It is easy to lose perspective when it comes to the money you have accumulated in long-term savings if you think of it as a lump sum. For example, would you say $50,000 is a lot of money? Most people would say that it is a lot of money because most people have yet to accumulate that amount. Not only that, but most people save money in anticipation of spending it. So yes, $50,000 is a lot of money to spend. But consider this, currently $50,000 will produce $1,000 a year in interest income when invested in a 5-year certificate of deposit at my local credit union. One thousand dollars will not cover a month of living expenses for most people. Now does $50,000 sound like a lot of money? Not if you plan to live off the income it generates.
Loss of perspective puts you at risk of a shortfall in retirement savings
Why is this important? Well, if you think $50,000 or $100,000 or even $200,000 is a lot of money, how are you going to accumulate the $1 million to $2 million it is estimated you will need to maintain your standard of living in retirement? You will not think that big, and you will come up far short when it is time to retire.
If you think of your savings as money to be spent, you will never save very much because at some point your savings balance will appear to be a lot of money, and you will spend part or all of it. Or you will quit saving and spend the money you used to deposit into savings thereby increasing your standard of living which will put you just that much farther behind in retirement saving.
One reason the average balance in 401k accounts is so small is people spend their retirement money long before they retire. They treat retirement savings like an emergency fund and dip into it every time there is an expense they cannot finance out of their monthly income or with credit. Nearly half the households in the country cannot come up with $400 cash without tapping retirement funds or borrowing. One reason short-term savings balances are so low is people tend to spend savings once they have accumulated a few hundred to a few thousand dollars. Often savings is used as a down payment on a financed purchase of some kind. Not only does this deplete savings, but it also adds to debt; money is spent that has not yet been earned which makes it more difficult to save in the future.
The choice to live off my long-term savings changed my perspective
In 1981, when I was broke and in debt, I thought if I could just accumulate $5,000 in savings, I’d have it made. I was making $1,200 per month, the most income I had made up to that point in my young life. I had less than nothing; so of course, $5,000 seemed like a lot of money. It would have been a good start on an emergency fund; $5,000 would have replaced four months of my salary if I had lost my job.
Once I had accumulated $5,000 in savings, it no longer seemed like that much money. By that time, my wife, Rosa, and I had decided to eventually live off of our long-term savings, not spend it. That choice changed my perspective completely. The $5000 I had in savings only produced $400 a year in interest back in the early 1980’s. It would take a lot more than that to become financially independent. I became a super saver.
Rosa and I targeted income rather than a lump sum amount
It may sound strange but the account balance in our combined long-term savings, while increasing steadily, never really figured into our thinking. We were not trying to accumulate X dollars in long-term savings, anymore; we were shooting for X amount of income generated by our long-term savings. After a few years, Rosa and I had a third revenue stream from the interest on our long-term savings equivalent to full-time minimum wage employment in addition to our two full-time salaries. We became a three-income couple. That third income, the interest income, continued to grow, year after year, until the Great Recession of 2007 hit and the Fed’s zero interest rate policy became a reality a year later. With interest rates plummeting, our interest income decreased by about 40% over the next eight years, but we kept saving even after we retired in 2009, because we knew that interest rates would remain low for many years. We needed more capital to offset lower interest rates.
We set aside and spent short-term savings
Although we did not spend our long-term savings, we did budget monthly for unpredictable expenses such as house maintenance and improvement; vehicle maintenance, repair, and replacement; appliance repair and replacement; and insurance deductibles. The balances in these accounts grew until they were needed and became part of our short-term savings. We also put money into a separate emergency fund to replace our income if there was a temporary interruption in income due to the loss of a job, an accident, or illness. The emergency fund also figured into our short-term savings. If there was a big ticket purchase we wanted to make, we saved for it in a targeted savings account which we considered short-term savings, as well.
The endgame for our long-term savings
As inflation eats away at our purchasing power in retirement, there will come a day when we will tap our long-term savings to supplement our monthly income and to pay for increasingly expensive medical care. Barring a catastrophic medical expense, we do not expect to begin to systematically spend down our capital until after age 75. However, we may decide to withdraw some capital earlier to enjoy a better quality of life.
If we live long enough, we will consume most, if not all, of our capital. Right now, at seven years into retirement and three years away from Social Security, we continue to add to our long-term savings. Income is still our focus with 25 years of retirement or more to go.
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages