When looking at retirement savings vs expense reduction, which gives you the best chance to reach early retirement? First let me define what I mean by expense reduction. Usually you see the question posed with debt reduction rather than expense reduction. I use the term expense reduction because it is all inclusive with debt being a part of it.
Debt is a killer if you are planning to retire young and early. It will require a low expense footprint in order to reach super-level retirement saving rates. I am no financial guru but I believe that the answer to retirement savings vs expense reduction is that you need to do both.
The whole retirement savings vs expense reduction question comes down to your own personal strategy. Everyone’s situation is different. Don’t ever accept a cookie-cutter all inclusive answer to this issue.
Here is how I looked at this question and developed MY STRATEGY. Obviously the lower my expenses. The less savings it will take to retire early. I bring it up because it is real easy to concentrate only on what you are saving without looking at expense.
My work journey was a slow moving climb. From an entry level position to engineer. With that climb the associated slow increases in income. I had to increase my income to make my strategy work. So I worked a 2nd part time job for 13 years to eliminate the debt we gradually picked up supporting a family of 5.
You must have a plan and stick to it. So make a list of priorities, goals, and your strategy to get there. The answer to the retirement savings vs expense reduction question is different for everyone.
Retirement Savings vs Expense Reduction – What Needs to be done
401K
Pay yourself first was the advice that I received and lived by. When I started contributing to my 401K I was only able to make the minimum contribution to get the full company match.
Always take advantage of your company’s 401K and if there is a match you are getting a hell of a return on your investment the day it goes in regardless of what your investment gains may be.
Being it is before taxes means it isn’t a dollar for dollar reduction in your take home pay. Once you have accomplished your debt and expense reduction you can then ramp up the savings rate.
Emergency Savings Account
Once again, pay yourself first. I know it is said you should have 6 months or even a years’ worth of living expenses to cover you if there is job loss or any other catastrophe. For me that was a formidable amount to achieve and still make strides to reduce expense.
Just allocate a percentage of your take home pay check and slowly build that account up to a figure that would carry you through a rough patch. Once comfortable with that balance, redirect you allocation to either Debt or 401K/IRA savings.
Expense Reduction
Go on an expense diet. Like a food diet, you need to be smart about what you are going to cut from your lifestyle. You need to decide what is really important to you, what really makes you happy, and what you can trim and stick to it. You don’t want to feel like you are living a deprived life where you will relapse and reverse any gains you have accomplished.
Targeting your debt
I knew that if I ever wanted to retire early I would have to be debt free. I did retire with a mortgage and knew that I wasn’t going to have it paid off for my first Leisure Freak retirement so I refinanced it for the least interest rate possible so that my payment was as low as possible.
There are many theories out there about paying off the smaller accounts first so you feel like you are making progress. I believe it’s best to make your money go where it will have the biggest bang for the buck and that is on the highest interest account. That was my strategy and it worked.
Eventually we had enough home equity to consolidate to a home equity line of credit and take advantage of the lower interest rate and receive the tax advantages. Once it was paid off, I was able to super-size my retirement savings rate and build my accounts up to pay cash for cars, my kid’s college and their weddings.
Final note
During this entire time I did increase my 401K allotment with each yearly raise until it was maxed out.
Sit down and form your own strategy and then stick to it. Allow some flexibility but keep your eyes on the finish line. These things don’t happen overnight.