like borrowing books, music, and movies from the library, and learning how to take advantage of “loss leaders” at grocery stores. Of course, there are other ways to cut your spending and still have fun.
None these concepts are very new or Earth-shattering – many college students apply a number of these methods to save money. However, while society expects people to live like this until they graduate and get a job, Jacob suggests extending the student lifestyle a little longer.
2. Save as Much as Possible
How much of your income do you save for retirement? According to Jacob, it’s not enough. In fact, he points out that the more of your income you save for retirement, the faster you can retire. By living cheaply and making as much money as possible, someone can easily retire much faster than they could otherwise, both because they will have more money and because they require less money to sustain their current lifestyle.
Someone who saves 10% of their income needs to work nine years to save enough for one year of expenses. Someone who saves 90% of their income needs to work one year to save enough for nine years of expenses. Clearly, the more one saves, the more time one has. This works both by cutting down spending and by increasing savings.
3. Transform Savings Into Passive Income
To stretch savings, you need to invest and earn some kind of yield on your money. There are many ways to do this: the stock market, bonds, lending money to people, or buying real estate. It doesn’t really matter how you invest your money, as long as you take the time to learn how to invest, invest smart, and average a positive annual return.
The math behind the concept is very easy. Mainstream experts say that workers should save 15% of their income for retirement. If you earn $50,000 per year straight out of college at 23 and retire at 65, you’ll end up with a little more than a million dollars in your retirement account, assuming you get a 5% annual rate of return.
Jacob pushes the math to its logical conclusion. If it takes saving 15% for the 42 years between graduation and retirement to pay for your post-retirement expenses, you can shorten the amount of time it takes to build that retirement nest egg by cutting expenses and raising your savings rate.
If you earn $50,000 out of college and save 85% of your income instead of the standard 15%, you may end up with a big enough nest egg to retire before 30.
Again, assuming a 5% annual rate of return, the nest egg will be worth about $289,000 in six years. While this isn’t quite a million dollars, it is enough to sustain the your lifestyle as a retiree. Because you’ve lowered expenses to 20% of income ($50,000 multiplied by 0.2 equals $10,000 per year), you need substantially less money to afford retirement, and this nest egg should last for the rest of your life.
This is true for two reasons. Firstly, your expenses are so low that you need to withdraw only 3.5% of your $289,000 nest egg every year – this money will last as long as you earn a real rate of return over 3.5% plus the rate of inflation. While that may be difficult if money is invested in treasury bonds at today’s historically low rates, that rate of return isn’t impossible for people who know how to invest in real estate, stocks, municipal bonds, corporate bonds, and other more risky investments.
It is easy to see how a mixture of aggressive cost-cutting and savings translates into an extremely early retirement.This might just sound like common sense – and it is – but the ERE movement points out that the most disciplined and committed penny-pinchers can apply these three concepts to retire well before the age of 30.
The book that Fisker has written has been pretty well received by a niche following (having sold more than 7,500 copies), although it’s unlikely that the lifestyle he advocates will be embraced by many. There are a number of controversies that detractors are quick to point out.
1. Quality of Life Can Be Lowered
The first question that many people ask is: Why would you want to live on $7,000 per year? Jacob answers this question at length in his book, which outlines not only the math behind his retirement strategy, but also the philosophy as to why this is a desirable lifestyle.
Not only does Jacob advocate delaying larger purchases, he suggests rethinking why we need to make larger purchases in the first place. In addition to extreme savings, Jacob recommends that a simpler lifestyle where needs are satisfied in ways besides spending money ultimately creates greater happiness.
Some might disagree with some of Jacob’s cost-cutting philosophy. For example, he recommends learning to live without air conditioning, stating in his book that the body can adapt to extreme temperatures, which many may find ridiculous and not worth the savings. However, it’s difficult to argue with the idea that a lifetime of true financial independence is extremely valuable – perhaps more valuable than having a big house, a fancy car, and a lot of pricey dinners in trendy restaurants in your twenties.
Others have criticized Jacob for misusing the word retirement. To them, living on such a small amount of money is a life of poverty and not retirement. To many, this may ring true, but it doesn’t affect the math: If you want a better lifestyle, a 60% savings rate will require about 13 years of work, or a 50% savings rate will require about 20 years of work.
2. You May Have to Return to Work
Jacob began saving in 2000, and in 2009, he retired. However, at the end of 2011, he reentered the workforce as a professional investor, stating that his early retirement gave him the opportunity to do what he wants, and now what he wants is to work: “Financial independence allows you to do what you want whether that’s travel, raising children, saving the world, or playing golf. That’s what’s important.”
3. Your Return on Investments May Take a Hit
Another concern many have is that it is almost impossible to sustain a rate of return that covers inflation and living expenses for such a long period of time. Someone who retires before 30 might need to make that nest egg last 60 years or more. Critics have pointed out that if you need to withdraw some of your portfolio during a year when your investments have had a negative return, your savings will be devastated.
4. Children Are Not Accounted For
People also point out that children are one of a family’s largest expenses. Jacob suggests keeping the costs of raising a child down by not giving them an allowance, encouraging them to save whatever money they get as gifts, buying children’s clothes at thrift stores, and encouraging them to go to a state school instead of an expensive private university.
5. Health Insurance Costs May Be Out of Reach
When it comes to health insurance, Jacob recommends a high-deductible HSA-compatible plan to cover expensive medical emergencies. He also suggests maxing out contributions to an HSA until the account covers the high deductible on the plan.
These plans are much cheaper than most on the market, since they cover much less, and even Jacob admits this is imperfect, since such plans do not help people in their extreme old age stay alive or cover the needs of people with chronic illnesses, such as diabetes. The health insurance issue lingers as the biggest unresolved flaw in the early retirement extreme movement, and changes to healthcare legislation may change the costs and needs for health insurance in America, making this even harder to account for in an ERE plan.
Even for those who don’t follow the ERE philosophy, the movement is a healthy reminder that we trade our time for our money, and we don’t have to trade as much as mainstream society tells us. If you want to retire sooner, you can – as long as you’re willing to make some sacrifices along the way. Since the principal is mathematical in nature, anyone can choose to save 50% of their income, or 90%, or any amount they want while choosing which expenses to cut and maintaining the lifestyle they desire.
Would you consider living on $7,000 per year if you could retire now?