I didn’t expect my previous post on early retirement and opportunity cost to be controversial. I thought it was just a matter of fact. There is an opportunity cost in everything; early retirement is no exception. Pointing out the opportunity cost is not the same as saying you shouldn’t do it. You can choose to accept the opportunity cost and carry on.
I declined a job offer that required a one-hour commute even though the job itself was very promising. If I were renting I would just move closer to the job and move back if the job doesn’t pan out. Because I own my home I’m not going to sell my home or endure the long commute for a job one-hour away. If someone says this is an opportunity cost of owning my home, I would agree. Absolutely. I don’t have to list all the benefits to justify owning my home.
Or you can say I declined the job offer because it was not promising enough to overcome the hassle and cost of selling and buying or the one-hour commute. If they offered a $1 million signing bonus I may very well have taken it. The decision depends on how large the opportunity cost is.
The Alternative Narrative
Opportunity costs cut both ways. It’s just the nature of opportunity costs. The opportunity cost of doing A (stay put in my current home with a short commute) is not doing B (accept the job offer an hour away). The opportunity cost of doing B (accept the job offer an hour away) is not doing A (stay put in my current home with a short commute). The two statements describe the same problem. Saying one automatically implies the other.
For some reason people still want to describe the early retirement versus high income from working the other way — the opportunity cost of working for a high income is not having as much free time as retiring early — even though it’s really the same as saying the opportunity cost of retiring early is not making the high income from working.
Here’s an alternative version of my conversion with my co-worker:
My frugal co-worker and I talked about his recent promotion and new stock grants. I said to him the opportunity cost of making this high income is that he wouldn’t have as much free time than if he just retires early now.
Although his after-tax income will enhance his life experiences in the future, during the years he’s working, he won’t be able get up late, take his long bicycle rides, learn a foreign language, go to the gym in the middle of the day when it’s not crowded, travel to Guatemala for weeks on end, or however he feels like spending his time.
Does either this alternative version or the original version say anything about whether my co-worker should retire now or continue working? I’m afraid not. It’s just two sides of the same coin. Between two appealing but mutually exclusive options, one is the opportunity cost of the other.
The Concept of Enough
Some readers brought up the concept of “enough” as in “If you have enough, you stop working for money.” It sounds good except “enough” is in such a large gray zone it’s not that useful.
If you have $10 million at age 60, by the standard of most people that’s probably enough. If you have $500k at age 30, by the standard of most people that’s probably not enough to retire on, although some people actually push the boundary and retire with that. Anywhere in between, which is probably the case for most people interested enough to read to this point, is in a huge gray zone.
Pick any number between $500k and $10 million. Can you make it work? Absolutely. Just make your budget according to the withdrawals that number can support. Tons of real people actually live on that much or less. You can do it too. Is that the living standard you want? That’s the big question.
If “enough” is defined as “supporting withdrawals for the living standard you want” it’s still not that useful, because “the living standard you want” itself is not set in stone. It’s not as clean cut as
Not Enough ==> Keep working
Enough ==> Stop working
Suppose at this time you don’t have “enough” but you can only find minimum wage jobs due to outsourcing. Do you continue with minimum wage jobs until you have “enough” or do you settle with a lower living standard? I would settle with a lower living standard. Suppose at this time you have “enough” but now if you work the next year you will double what you came up with in the last 25 years. Do you say no or do you seize it to expand your possibilities from the following year onward? I would work that one year and ignore the Internet Enough Police.
What goes into the decision? The opportunity cost! “Enough” can be moved up or down depending on the size of the opportunity cost relative to your wealth, age, hours and stress, and many other factors.
We are back to our original problem: high earners face a large opportunity cost if they retire early; working for a high income incurs an opportunity cost in free time. Which way you go depends on the opportunity cost.
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I’ll soon turn 61 and I’m eligible to retire today. If I continue to work until age 62, my inflation-adjusted pension will be permanently increased by 10 percent. In the first year of retirement, that’s worth about $6,000. While my wife and I would like to retire, I’m holding out for this permanent pension bump. Waiting the additional year also allows us to further pay down our mortgage, which will be small as we enter retirement. And, of course, we’ll continue to fund our 401(k) plans and backdoor Roth IRAs. I recognize the opportunity cost of working the additional year but believe we’re making the right tradeoff for the long term.
Its just a miserable way of looking at early retirement (or to continue working)
No one wants to think I have given up on money to retire early. And likewise no one wants to think they have given up on time to continue working.
Rather one would retire early because they have what they wany to live off and one continues working to feel more comfortable in retirement!
Opportunity cost ignores the idea of a goal that once reached there is no need or desire for alternatives. Or at least the value of the alternative diminishes greatly.
Harry Sit says
Whether one wants to think that way, is it correct though? Just putting on a blindfold is only hindering one’s own good decision making. How was the goal set in the first place? Is it still the right one given the current circumstance? That’s when you need to consider the opportunity cost.
Physician on FIRE says
I’m glad to see a follow-up on this one. Your recent posts on this topic have been discussed on a couple of the forums I frequent (Bogleheads, MMM).
I’ve participated in some discussions on the opportunity cost of an early retirement, particularly as it relates to high earners, and the concept of “golden handcuffs” that the opportunity cost represents.
I’ve said more than once that the only way I can justify walking away from millions is to have millions already. I’m going to disagree with the assertion that Enough is too big a gray area to be useful. Across society, it’s a gray area. $500,000 may be more than enough for a simple, single person. For others, something north of $10 million could disappear in a year.
Enough is an individual concept, and it’s based on annual spending. The caveat is that individuals change over time, and so might needs and wants. So each individual or family has a gray area or a couple standards of deviation from what Enough might be at one time point.
To cover our gray area, I’m shooting for more than Enough. It helps that I usually enjoy my job. But I enjoy all those non-job related things I could be doing even more (sleep, bikes, Guatemala…). My answer is not to call it a day at 25x expenses, but shoot for 40x to 50x and re-evaluate. For me, that should be more than Enough and our gray area will be accounted for.
The opportunity cost balance will have shifted in favor of recapturing my time rather than more money.
Harry Sit says
Physician on FIRE – I agree with you. How large is a couple standards of deviation? It sounds like plus or minus 50%, which is still quite large.
Invested Life says
It must be noted that 25x expenses already includes a standard deviation in it because it’s historically based on worst case scenario. The majority of the time, someone calling it quits with 25x expenses is able to spend more over the coming years because the portfolio has grown as a rate that outpaces your expenditures. I think many people have difficulty trusting this, which is is why they plan to save more. This, in effect, isn’t just doubling up on the safety margin. It’s SQUARING it because now the doubled up portfolio will outpace one’s expenses in the majority of scenarios where one withdraws 4% of the initial portfolio value, leading to an even larger runaway portfolio balance over time. Saving beyond 25x then represents one of three things, either a belief that the future will be worse than anything in the past, a lack of understanding that someone spending 4% is most likely inevitably able to spend more, or being so risk intolerant of not being able to flex higher with future expenses that, even though it would occur in only the worst case scenarios, it is too great an opportunity cost to stop working. Perhaps there’s a middle ground where the fear of 4% not being enough, and the math that it is, and the realization that the effect of overshooting is squared, not doubled, might allow someone to trim how far they want to overshoot.
Physician on FIRE says
Thanks, Harry. I don’t suppose you could calculate the standard deviation without knowing how much you spend each year for a number of years.
I think a 50% buffer is large enough to cover most peoples’ “gray area.” If you are starting from a barebones existence and a shoestring budget, you’ve got more room to grow than someone already living a middle class lifestyle with the usual creature comforts, which is where I’m at.
I think of the opportunity cost dilemma in terms of a “likelihood of regret” scale. At this moment, age 40, I am more likely to regret retiring early and giving up my best earning years. By age 50, I think I’ll be more likely to regret not retiring earlier, rather than continuing to work for money I clearly don’t need. The 2 lines of likely regret intersect somewhere. In this example, it’s probably somewhere near age 45, which is the age I expect to have my 40x to 50x expenses. I think I just derived my ideal retirement age.
M. Anderson says
I read your post about early retirement. I found it insightful and compelling, and thus saw no reason to comment on it. Don’t assume that those who take the time to comment represent the views of everyone, or even the majority.
It helps if you really like what you’re doing. On the other hand, if you don’t the opportunity cost of keeping on keeping on is always too high.
Harry Sit says
If you don’t like what you’re doing, find something else you like. That applies whether you have “enough” or not.
Maslow or someone else like that opined that rewarding work is a key to a happy life. Being a retired lotus eater is not necessarily going to make a person who was unhappy in their career any happier. How many early retirees who couldn’t wait to get away from their jobs are going to admit that?
Mary Kelley says
The comments seem to ignore the fact that we don’t know how long each of us will live. So at the end of your working life, every year worked is one less year of life enjoying retirement. This is what I find so difficult to calculate. I think of that book title, “Your Money or Your Life.” We give up days, years of our life to get more money.
Missing from the analysis is the apparent notion implicit in some people’s attitudes that work is an intrinsically unrewarding endeavor other than for its financial compensation and therefore that there is no non-financial opportunity cost to early retirement. I’m sure most of the people here and at bogleheads aren’t unhappy drones toiling away on an assembly line crossing days off the calendar until they’re eligible for the gold watch. Do otherwise happy productive people really think they need to retire to fully enjoy their lives? It kind of makes one wonder how they ended up in whatever their profession is in the first place.
