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January 20, 2000
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Re: Scott Burns article in Worth
[The following is from a thread discussing an article in Worth]
He's assuming incomeWorking=ExpensesWorking=1.2*ExpensesRetirement.
We assume incomeWorking >> ExpensesWorking = 1.2 * ExpensesRetirement
Thanks a lot. I understood this until you turned it into a mathematical equation!
If you live well below your means and save/invest the rest then retiring early is a pretty obvious option and there's no real convincing needed. If you live at or above your means you're trapped. It's that simple.
You are right, it is that simple--as a matter of logic. There are powerful currents of emotion at play here for most people, though. The average person has never done the exercise you are talking about--determining whether they are living at their means or not, how close they are, and what they would have to do to get closer. That last sentence strikes me as an amazing fact. It's as if we were to say, the average person has never considered what kind of foods it is good to eat. Yet the reality remains.
|"...many people reason not by a process of logic but by a process of comparison."|
My explanation of the paradox is that many people reason not by a process of logic but by a process of comparison. Retire Early people run calculations, question those calculations, ask questions about them, refine them, etc. Many others instead come to their beliefs about personal finance by looking at what others around them are doing. They say, "I am saving five percent and others around me are saving 10 percent, so I had better improve." Or "I am saving 15 percent and others around me are saving 10 percent, so I'm sitting pretty."
That's why I put forward the following bold assertion: The rule of thumb that "one needs about 80 percent of one's current income to live on in retirement" is the single most damaging force (in personal finance terms) in the world. It's worse than consumerism, worse than lethargy, worse than easy credit, worse than procrastination.
Why? Because there are natural means of overcoming all of these other negative forces. As one gets older, one usually starts to consider retirement and there is a natural impulse to take action to improve one's financial circumstances. For most people, though, the 80 percent rule cuts off this healthy impulse.
Take the individual who has too much debt. At age 35, he might be inclined to put his finances in better working order, and he still has time to make great strides. He hears the 80 percent rule, though, and then talks to friends or reads magazines and books in an effort to determine what he needs to do to satisfy the requirements of the rule. What he hears is that most "good savers" are putting aside 10 percent or perhaps even 15 percent of their income in savings each year; if he does the same, he is told, he should have no big problem.
This is comforting because the goal is not really that hard to reach. Yet it is believable because it is not really all that easy to reach either. It's just hard enough a saying to appeal to that inner voice telling him it's time to repair his finances. And just soft enough to appeal to the part of him that never wanted to deal with this stuff in the first place.
So he does it--he takes a vow to start saving 10 percent. And that's an improvement over what he was doing before. But it is also a lost opportunity of major proportions. It's very hard to get people concerned enough to want to improve their finances. So to offer them half-measure solutions when they are in a mood to listen is to do real harm.
Instead, they should be told the truth, which, as you noted, is really very simple. You can live at any of many different levels of spending, and the choice you make will determine how long you need to work until you are financially independent. If people were told this by conventional financial advisors, some would choose a goal of retiring early and some would not. The key is that they would make a choice--they would be forced to before their consciences would allow them to go back to their day-to-day concerns.
|"The 80 percent rule acts as a narcotic that relieves the pain that has been growing over years of financial ignorance."|
The 80 percent rule acts as a narcotic that relieves the pain that has been growing over years of financial ignorance. Those who put forward the 80 percent rule will argue that it helps many to at least save something, and that that's a good thing. It is only if considered in isolation (not taking into account the damage done).
But what irritates me so about this rule of thumb is I don't see why we need it. Rules of thumb are a good thing when one is trying to impart a simple means of dealing with a complex bit of information. It's a rule of thumb to say (as Burns does) that "one needs to have saved 20 times what one wants in annual income in order to have enough to retire" (he presumes a 5 percent rate of return). That rule of thumb is useful because it saves one the trouble of calculating out expected rates of return over expected years of retirement, etc., and because it is true.
The 80 percent rule is not true. In fact, one does not need to examine its possible applications very long to realize how dumb it is. If this rule were true, it would mean that an individual earning $50,000 who is progressing perfectly on his retirement plan would suddenly be in great peril if he were offered a job paying $100,000. He would be well advised to turn the job down rather than jeopardize his retirement plan.
It's a rule of thumb that encapsulates not a financial truth, but a financial falsehood. The premise behind the 80 percent rule is that one's spending increases exactly in conformity with increases in one's income. This has been known to happen. But is it to be encouraged? Should we be passing along financial advice based on behavior that, however, prevalent, is self-destructive, mindless, sheeplike, or confused (choose your adjective according to your level of vexation)?
The mystery to me is why financial advisers continue to iterate the 80 percent rule. The charitable explanation is that it's what they were told when they were novices and they just keep passing it along without thinking. The less kind view is that they don't want people to reach financial independence because their services would not be in as much demand; so they deliberately repeat a rule with a flawed premise as a means of keeping customers in financial chains.
I warned you it was a pet peeve.
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