In Lighting a FIRE I talked about what FI and RE mean, as well as some of the reasons I want to get there. But how do we get there? How do we earn our freedom?
“You want to have enough money so that you don’t HAVE to work any more . . . and you want to do this in your 30s??? This just sounds like a pipe dream. Nobody could ever really accomplish this . . . right?”
Wrong! It turns out that many other people have already been down the FI road and have done this very thing! That’s what’s so great about all the FI blogs available, you can learn from those who have gone before you!
“What about you Mister DS? Have you reached Financial Independence?”
We have not reached FI yet, but we are on our way! I’m writing this blog to share some of what we’ve learned on our journey, and hopefully also to learn from you, our smart readers, via the comments!
So how does this whole FI thing work? As Jim Collins said: “Spend less than you earn, invest the surplus.” It’s that simple. Remember though that simple doesn’t mean easy.
Speaking of Jim Collins, I recently read his book, The Simple Path to Wealth. If you or anyone you know is intimidated by investing, read this book. It is fun and easy to read, and makes a strong case for why the simplest approach to investing is the best.
To reach FI fast you need to do 2 things: Save a large percentage of your income, and invest the money that you saved.
Save Money
So how much total do you need to invest to retire? The most common answer is the 4% rule. That is, you can *safely withdraw 4% of your net worth per year and your money will probably last forever.” Thus the amount of money you need is 1/0.04 = 25 x your yearly expenses.
One key word there is expenses. Many retirement resources will advise you to aim for some percentage of your income. Your income is irrelevant once you retire since it will be gone. It is your expenses you need to pay attention to.
For example, if a family of four can live comfortably off of $40,000 per year, then they will need $1,000,000 invested in order to retire.
So how much of your paycheck to save? Mr. Money Mustache (MMM) notes that the math behind FI is shockingly simple. It all comes down to savings rate. That is, the amount of money you invest divided by the income you bring in. The higher your savings rate, the faster you can wave goodbye to your cubicle. There is a handy calculator here.
Many conventional finance books and websites recommend saving 10% of your income . . . but that is total wuss-dog territory! Invested in index funds, a 10% savings rate would lead to approximately a 50 year working career! That means if you start working in your twenties, you are not done until your 70s (barring any aid from social security or other windfalls). You need to save more!
On FI blogs, a savings rate of 50% is a common recommendation for a minimum savings rate. At that rate your working career drops to 17 years. If you start at 21 you can be retired by 38. If you save 2/3 of your salary you should be able to get there in under 10 years. This is how MMM and others were able to retire in their early 30s.
Increasing your savings rate is the single most important thing you can do to accelerate your FI date. It’s the 80% in the 80-20 rule. Everything else that people like to debate (which specific investment you choose, whether you go with Roth or traditional IRAs, real estate vs. index funds, etc.) is all just trying to get you that extra 20%. The bottom line is that if you get your savings rate very high you will succeed, and if you don’t then you probably won’t (at least not quickly).
As a couple that didn’t save a dime** until learning about FI in 2016, Mrs. DS and I can personally confirm two things about saving rates:
- The mythical 50% savings rate IS possible!
- We did it! Prior to FI our savings rate was near zero. $200/month to the 401k + the principal portion of our mortgage payment was all that we saved until the end of 2015.
- We worked very hard on our spending and in July 2017 we hit a 50% average savings rate exactly!
- Note that I calculate this as our average savings rate for the previous 12 months on a rolling basis. We had many months that were higher, and many months that were lower than 50%.
- Getting to a 50% savings rate is NOT easy, but it is worth it!
- In the fall of 2017 we had our second kid and my wife stepped away from her job to be home with them.
- This put a serious dent in our average savings rate. It dropped down well into the 30s, but we’ve not given up working on it, and our average savings rate is now back up to 40%. With income continuing to rise, and expenses continuing to fall, we will get back to 50%!
- Having the ability for my wife to stay home with our young kids is amazing! There is so much work to be done outside of work when you have young kids. Having one person be able to make this difficult job their focus has made such a difference in our happiness level.
- This is something we never could have afforded if we hadn’t first spent a year and a half getting our spending under control.
- We are not Financially Independent yet, but just pursuing it has made such a difference in our lives already!
So how does one go about increasing their savings rate? There are only two ways (and you should do both):
- Decrease spending
- Increase earnings
Decrease Spending
Assuming you are already at or above the median income, decreasing spending is where you should start. You have the most immediate control over this, and you get a double benefit when you spend less: You have more to invest now, AND since you are now living on less money the total amount you need to save decreases!
