Being cheap is fine if you're a broke student. But if you want to build wealth quickly in order to retire early, staying cheap is a suboptimal way to go.
To live a rich life, you must adopt an abundance mindset where you believe you can build an unlimited amount of wealth through hard work and wise investments.
Those who are overly frugal suffer from a scarcity mindset – where they believe the main way to create wealth is by not spending money. Being cheap can also make you too afraid to take risks.
Stop stressing about spending $8 on avocado toast or trying to save $2 by buying one-ply toilet paper. Instead, start focusing on making hundreds of thousands of dollars. Make better investments, negotiate a higher salary, refinance your mortgage, build side business, and more.
Opportunities to make more money are unlimited. Whereas, you can only save so much to build wealth.
Being Cheap Has Negative Consequences
Here are some things that may happen to you if you try and cheap your way to early retirement:
- Life may get mundane. What happens when you're too cheap is life can get really dull. Due to your desire to save money, you move away from a vibrant city like San Francisco with a tremendous amount of job opportunities, culture, entertainment, and diversity. Your new environment ends up being a homogeneity, filled with people who all think, act, look and speak alike. Further, you've lost your network of friends and contacts built over the years.
- Living arrangements may become uncomfortable. You decide to live in a shoebox to save on rent. As a result, you and your partner end up fighting much more often because you're all up in each other's space. As you get into your 30s, 40s, and 50s, you start resenting the fact that for the sake of retiring early, you're still living like a broke student.
- May miss out on real estate gains. Because renting is often initially cheaper than owning, you might get lured into believing that renting, over owning, is the financially savvier way to go. But just as shorting the S&P 500 over the long-term is not a wise move, shorting the housing market by renting long-term is also unwise. The return on rent is always negative 100 percent.
More Negatives Of Being Cheap
Here are even more negative side effects of contracting the cheap disease.
- May end up making less money. You may miss out on employment opportunities because you are unwilling to move to a higher cost of living area. In actuality, the best way to get rich is to first make as much money as possible in higher cost cities where pay is higher and then move to a lower-cost area of the country once you've had your fill.
- May miss your window for having kids. For those of you who delay having kids into your late 30s or 40s due to cost, your ability to naturally conceive plummets. Being overly frugal might end up costing couples tens of thousands of dollars in IUI and expensive IVF treatments, not to mention a lot of potential heartbreaks. You may end up never having kids.
- May become a taker, instead of a giver. Rather than being a net contributor, you may end up being a drain on government resources. Not only will you pay fewer taxes when you don't focus on boosting income, you might end up needing to take advantage of government subsidies for healthcare, food, and housing.
- May never reach self-actualization. You don't challenge yourself to achieve your full earnings potential. Saving money is easy. Making more money through excellent job performance or entrepreneurial ingenuity is much more rewarding.
Living In Or Near Poverty Makes No Sense
Instead of living a spartan lifestyle for years so you can retire early and live near poverty, it's much better to find rewarding work in order to maintain a more balanced lifestyle.
The definition of poverty per the government is as a dollar amount by household size. For 2021, an individual making $12,880 or less a year is considered living in poverty. A household of four living on $26,500 or less is considered living in poverty and so forth.
It's safe to say that a household earning up to about 150% of the Federal Poverty Level is consider living near poverty. If you live in a high cost of living area like San Francisco, earning up to 200% of FPL is certainly living near poverty.
Some of you younger readers might be thinking that living on 100% – 150% of FPL isn't so bad. However, I'm certain your views will change once you move out of your mom's basement and start having kids of your own. It is nearly impossible to retire early with kids due to the time and cost it takes to raise them.
Parenthood And Being Cheap
If you want to have children, please be careful when listening to the advice of early retirees without children. They absolutely have no idea how much of a financial and time burden children are on parents. In comparison, retiring early without children is like going for a walk in the park.
If you do not receive ACA healthcare subsidies, your monthly health insurance premium for a family of four could easily run over $2,000 a month. My family pays $2,380/month for a platinum healthcare plan. This payment doesn't include our 20% co-insurance and $25 – $100 co-pays.
Then there is childcare and preschool costs to account for, which can easily run between $1,000 – $2,500 a month per child. Some homogenous preschools and hoity toity exclusive preschools cost even more. Then of course there is the tremendous amount of time and energy it takes to raise kids, which takes away from your ability to earn money.
