Retiring Early: Lost Savings

by: Dirk Cotton

In my last post, The Risk of Retiring (or Being Retired) Early, I provided some thoughts about the risk of retiring early and perhaps extending what would already have been a long and expensive retirement. A second risk of retiring early is that we will stop saving for retirement sooner.

As the savings, or "accumulation," phase of retirement progresses, the contribution of new savings to our net worth becomes progressively smaller as the contribution from existing portfolio growth increases. Consider the following three graphs. First, our earnings tend to grow from the beginning of our careers, peak in our mid-fifties and then decline a bit each year until we retire.

Assuming a retiree saves 10% of earnings annually until retirement, annual savings contributions would look like the following curve. Note that by retiring early, we stop saving when our annual contributions are near their peak around age 55 to 60. On the plus side, we're robbing our own savings at a time when their potential compounded growth is relatively low because they have fewer years left to grow than did our early-career savings.

Assuming this retiree earned a consistent 7% rate of return on her portfolio, the contribution at each age to her portfolio value from new savings is shown below in red and the contribution from investment returns on previous savings contributions is shown in blue.

The graph above shows that if we retire early and stop saving at age 60, for example, the value of the lost savings is probably a lot smaller than the return we will continue to receive on our portfolio, but the loss can still be substantial.

The following chart shows the results of retiring at ages 55, 60, or 65 instead of age 70, using the same assumptions as above, but assuming that contributions stop at retirement age and that we don't start spending from the portfolio until age 70. (I will discuss the impact of early spending from savings in my next post. For now, let's just look at lost savings.)

If this person retired at age 70, he would save $1,832,840. Stopping annual savings at age 65 would reduce the portfolio balance by 3.3%. Stopping savings contributions at age 60 would reduce it by 8.3% and stopping at age 55 would reduce the portfolio balance by 15.5%. Reducing the size of your retirement savings portfolio balance reduces sustainable retirement spending by the same percentage. Reduce your portfolio balance by 3.3% and you reduce your sustainable spending amount from your risky portfolio by 3.3% annually.

Note again that reducing savings by retiring early has a significant impact on a retiree's finances, but that most portfolio growth late in our careers comes from market returns on our accumulated savings and not new savings contributions. On its own, losing a few years of savings contributions is tolerable.

The problem is the two-edged sword created by stopping additional annual savings early and beginning portfolio withdrawals early. I'll look at the latter next time.