Early Retirement Extreme
Two issues keep on puzzling me about economics. On the one hand, it undoubtedly is an incredibly important subject. At present, my life pretty much depends on being able to buy certain things from a functioning economy and the same holds for just about everybody else. On the other hand, there seem to be a number of serious problems with deeply rooted beliefs about economics held my many professional economists. (This, then, also is one of the most important reasons why we are in a precarious situation in the first place – if people want “to save the planet”, I like to ask “from what?”. The answer seems to be: “from the consequences of an untenable economic ideology”.)
So, developing a sane perspective on economics and in particular one’s own economic role certainly is an important goal. And no, I do not think management professionals who tell their students in their lectures that spending money on french brand name cosmetics is smarter than spending it on other cosmetics have anything to offer that I’d personally be interested in, thank you.
There are, of course, a number of quite useful perspectives. Fritz Schumacher’s Small Is Beautiful: Economics As If People Mattered certainly contains a number of important ideas one should know about. The same holds for the writings of another “maverick” professional economist — Scott Nearing. Bill Mollison also has a lot to say about economics — but the problem with Mollison in particular is that some of his economic approaches are simultaneously powerful and radical (“Some of the things you are going to do will be charitable, and it would be stupid not to do them through a charity and get the corresponding tax benefits, so for heaven’s sake set up a charity — that will be useful for a thousand other reasons as well”), but difficult to implement without an experienced mentor. All in all, economics is a confusing puzzle, and neither the picture assembled from all the pieces by professional economists, nor the “self-sufficiency” picture assembled by John Seymour seem to be without serious flaws.
Recently, I have come across another puzzle piece which seems to play a fairly important role. It comes in the form of a small book written this year by a clever guy who incidentally happens to be a theoretical physicist (amongst other things). Now, one thing that usually comes with an education in theoretical physics is that one develops the ability to make up one’s own mind about things (rather than having to parrot somebody else’s ideas, which most people do), by studying the underlying structures. Physicists develop the skill to see through illusions.
First, he did not buy the commonly accepted model of how one should behave as a model consumer citizen. Then, he analyzed the rules of the game. Then, he developed a fairly robust and straightforward strategy. Next, he implemented it in his own life. Then, after five years (he now is at the age of 34), he had achieved the level of 100% financial independence and effectively retired — which means that he has time to spend on things that matter to him. Some of these may bring in money, but strictly speaking, he does not depend on that.
So what is the trick then? By and large, people in western societies are financially mostly illiterate. When first confronted with the issue of buying a house on a mortgage and hence paying it off more than twice, some people might have a “hang on a second” moment — but eventually just mimic what is generally considered the socially expected behaviour. Many, however, use money much more widely in similarly inefficient ways by buying all sorts of stuff on credit. Banks of course like that, and even try to seduce customers into borrowing money to finance luxuries such as vacation trips. Conspicuously, schools by and large do not seem to try to educate young people about doing a few simple but extremely revealing financial calculations (the same actually also holds for energetic calculations, for that matter). Cynics might well consider this to be part of a big plot to educate them to become model customers.
So, this theoretical physicist, when starting to save for a small house, started to actually think the whole thing through at a more fundamental level, mostly ignoring culturally established behaviour and asking “what if” — a question which normally no one seems to ask.
Retirement plans usually involve setting aside 10% – 20% of one’s income as savings to be put into a retirement account with some 6% interest or so. A saving rate of 30% generally would be considered as exceptionally high. This physicist pondered the question: “Assuming a realistic interest rate, what would actually happen for saving rates in a range no one ever seems to think about, say e.g., around 75% or so?” Arriving at the answer “one would pretty much invariably end up with total financial independence in well under 10 years”, he set out to implement this plan — and afterwards wrote a book about it.
A key insight is that, assuming one starts to work at 20, dies at 100, and invests a certain share of one’s income at a given effective interest rate, then for very high saving rates of more than 70%, one is pretty much bound to become financially independent in well under 10 years as long as the interest rate is anywhere above 4%. For low saving rates of less than 30%, the outcome very strongly depends on the interest rate, but for high saving rates this is a robust result. At a saving rate of 70%, the difference between an investment with a 4% interest rate and a 6% interest rate is that the former will take 9 years till financial independence, while the latter about 2.5 years less. Here, one must note that this analysis does not depend on absolute income – as long as one can maintain a saving rate of above 70% and invest at a seemingly moderate guaranteed effective interest rate, this strategy will work. (For a saving rate of 80%, the figures are just over 5.5 years vs. just over 3 years.)