I like what I do and find my work rewarding. I has taken me many years ( over 40) to be good as I feel I am now and as proficient at what I do. I still think I get better. I think I make a difference.
I take to be financially independent is a gift. If I do not like to play ( work as a career) any more I have enough marbles to retire, for me “enough” 500 K or 10 million” has little to do with it.
Harry Sit says
That aspect is captured in Staying In Your Job After Financial Independence. This one is more for people who, if given a choice, would like to spend more time on riding bicycles, learning a foreign language, traveling to Guatemala etc. Not that people can’t do those things while working, or that they must dread every day if they want to retire early, they just prefer recreation over working.
Harry, I think you are right on. First off I can’t tell you how often I’ve made logical observations, only to be accused of making an emotional one. As a matter of fact, early last year I told my wife that unless we changed our plans, 2015 would be a break-even cash flow year. She then accused me of being negative/pessimistic… and she knows me better than anyone; I’m a very optimistic person, and took mild offense, in a bemused sort of way. But my 50/50 forecast established an expectation that was in opposition to her hopes [& she’s a fantastic accountant, with amazing skills that I can’t replicate – but few people are good at forecasting uncertainty, which is what i basically do for a living. I nailed that forecast, by the way.]
I am always amazed at people talking 25x savings. At age 45-50 we have about 6.5X: 5x in retirement funds & 1x in business equity, 0.5X in Real Estate (not our home). The interesting thing about that is, based on the stats I can find, we’re in the top few percent of savers relative to our income. 25x is in the top 1% of savings relative to income. Kudos to you.
In any case, my personal retirement minimum from this point is $1M (independent from my wife, who is having fun and has plans to work another 15 years, & has job security). I need to earn it, or my investments need to do that much better than expected, before I can retire – at which point I might shift careers or just do the house husband thing. However, you’re right… if I lose my job and can’t find another one that pays close to it, it might make more sense to just retire. We might have to sell our house and move if we decide to pay for all the kid’s college, but we’d make it. No matter what happens at this point, we won’t starve; we’re working for lifestyle now, which makes O.C. a prime consideration.
Great article Harry. The whole concept of opportunity cost is a tough one for many to grasp, and you explained it well. There is a huge opportunity cost to early retirement. For most of us our income stream is our greatest asset. I think everyone in the FIRE community struggles with this. We call it golden handcuffs, or one more year syndrome, but it is really the opportunity cost of cutting off that income stream. Its not as easy as it sounds to take the 4% rule and just walk away. I admire people that can. I think they have less fear than most.
Another related concept is that it’s hard to value the lost opportunity because we are so bad at predicting our future wants, and to a lesser degree needs. Even if we are intellectually aware of hedonistic adaption, it doesn’t mean that we are immune to it’s effects. What if spending 20% a decade in the future DOES bring me more happiness and I’m just not aware of it now?
Jonny Pean says
I declined a job offer in Australia when I had just embarked on my entrepreneurial journey. After reading your post I have realized that I had actually let go off an opportunity cost which was not impressive enough for me to hold my entrepreneurial dreams!
Millennial Moola says
It’s amazing how most people’s answer to what enough is, is often 2 two times their current networth. Then they obtain that and its 2 times higher again. Lifestyle inflation at its finest
The concept of enough is different to different people. For me, accumulation of wealth has always been about financial security rather than Ferraris and Bentleys. That’s not to say one lifestyle is superior; rather, it’s just a personal preference.
Many high-earners who peruse financial blogs are likely to face this sort of fork in the road sometime in their mid to late 40s: retire now with debts paid off and net worth in the millions or keep working until 65 to maybe triple their current net worth (or something in between).
In this sense, for someone with a good financial acumen, enough can be more tangible idea. You should have a relatively decent estimate of how long your current retirement portfolio should sustain your desired lifestyle. No doubt fifteen or twenty years of high income is a lot of money to forego, but, nonetheless, I think it is a legitimate question for people to ask themselves.
A person living a life not chained to one high-paying job may indeed be living a better lifestyle than someone with three times the net worth but no flexibility in schedule to make use of it. Kind of like the old saying: “A bird in the hand is worth two in the bush.”
People saying this is a false choice are only partially correct. If you have a flexible job you like, perhaps you can make time for work and play quite easily. I know this isn’t my case. In fact, I don’t think it’s mathematically possible for everybody in our society to be happy and/or passionate about their job. That doesn’t mean I hate my job either; I’m just more realistic about the fact that not every child sitting in a school room is going to “find their calling” so to speak.