I asked this question – How much I need to save to retire richer than my friends; out of disappointment & anger. It feels very bad when you fail in the class, right? It feels much more worse to see your best friend pass the same class while you had failed. Isn’t it? This is true in life too. In our subconscious minds, we are always comparing and competing with our close relatives and friends. It’s called human nature. I believe as far as it’s a healthy competition, its important to have one because it keeps us motivated to do better and grow.
Will you not like to beat your friends and retire richer than him or her? If your answer is yes, then this post will greatly help you shape up your mind in right direction and move forward towards achieving this goal. But first, lets talk a little bit of myself and my past.
In my young age, I didn’t have any mentors or god father to guide me on making right decisions in life. I made lots of mistakes in my life as most people do. But on the brighter side, I was trying my best to learn whatever I could on my own. Over the years I learned a lot from my virtual mentors – Warren Buffet, Charlie Munger, Elon Musk, Tony Robinson & Jim Rohn. Each one of them have taught me different lessons in life. I highly recommend you to listen to Jim Rohn or check this, this and this great resources.
It was a long learning process which is still going on for me. It took me 10 years to realize how many great opportunities I had missed in past. The irony is that my close friends were capturing these opportunities at the same time while I was totally ignorant. I don’t blame them for not sharing it with me as I feel it was a natural process for them to save & invest. They were born in a family culture where expenditure comes after savings. In my family, expenditure is first and whatever is left (if any) will be saved. This cultural difference is the main reason why I missed to understand the importance of saving and investing at an early age while people around me were doing exactly opposite of mine and getting richer.
So, I thought what can I do now to cover up the loss of time in savings and investing. How can I retire richer than my friends at age 65. Although my plan is to retire sooner than that but as my friends are planning to work until age 65, so we will use this age for our research.
As you discussed in a separate post how knowledge is the true power when it comes to your finances, here’s the first lesson of my life that I learned too late.
Magic of Compounding to the Rescue
For those who aren’t aware of the magic of compound interest, let me divert from topic for a little bit and explain it with a short story.
Long ago in history, there was an inventor who invented a game that we know as ‘chess‘ today. It is one of the most famous game in the world by the way.
So, the inventor went to his king to showcase his newly invented game called – the chess. The king was very happy to play this game and immediately asked his finance minister to reward the inventor with gold and diamonds equal to his weight.
The inventor wishing to be playful, said, “my gracious king! what would I do with gold and diamonds? If you are pleased on my invention and want to reward me then please give me grains of rice for each block of chess board in following manner;
In block 1 – place 1 grain of rice;
In block 2 – place 2 grains of rice;
on block 3 – place 4 grains of rice;
block 4 – place 8 grains of rice;
& so on until block 64.
King thought although this guy invented a great game but he is an idiot to say no to gold and diamonds. So, King ordered his minister to give inventor what he requested.
After 5 days, finance minister approached the king and said my lord, there’s no grain of rice left in the city and still we aren’t anywhere near completion. King was amazed and asked him why? Finance minister said that we will need 18,446,744,070,000,000,000 grains of rice to satisfy inventor’s wish. These many grains aren’t available on entire earth.
That is the power of compounding. Here’s how it works;
Every block of chess board will have twice the number of grains from the previous block. So, if we started with 1 grain in first block, 2 in second block and so on; we will need 264 grains in total to cover all 64 blocks on chess board. The inventor wasn’t stupid rather he knew the magic of compounding. At that time, that much of rice wasn’t available in entire world which obviously far more valuable than few kilo of gold or diamond.
Ofcourse King couldn’t satisfy inventor’s wish and after realizing that he was fooled, he ordered death penalty for the inventor.
The key take away from this story is the magic of compounding which we will use next to beat our friends and retire richer.
On a quick side note, I highly recommend you to checkout why order of rate of returns on your investment is very critical to understand. It has the power to change your life after retirement; so don’t miss that post.
How to save money
Before we can invest, we need to save. There are various ways to save a little extra which will have major effects on our savings. Here are few ideas to save little extra money:
1/ Are you living under Influence
Rather than talking about health issues related with smoking and liquor consumption, we will talk about how much money this simple idea can save us over the time.
Any sort of addiction can’t be good for anyone. It has adverse effects on our health as well as on our financial life. Here’s a small calculation that I did for my father who was a chain smoker for almost 40 years of his life. He used to consume 2 packs of cigarette daily, costing him around $13.38 a day. For a year, the total comes out to be around $4900. That’s a lot of money to change anyone’s life around and help us retire richer. I will prove in a little bit how in this post. For now, just remember that someone can save $4900 a year if he/she is spending $13 a day on cigarettes.
Now lets take a look at expenses related to liquor consumption. Suppose a person drinks just one beer a day which costs on average $4.22 as of today. Add this for a year and you have another $1542. Wow.
It doesn’t need to be a cigarette or liquor by the way. It could be as simple as a Starbuck coffee or anything else that we buy on way to office or back to home every day. In your case it may even be a lunch that you might be enjoying every day near office. So, whats important here is to find out that one daily item that is taking few dollars away from our pockets. As shown above, just from cutting down on cigarette and liquor, a person can save about $6500 a year which can grow to over $4 million in 45 years at 10% return as shown above.
2/ Are you overpaying for your utilities
Many people completely ignore their utility expenses. I saved over $110 a month on my electricity bills. Check your recurring bills whether it’s electricity, internet or phone; there are always some better deals which you can benefit from. This can surely save around $1000 to $1500 a year if you shop for better plans.
You can also buy this device to find why your electricity bills are higher. It has helped thousands identify and save money. I highly recommend to get rid of older appliances which consume high power.
