Tuesday, November 4, 2008

Shortcuts to Early Retirement – Absurd Frugal Thinking or Common Financial Sense?

Permanent income gone astray

The past week has been exceptionally long. I've managed to work 42.5 hours in just three days. Since I found this particular project very interesting it hardly felt like work was robbing me of my spare time. I often dislike working long hours as it simply seems like the days are glued together, endlessly working through the week.

Something else was different this time around as well. I've been accustomed to a global salary which remains the same no matter how many hours one invests. These are naturally higher salaries but they weaken the link between office hours and salary and often cause frustration, especially when your colleagues always seem to be relatively underworked and overpaid.

Getting paid for overtime is fantastic in that aspect. Even though I'm well into my 14th hour at the office on any given day my "reward" is directly linked to the time invested.

Since I spend considerable time pondering personal finance in general I started thinking about overtime from a financial-philosophical perspective. Thankfully, we've currently got our hands full of work. Each and everyone who wishes to get more done are quickly assigned another project and another. Many of those who wish for more spare time are often assigned more and more as well.

My financial-philosophical line of thinking quickly led me to a hopeful yet somewhat disturbing conclusion. Walk with me through this simple line of thought: Each extra hour of overtime I put in is quickly translated to a higher salary at the end of the month. Now, since we are currently able to save a portion of our income each month an additional hour of overtime would simply increase our savings by that amount directly.

Now comes the hopeful yet disturbing part. Since we all know the power of compounding interest each hour of overtime is quickly translated to 2.5-3 hours of early retirement 20 years from now! (compounded using a modest 4.5% return for 20 years). Assuming approximately 1,800 work hours a year, all I have to do to retry a year early is to work 2 more hours every day for 3 years.

The more I work today, the higher the compounding effect so I might as well go for 4 hours a day, right? That's where the disturbing part kicks in. Mortgaging the present for future's sake is a part of extreme financial frugal thinking.

The basic economic logic behind this line of thought is called permanent income and states an individual wishes to smooth income over the course of one's life. When earning more one will save more to compensate for a potential future in which less income would be available (such as retirement).

But there is more to this line of thought than permanent income. Philosophers often disprove arguments by giving absurd examples which the argument supports. This technique is called Reductio ad absurdum and it is very fun to use.

If we continue with this line of thinking than every vacation we postpone will compound and be worth so much more in the future (far future). Every expense we avoid can be saved and left to compound for eternity. There's more to life than compounding, isn't there?

We financial people tend to see everything in terms of present and future value, interest rates, returns and capital. It seems we forgot to enjoy life as it is. The assumption early retirement will bring us some great joy is dubious at best. If ever, many retirees I've talked to have distinctly pointed out they miss work and meaning. I do believe I will be able to find meaning in retirement as well but I think I'll avoid thinking about overtime as a shortcut for early retirement for now.

Related posts:

Image by: anguskirk


Mike said...

This is exactly the type of thing I often find myself pondering. Thanks for a suitable topic to consider for the next few days.

Funny about Money said...

Hmmm.... Overtime minute-wise and hour-foolish if you make yourself sick with overwork and cut short your lifetime. ;-)

I prefer to think of the evenings and weekends as snippets of early retirement. And the closer real retirement comes (or, in these times, the further it recedes...), the less inclined I am to let work interfere with those moments of "early retirement."

Dorian Wales said...

@Funny about Money - when you put it like that I'm forced to agree.

There's something about waiting for retirement which feels wrong. What about the present?

The human fate I guess..

billyakerman said...

Too many people don't realize what they lose in return of making more money now.

Mary@SimplyForties said...

I've heard many middle-aged divorced men, when expressing their lack of understanding about their wives complaining that they were never home, say words to the effect of, "I was doing all that so she could have a nice home, car, jewelry, etc.". On the other hand, most women I know will say they would rather have more time with their husband than any of the material things all that extra money buys. Just a thought!