So, regardless of any motivation with respect to how one should invest these savings (earth repair, anyone?), this makes a clear statement about very tangible immense rewards of eliminating inefficiencies and costly bad habits. A saving rate of over 70% is possible, but requires a lot of discipline and essentially a design approach. (Perhaps he did it because physicists tend to like “impossible” challenges?) How about interest rates with a potentially major (peak energy related) economic crash around the corner? Apart from the fact that whoever managed to reduce one’s need to earn money to a level that allows a 70% saving rate will be in a strategically very strong position in comparison to others, it can be expected that, as some part of the economy that was based on untenable beliefs tanks (perhaps quite a large one), that part that was based on more appropriate beliefs may be expected to do fairly well. Nature abhors a vacuum, and when businesses that provided inappropriate solutions fail, other businesses with more appropriate ideas will grow to occupy the void. (Bicycle ambulances, anyone?) Being aware of the relevant issues that actually drive the economic reconfiguration should then be a major advantage.
Having systematically reduced his expenses to a minimum, he writes:
Figuratively speaking it is quite possible to match up the relative sizes of the cash flows between two people. For example, I spend about as much on my total living expenses as an upper-middle-class family spends on their mortgage interest alone. Effectively speaking, I’ve lent them my money so they can have a house with five bedrooms, three bathrooms, a vaulted foyer, and a two-car garage. In return, they pay all my expenses. Hopefully, we both consider this a good deal; I know I do.
Personally, I find it brilliant if someone who grew up in western culture mastered the art of reducing personal expenses to such a degree, but of course there are more appealing investment strategies in terms of redistribution of surplus than letting somebody else live a wasteful lifestyle.
Even if one has no own plans to do something similarly extreme, his book offers a number of very useful insights. In particular, it offers a perspective on the true price of things that seems to be missed by many. Quantitatively speaking, for example, if we assume a mere 3% rate of return, then kicking a habit that costs $1/month amounts to reducing the size of the fund that is needed to reach financial independence by about $400. (So, $20/month means $8000 in funds.) Given that the vast majority of people have a strong tendency to spend money on bad habits, rather than trying to develop discipline and a strong character, and that there actually is a trend towards not educating people about possible ways to cultivate personal self-discipline (as much of the economy depends on the misidentification of wants as needs), there is considerable potential for most people to go much further on the road to a high degree of financial independence than they ever contemplated.
The book itself to some readers might seem a bit too abstract; it deliberately is not a recipe book for frugality, but instead discusses fundamental principles. As the author says, there is little point in giving someone a list of directions if they would do much better with a map — but in order to use a map, one needs some navigation skills. It tries to be an eye-opener by pointing out a few fairly simple relations which actually are overlooked by most and help the reader to develop navigation skills.
Permaculture is a lot about increasing resilience. This particular book has a lot to offer in terms of personal economic resilience and certainly is relevant not only to people with a plan to retire extremely early, but just as well to people who intend to set up their own company (say), or just want more time for those things that really matter to them. Personally, I was amazed to discover that many of the things I already had implemented in my own life — such as not owning a car and building a productive asset base that provides separate income streams (based on actually useful products) straightaway, rather than being locked away until retirement age — are also considered as crucial strategies by this author, even though we arrived at these conclusions for almost completely independent reasons.
While the book is not directly about Permaculture and in particular considers debt-backed fiat money as the given rules of the (present) game (still with a strong emphasis on the importance of alternative arrangements such as barter systems), it occasionally refers to probable scenarios in relation to resource scarcity and pollution problems and discusses ways in which our economies will necessarily have to change (essentially, by changing from a producer-consumer system to a more complete system including decomposers that do the recycling and upcycling of resources). The strategy presented uses the present rules of the game in a creative and quite unconventional way, but it is pretty clear that even if there were a major change in the way money works that is unexpected to the author, he would be in a much better strategic position than most others, due to systematically having worked on becoming conscious of and eliminating his costly bad habits. This book hence seems to be especially relevant as it means that combining such financial strategies with value-increasing earth repair strategies should make a very powerful combination. Above everything else, it very clearly shows the power of systematically reducing one’s recurrent expenses, in permaculture more widely known as the “need to earn”.