There are few more ideas to save money that I have shared in following posts:
- How to Become a Millionaire – Things I Wish I Knew in my 20s
- How to become rich when you are in your 30s
- Easy Money – How I Made $5,088 from Credit Cards without Top Cash back
- How to Get Rich Doing Nothing
I recommend you to check out many more ideas to save money using common sense and no effort as well in above posts. Let’s now move to our post about how to retire richer than my friends.
As we have seen, by simple changes in our lifestyle we can save around $7000 a year. Now say we have those extra $7000 a year available for us to invest and beat our friends. For this case study, I have taken example of one of my dear friend who I know was saving from the time he received his first paycheck.
He started by saving $200 a month into some mutual funds using automatic deductions. He has continued that ever since. With following assumptions, lets see how much will it take us to catch up with him and actually retire richer than him at age 65. In other words, just beat him at the finish line. I may be sounding devilish but I love my friend and it is a healthy competition that I am pursuing. In fact he knows about it too and working even harder on his savings. So it’s a win-win situation for both of us.
In scenario 1, our assumptions are as follows:
- My friend made same investment of $200 a month throughout until he reaches age of 65 years.
- His investment return average is 8% over 42 years period (which is a great return by the way).
Now using above assumptions, let’s calculate my friend’s final return at age 65.
As seen in above table, he started saving $200 a month at age 23 and made same amount of investments until age 65. At 8% average annual return he would accumulate approximately $849,414 by age 65.
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In order to beat him and accumulate more than $849,414; I have to start with little more than $200 a month as I am starting late (very late actually). Say I start at age 35 with monthly investment of $535 into same mutual funds that my friend had invested in. My yearly contribution towards investments will be $6,420 which is under $7000. Remember this $7000, is coming from money I saved from little changes in my lifestyle and by cutting unnecessary expenses as detailed in section – How to Save Money in this post.
With this plan, my savings would look something like this:
Great, I can beat my friend and retire richer than him following this plan. But note how much I had to invest to beat him. I have to invest 3x times more than what my friend did. This is due to loss of time that I wasted by not started early.
Here’s side by side comparison for both of us:
Although I may be able to exceed the dollar amount but I won’t be able to beat my friend on his overall returns. Look at his astonishing returns over mine. His returns are at 723% while mine is just 327% in this scenario (less than 50%). This is because I started 12 years late. What I learned from this is;
Time is a friend of early starter and time is an enemy of non starter.
Life is not still.
The change is the only constant.
Assuming that my friend will keep saving same amount of money every month for rest of his working life; will be unwise. He got such a good start and it will be totally stupid on his part if he doesn’t invest a little more than previous year every year. Moreover, now he knows that I am chasing him to beat his net worth at age 65. So, here’s the 2nd scenario assumptions:
- My friend will increase his investments by 5% every year until age 65.
- His investments will yield an average 8% return over 42 years.
Let’s recalculate how much would he be able to accumulate with in this scenario:
Wow, just by saving 5% extra a year; he would accumulate twice as much in scenario 1. Under this plan, his accumulation will be around $1,655,481.
Now, let us see how much will I have to start with & regularly invest at age 35 until 65 to beat him.
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I will have to invest close to $610 a month or $7,320 a year in this case. This is a little over our savings of $7000. But if I continue investing $7,320 a year and increase my investment by 5% a year, then I can accumulate $1,662,091 and retire richer than my friend.
Here’s side by side comparison:
Clearly, it won’t be easy as I will have to put up to $31,637 a year at age 65 while my friend would need only half of that. This is the penalty of not starting early with our investments. This plan is little difficult for anyone to follow as more funds will be required every year than previous year and if you haven’t started early, then the burden will be even higher.
Let’s look at next scenario to start with a lump sum in the beginning.
What if I manage to invest a bigger amount in the beginning to get a little acceleration and then maintain monthly investments of $600. Here are the assumptions for this scenario:
- My friend is investing $200 a month which is raised by 5% a year
- His investments are yielding 8% return a year.
- I invest X amount in year 1
- I invest $600 a month raised by 5% every year from age 35 until 65.
Here’s the calculations under this plan:
As you see, I will need at least $18000 as one time investment in year 1 and then $7200 a year raised by 5% at end of every year. Even with this plan, I will have to invest much more money every month than my friend.
In the end, I will manage to beat him and retire richer with $1,669,121.
In this scenario, say I want to keep my yearly investments same as of my friend. How much will I have to invest in beginning? Here are the assumptions for this plan:
- Invest same dollar amount every month as my friend
- Invest in same mutual funds to get same returns over time
Under this plan, the calculation would look like following:
As we see, I will need to invest almost $72,000 as one time investment today in order to keep yearly investments same as of my friend. Remember he started with just $200 a month and raised it a little (5%) a year. Basically I will have to match up with his current net worth and use that amount as my starting amount to beat him.
In all these scenarios, I will be able to beat my friend and retire richer as proved above but my overall returns will be much lower than his returns. This is where he really beats me. Moreover, my overall invested amount will be much higher than my friend.
This is the magic of compounding. A small amount of money invested early in life, makes a lot of difference many years down the line.
I might be able to beat my friend and retire richer on dollar terms but I will not be able to generate as good returns as his.
I want to re-instate this that this exercise was done as a way to compete with my friend in a healthy competition which will be a win-win situation for both of us down the line. You might have a relative whom you want to compete with or a friend. It doesn’t matter as long as it’s a healthy competition.
I also want to emphasize that we shouldn’t compare ourselves with others and be envy of their success. If anyone follows this path, then he/she is or will live a miserable life. This post isn’t about comparing yourself with your friends but to motivate ourselves to do better than others. This is the key to stay focussed and always looking for better ways to achieve our goals.
Are you saving less or more than your friends today? Did you start early or late? Let me know your thoughts about this post in comments below.
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