How Much Capital To Accumulate To Retire In Near Poverty
Now that we know the definition of poverty and near poverty in America, let's calculate how much one would have to accumulate in order to generate near poverty income in retirement. Study the chart carefully so we can discuss the nuances.
Using a 4% rate of return or 4% safe withdrawal rate, a family of four who is OK with living in poverty in retirement ($25,000/year = 100% of FPL) would require $627,500 in capital.
If the family wanted to live near poverty in retirement ($37,650 = 200% of FPL), the family would need to accumulate $941,250.
If the family wanted to a little more breathing room to live off 200% of FPL, the family would need to accumulate an impressive $1,471,000.
Here's the thing. If you're disciplined enough to have accumulated $627,500 – $1,471,000, it'll be very hard to then accept living in or near poverty in retirement. You'll start to question the point of living, especially if you've spent decades accumulating the capital and still struggle with being cheap and living like a frugal miser.
The typical American with a retirement account has less than $150,000 saved according to a Federal Reserve Study. To think that you can save 4X – 10X more than the typical American or 1.5X – 3.5X more than Americans earning a top-10% income is hard to do without making an above-average income.
Spending decades scrimping and saving just so you can live a spartan early retirement life is a disconnect from reality.
The Better Early Retirement Strategy
Being cheap is not a great way to retire early. The key to achieving financial independence is to make as much money as possible while also keeping expenses as fixed as possible.
The easiest way for Americans to build wealth is by maxing out their 401(k)s, IRAs, and Roth IRAs. After you've taken full advantage of tax-advantageous retirement vehicles, it'll be time to build your taxable investment portfolio. It is your taxable investment portfolio that will produce the income necessary which enables you to retire early.
Below is a conservative pre-tax and after-tax capital accumulation amount by age to follow if you want to retire early and live a simple life. The targets are for an individual or a couple.
Now take a look at the 20-year annualized returns by asset class below. You'll see that Real Estate Investment Trusts (REITs), Gold, Oil, the S&P 500, and a 60/40 portfolio led the way. You'll also notice the average investor who traded his or her own portfolio didn't even beat inflation.
Your goal is to make prudent investments that will end up making money for you so you don't have to. The two most common asset classes the average person should focus on to build wealth are: real estate and the S&P 500.
If you know where you want to live for the next 10+ years, get neutral real estate by owning your primary residence. Only when you own more than one piece of real estate are you truly long the real estate market.
The easiest way to get long real estate is by owning a REIT index fund to get broad real estate exposure. If you're looking to invest in particular cities or regions, real estate crowdfunding is a more targeted way to go.
I'm personally investing in secondary cities that have lower valuations, higher net rental yields, and potentially higher appreciation rates. I believe there is a multi-decade demographic shift away from expensive coastal cities towards lower cost areas of the country thanks to technology and work mobility.
The S&P 500 has returned a consistent 8% – 11% a year since 1926. There have definitely been years when investors have lost money, most recently in 2018. But if investors can ride out the dips, over a 10+-year horizon, the S&P 500 has never had a negative return.
Finally, it's vital that everyone stay on top of your finances each month. Use a free wealth management tool to track your net worth, analyze your cash flow, x-ray your investment portfolio for excessive fees, and make pro-forma calculations on your retirement cash flow.
The people who wake up 20 years from now and wonder where all their money went are the same people who look in the mirror and wonder how they got to be so unhealthy looking. Take control!
Adopt An Abundance Mindset
Instead of retiring early on a small portfolio that generates a poverty-level income, find a job you enjoy instead. Keep on working until your portfolio can generate at least 300% of FPL in passive income and then call it quits.
If you can't wait to retire early, definitely don't have kids. The cost of healthcare, housing, and tuition will really slow down your early retirement plans.
But if you still want it all, there's one final technique that many modern-day early retirees employ. Find a spouse willing to continue working so you can live a life of leisure. Good luck with that!
Subscribe To Financial Samurai
Listen and subscribe to The Financial Samurai podcast on Apple or Spotify. I interview experts in their respective fields and discuss some of the most interesting topics on this site. Please share, rate, and review!
For more nuanced personal finance content, join 60,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.