Financial Independence / Retire Early (FIRE) is elusive to most. But is the answer more obvious than you think?
Many Americans dream of a day when they can walk out of the office for the last time, and ride off into the sunset - retired and free to pursue their life's dreams. The reality for most Americans is a life spent working - underpaid, well past 65 years of age and deeply in debt. Between obesity and debt, America is plagued by two vicious epidemics. While obese, long term health is a major factor influencing retirement plans. It is difficult to plan for a retirement date 30 years in the future, if your current obesity level suggests you will not be alive to enjoy it.
And then there is debt. American's are swimming in it, and day by day, more Americans are drowning. In nearly every state in America, the debt level to income on average is greater than 1. In other words, if the only thing Americans spent their money on was debt, it would take more than a year to pay it off. In the real world, workers pay taxes, insurance and money on things they need and want. Debt payments are typically pretty low on most people's priority list.
Getting to FIRE means either an effective plan and sticking to it, or what I call HEFA, or HElp From Above. Americans fortunate enough to win the lottery, receive an inheritance, get a large severance package from work or any one of many other one-time, non-repeatable sources of income are able to finance their retirement with help from above. Creating and sticking to a retirement plan to achieve financial independence is a great goal, and one every American should pursue. But the odds are definitely stacked against American consumers.
Consumers are inundated with temptation in the form of loyalty programs, sales funnels, new gadgets and advertising in virtual all media. And with the proliferation of devices at home and at work, advertising is more in their face now than ever. Advertising is not only explicit in the sense that while browsing the web or watching TV an advertisement appears. Very often companies will pay to have their products featured within the program consumers are watching. One of the more prominent examples of this was on the long running TV show The Office. As the show gained popularity, Apple began paying to have characters within the show us MacBook Pros. The idea that lower income office workers would have a $2,000.00 laptop is pretty much the height of financial irresponsibility. Nonetheless, the trick worked. Between 2006 and 2012, the period during which Apple paid for product placement, sales of MacBooks went from about 5 million units sold per year to 18 million units sold. And in the year following the end of the show, MacBooks dropped in sales to about 16 million units for 2013.
The question of retirement boils down to this: how long will it take you to save an amount for which an annual 4% withdrawal will cover your expenses? If you currently save 10% of your income, and that income is the average of most American hourly workers, you are putting aside $4,829.45 per year, and living on $43,465.03. At that rate of savings, it will take 48 years until the combined effect of your savings and the income you will earn on your savings will total $1,082,511.96, for which 4% is very close to your living income at $43,300.48. Somewhere between 48 and 49 years you will hit the exact number that matches your income requirement.
In looking at that math, it seems pretty obvious that if you plan to retire early, 10% won't cut it. To retire in a more reasonable 26 years, your rate of savings needs to be 30%. The amount saved will need to total $854,778.67 in order for a 4% withdrawal to be sufficient to meet your living requirements. At a 4% withdrawal rate, you will be able to live on $34,191.15 perpetually, assuming your savings will continue to grow at a rate of at least 5.4%.
At Moneyade, we've done the math and here's the bad news: if you get a $40,000.00 loan and amortize it over 7 years (which may be difficult to get from your bank - they will typically be looking to be paid back in fewer than 7 years), the amount you would pay to service the loan is $7,013.28. That would leave $7,475.06 to invest. No matter how you slice it - up front loan, a new loan every 7 years, a loan offset by periods of savings - you are always better off putting the full amount of your savings to work without any form of financing. The only time this logic might break down is if you somehow become aware of a sure thing and borrow to invest in it heavily. Of course, sure things can also backfire, so borrowing for such an event is, like, super high risk.
Summary
It's tempting to think there is a short cut to retirement with that short-cut being debt. With so many offers out there, you would think that competition among lenders would result in a deal that would help you in your quest for FIRE. But no matter how you slice it, a loan in your pursuit of retirement is never a good idea. In a certain sense, there is an obviously logic at play: you're trying to save the maximum amount of money...the last thing you need is a barnacle slowing you down in the form of interest on a loan.
Do you have experience with using a loan to help accelerate your path to retirement? Did it work out for you and how did you manage the payments?