Which expenses to target first? Recurring expenses, particularly large or frequent ones, are the most fun. This is because every time you eliminate a recurring expense it is like getting a huge lump sum payment deposited directly to your investment account!
What do I mean? Well let’s say you decide that TV is a waste of time (it is), so you cancel your cable subscription and save $100 per month. $100 per month is no big deal right? Wrong! $100 per month adds to $1,200 per year. The 4% rule says that to support any amount of spending in retirement you need to have 25x that annual spending sitting in an investment. So to support a cable TV habit you need to save and invest $1,200 x 25 = $30,000. So by removing that expense forever that is $30,000 you no longer need to save, i.e. you are now $30,000 closer to retirement! How long does it take to cancel your cable TV? 10 minutes? You just made $30,000 in 10 minutes! That’s like $180,000 per hour! That’s 10 minutes well spent!
In addition to the $30,000 lump sum you just earned, you now have $100 extra every month that you didn’t have before! Here is the trick to the whole thing though . . . you must invest the money you save! Don’t spend it on something else or your magic $30,000 disappears.
You think cutting monthly expenses is fun? You should try cutting weekly or daily expenses! The payout is huge! This is where the so-called latte-factor comes in. Cut out your $5 latte and make good coffee at home for $1 instead.
“I get to save $4??? Yippee! Mr. DS, you’ve got to be kidding me! What a waste of time!”
Actually no, it isn’t a waste of time. $4 x 365 days a year = $1,460 per year. $1,460 x 25 = $36,500 . . . Cha-ching! Payday! And you aren’t even giving up good coffee, you’re just making it at home, which is fun anyway!
I recommend tracking every recurring expense that you eliminate and adding that up onto a mandatory savings list. The total from your list should be taken off the top of your budget every month and put directly into your investment bucket. This way you aren’t tempted to spend it. It’s money you were already spending anyway, so you shouldn’t miss it in your budget. Note that this list is just your minimum savings amount each month. You should try your best to put away much more than this, but there should never be a reason to save less than this amount.
For example, if you saved $100 per month on cable, and another $200 per month by canceling the house cleaning service and cleaning the house yourself, then your Mandatory Saving List would total to $300. Budget this $300 to investing before doing any of you other budgets. This way you will always invest what you are saving instead of blowing it on other things.
I’ll go over many ways that we’ve cut our spending in future articles. That said, as Scott Trench noted in his book Set for Life, the largest expense columns for most people are housing, transportation, and food. Make big cuts in those areas and you’ll be well on your way to the mythical 50% savings rate and beyond.
Increase Earnings
Although decreasing spending is incredibly powerful and totally within your control, there is a limit to how far you can reduce. I don’t think you can take your spending to zero, and you certainly can’t go below that. However, unlike savings, the amount you can earn is theoretically infinite, so why not earn as much as you can?
There are many ways to increase your earnings. You can start a side hustle. You can find a job that pays better. You can get better at the job you currently do. That’s just a few, I’m sure there are more.
Side Hustles: These are anything you do outside of work to earn extra money. This post has a ton of ideas. As long as you pick something with low startup costs, there is little risk in trying to start a side business. If one of these side hustles really takes off, you could end up as a business owner doing it full time! You may not even need to wait for FI. Time to hustle!
Get a Better Job: If your job isn’t compensating you enough, or if you aren’t passionate about it, then look around! At the time of this writing the economy is hot! Many employers are having a hard time finding good people to help them grow. Be that good person! There are many online places to look for a new job. www.linkedin.com is a great one.
As a side note, I’d recommend reading the book The Magic of Thinking Big. If you become the person described in that book, you won’t have trouble landing and excelling at a great job.
Get Better at Your Job: If you already have a great job, the logical thing to do is get better at it. By finding ways to add value to your company you will turn yourself into a key person. Key people get compensated better! I plan to write a series of posts on how I improved myself at work. From getting organized, to being more effective, to becoming a happy person that people WANT to work with, there is a lot that you can do!
If you can simultaneously cut your spending and increase your earnings you will be amazed at how fast the money piles up. The question then becomes, what to do with the pile of cash…? Find out next week . . . same bat-time, same bat-channel!
*Nothing in life is totally safe or guaranteed, especially not investments. That said, the 4% rule seems like a good place to start. Mad Fientist put an excellent article together on it here: Safe Withdrawal Rate for Early Retirees. If you want to read another view that suggests perhaps shaving the safe withdrawal rate down a bit, check out the Safe Withdrawal Rate Series on Early Retirement Now.
**This is not technically true. I set up a small 401K contribution of $200 per month when I started working in 2005, and I suppose you could count the principal portion of our mortgage payment as savings as well. These 2 things together, however, added to a very small percentage of our income.