Two Mind Hacks to Lower Your Expenses

The following is a guest post by RJ Weiss from Gen Y Wealth.

This article is about looking at money in a different way then you're used to - about transforming how you value each expense.

More specifically, about using two mind hacks, that will make you look at money differently from this day forward. Lets get right into it.

Mind Hack # 1: Reverse 4% Withdrawal Rate

A general rule in retirement is that you can withdrawal 4% of your investments each year. This withdrawal rate, combined with the proper asset allocation, should make your money last forever.

Therefore, if you want to live off of $50,000 a year, you would need to accumulate $1,125,000 in your retirement portfolio. A $1,250,000 portfolio is very achievable if you have time on your side

But what if you don’t have time on your side and can’t afford to save 50% of your income. Just use the reverse 4% withdrawal rate to see how much less you would need to accumulate if you cut your expenses.

For every $10,000 less you spend each year, is $250,000 less you need to accumulate to retire. If you can manage to get your expenses down to $40,000 a year, you only need $1,000,000 in a retirement portfolio. Could you live on $30,000 a year? Then you only need to save $750,000.

If you know your annual expenses, try doing a simple calculation. Take your annual expenses and divide them by .04. This is roughly (a lot more goes into this calculation) the number you will need to accumulate in your retirement portfolio, to maintain your current standard of living.

For example, if your annual expenses are currently $50,000 a year, divide 50,000 by .04, which equals $1,250,000.

The next step is to see the difference between the amount you need to accumulate now and the amount you would need to accumulate in the future, if you were to cut your expenses. By doing the same calculation as above, but this time with a reduction of expenses, you would find that:

• A 5% reduction in expenses, would mean you would have to accumulate $1,187,500
• A 10% reduction in expenses, would mean you would have to accumulate $1,125,000
• A 20% reduction in expenses, would mean you would have to accumulate $1,000,000
• A 50% reduction, would mean you would have to accumulate only $625,000

Using the 4% withdrawal calculation made me transform the way I look at every expense. I hope it can do the same for you.

Mind Hack # 2: Stop Thinking % of Paycheck and Think % of Life

Say you make $30,000 a year after taxes and you're about to make a larger purchase, such as a car. For simplicity reasons, you're putting zero percent down and make payments of $400 a month.

Since you're making about $2,500 a month, $400 is probably no big deal right? It's only 16% of your paycheck.

However, what if instead of comparing the ratio between payment and monthly income and calling it a day, you took that 16% and multiplied it by 240, the average amount of workdays in a year. 

What does this number represent? It shows you how many days a year; you’re working for your car. In the example above, you would be working 38 days a year or about all of January and February, just for your car. Would you rather have that new car or take two months off to start the year?

Moving Forward

I challenge you to look closely at your major spending categories (shelter, food, health care, and transportation) and apply the two mind hacks above.

If you're spending 40% on rent or mortgage, how would your life change if you only spent 20%? How much less could you retire on? Could you start working part time?

If you start thinking differently today, you can start living differently tomorrow.

Comments

[Rod Ferguson]

You forgot to factor for inflation in that retirement calculator, RJ. Ask anyone who starting saving for retirement in the '80s who thought they'd only need a few hundred thousand dollars to be retired comfortably now.

You're concept is sound, though. As I've said before: reducing overhead is more important than collecting dollars.

[RJ]

True. Didn't factor in inflation. Which makes the formula work well in the short-term, but a little misleading in the long-term.

[Rod Ferguson]

And I can't type this morning: "calculation" instead of 'calculator' and "Your" instead of 'You're'. Just goes to show, we all make mistakes :)

[Doug L.]

Really like the idea of % of lifetime. I always look at how many hours I am working to purchase things.

[Budgeting in the Fun Stuff]

I like and use both mind hacks.

Our early retirement plan concentrates on trying to save enough in the next 25 years to be able to live comfortably off of 4% or less, but cutting back our expenses is definitely our back-up option and probably something that will come naturally to us anyway since we'll feel weird without the monthly paychecks.

I also look at big expenses based on how much of our time will be spent working for them. It doesn't work well on small expenses though because we'll start justifying $10 purchase since it's only x amount of minutes...those minutes add up fast, lol.

[Rob]

Good ideas, thanks for the tips. I never thought about thinking about purchases as a percentage throughout life. I have in the past thought about how long I have to work for something though.

[Georgia]

I guess I'm in big doo-doo. I have less than $100k in my 503b and I'm 73 and healthy mostly. Luckily, between SS & 2 small pensions, I can live on that and save some too. I use the 503b to do repairs and upkeep on my home. I also intend to live long. If I run out of money, I'll have to really get busy.

Actually, all my 503b is set up in a regular, not stock, account. When I first started it @ 1990-95, the interest rate was close to 7-8%. Now it is 2%. But, in the 4 years since I retired I have withdrawn just over $15.5k and yet, by year's end, when I withdraw my minimum, my total will only be down less than $1.5k. I think that proves the value of compounding interest. I love it.

Keep up the good work. I still can use financial information. Right now I am adjusting my income around in order to give 20% and save 20%. All prayers are appreciated for my success.

[glory]

ok first of all people are living longer. If you retire at the age of 65 chances are pretty good that you'll live another 40 years. That's if nothing changes in medical sciences. it may be even longer than that, so you need to find out what the average inflation has been over the last 50+ years and add that to your savings as well, since the last thing anyone wants is to die, cold, broke and eating cat food(if you're lucky) also take into account that you probably wont have a mortgage to pay, then try to set up your plan from there. And remember, its better late than never.

[Brian Ferrick]

This is an interesting way of looking at income and wants vs. needs. There is a fine line between what we want, what we need, and what we can truly afford. Unfortunately the savings patterns of Americans will probably go back to poor once3 the economy comes back. I am trying to save even more and will continue to the end.

Thanks,

Brian

[Concojones]

Very insightful post! I'm familiar with the ideas, but for those who aren't, this stuff is enlightening. It's not for everyone though, because assumed that (in mind hack #1) you are actively planning/budgeting retirement, and (for mind hack #2) your job allows you to take that two-month vacation (or you're interested in retiring 2 months earlier).