Money Basics

Utility vs. Interest (Part II)

Last week I asked the question, “Is it better to spend or to save?” Would you rather have some fun right now, or the possibility to have even more fun in the future?

I went through some math to show that $500 of spending today could instead be used for $2152 of spending (in today’s dollars!) in 2049—that’s my personal 401k/Roth IRA retirement date. We talked about how having $500 today can be fun—that new road bike—or even vitally important to your lifestyle security if it is part of your emergency fund. But what I want to do today is delve a little bit deeper into that 4.3x growth factor ($2152/$500) and show you how a dollar saved today leads to an early retirement later. I’m going to be converting dollars spent today (utility) into months-worth of living expenses at retirement (interest).

First, I’m going to look at my hypothetical retirement expenses, but use today’s dollar value in order to stay consistent. What do I mean? Well, I’m paying a mortgage today, but I don’t think I will be when I retire. Hence, mortgage won’t be an expense that I’m looking at. Property tax, however, will be something I’m still paying. I’m not sure what the property tax rate will be when I retire, but thankfully my previous analysis converted retirement dollars into today’s dollars, so my $400/month property tax and insurance (today) is something I’ll account for when I retire. What else?

ItemMonthly Cost
Property Tax & Homeowners Insurance$400
Cell Phone$40
Car Insurance$60
Dining Out/Fun$175
Home Maintenance$200
Auto Maintenance$75
Retail (books, gifts, clothes, etc)$150
TOTAL$1780 per month

But your medical costs at retirement are gonna go way up, JC! Yes, they will. Then again, gasoline might not exist. I might never dine out, and my tax bill might increase at 2x the rate of inflation. There are plenty of unknowns here, so grant me the assumption that my approximate costs—other than my mortgage—will remain the same.

Now, let’s do a little math with our $1780 costs and our 4.3x investment multiplier. In order to pay for a month of living expenses when I retire, I’d need to put in $1780/4.3 = $414 today.  Flip that around: if I put in $414 to my 401(k) today (or this month, or really even any time this year), and it grows by the predicted 4.3x, then that covers the expenses for one month when I retire. I won’t have to work that month, because the money I’m putting away now today is covering me later.

If I happen to find an envelope on the ground with $414 in it, I could think of my good luck as, “Great! If I sock this new money away, that’ll pay for a month of retirement; I can now retire one month earlier.” Money now grows with interest, and provides me utility later. So…

How much time would it take me to earn an extra $414 right now? Or what sacrifices would I have to make in my budget in order to not spend that $414 in the first place? Is that time/sacrifice worth it in order to retire a month earlier?

Here are some examples:

Starbucks @ $3 per drink, 1 drink per day = $1095/year right now = $4710 in 31 years = 2.6 months of early retirement

Would you give up a Starbucks habit (for only one year) in order to retire an extra 2.6 months early? Think of it as 10 weeks of vacation time.

Dining out @ $25/meal, once per week = $1300/year right now = $5590 in 31 years = 3.1 months of early retirement.

Commuting 40 miles roundtrip to work, US gov’t suggests 54.5 cents per mile, or $21.76/day for 5 days a week = $5440/year right now = $23380 in 31 years = 13 months of early retirement.

…not to mention the cost of your time if you spend an hour in the car every day. Reducing your commute can save you months-worth of money, and that’s if you make the change only for one year.

I keep on emphasizing “only for this year” because the math changes the closer we get to retirement. The savings we’d have—and the subsequent investments we’d make—would have less time to grow. While saving money is always good, it does the most good when you’re young. Once people understand this fact, they’ll often say something like, “I wish I’d started investing when I was younger.”

I don’t want to make you feel bad. I buy breakfast sandwiches for $5. I’ll drive 100 miles round-trip to see my family. I live life in a lot of the same ways that you do. But, I try to focus on the repeated and frequent spending habits that I have (and most people have), and actively try to cut that spending down. I don’t buy that breakfast sandwich every day; I make an English muffin and my own coffee at home. That’s 50 cents for the muffin, 15 cents for the peanut butter, and probably 15 cents for the coffee grounds, filter, and water. I spend 80 cents on my breakfast. The same thing at a chain coffee place or fast food joint would cost…$4? If I spent that extra $3.20 every morning, it’d be very similar to the Starbucks and Dining Out examples above; one year of that extra spending would postpone my retirement by about 3 months.

So as I’ve said, don’t feel bad. I’m not here to moralize anyone’s lifestyle, but instead to make you aware of what the trade-offs are.

As much as spending is fun, think about a version of the following statements that might apply in your life.

  • That Chipotle sounds really good, but I’m 20 minutes from home and have a fridge full of groceries.
  • I do really like that $20 t-shirt, but I have tons of shirts already, and there exist significantly cheaper clothing options.
  • I can’t wait to read that book! Except maybe I can? My library gets it in a couple months, and free loan is better than spending $15 on it today.

Personally, I’m going to make my own muffin, make my own coffee, and spend an extra 3 months not working, doing only things that I want to do. If you’re so inclined, I’d encourage you to see what you can save on.

Good luck! I’ll see you next week.

About Jesse Cramer

Jesse Cramer created The Best Interest to explain personal finance and investing in simple terms. His writing has been featured by CNBC, MSN, The Motley Fool, and other national publications. He resides in Rochester, NY with his girlfriend and their dog. Follow him on Twitter: @BestInterest_JC
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