Why would someone on $250,000 a year never be able to retire? Because they’re spending $260,000. They’re always chasing debt.
At a certain level of income, your basic needs are met – food, housing, clothes, utilities,
public transport. If you earn beyond this level of basic needs, it’s up to you as to how soon you reach financial independence. Every dollar you earn above your basic needs is a choice between spending the dollars today, and investing the dollars in your future. It is a careful balance, requiring some planning and a little bit of willpower. The truth is that most people on an average income can reach financial independence or retirement a lot earlier than they may assume and it all comes down to expenses.
Here are some very basic calculations I did to see how my expenses would impact my
financial independence. For these, assume a withdrawal rate of 4% (ie. how much you withdraw from your wealth each year post-retirement) and a real interest rate about 3% (ie. how much return you receive on investments above inflation). These are true for all levels of income after you first begin saving:
- If you spend 100% and save/invest 0% of your earnings, you will never retire!
- If you spend 90% and save/invest 10% of your earnings, you will reach financial independence in 70 years
- If you spend 75% and save/invest 25% of your earnings, you will reach financial independence in 40 years
- If you spend 50% and save/invest 50% of your earnings, you will reach financial independence in 19 years
- If you spend 25% and save/invest 75% of your earnings, you will reach financial independence in 7.5 years
- If you spend 10% and save/invest 90% of your earnings, you will reach financial independence in 2.7 years
After seeing these numbers and adjusting for different incomes and expense levels, I realised two key things:
- Your savings rate is key to financial independence. Depending on your situation, improving your savings rate (% of income not spent) may be more easily achieved by either earning more and maintaining expenses or by spending less and maintaining earnings. My current income as a full-time teacher allows me to easily meet my basic needs and more, so I have found that cutting $100 from my regular expenses is more easily achieved than regularly earning an extra $100 (up to a point!). For an extreme example of expense minimisation and achieving early retirement, check out http://earlyretirementextreme.com/ . This level of cost-cutting is not achievable or desirable for everyone, but it does give some insights into the importance or the savings rate and how to find ways to significantly reduce expenses.
- An additional dollar saved is more powerful than an additional dollar earned, in
the quest for early retirement. To understand this requires a little maths. Lets say you’re saving 0% and then you cancel your unnecessary, expensive cable and gym memberships and now you’re only spending 80% of your income, your savings rate is 20%. But your mate who also saves 0% thinks that’s a terrible idea and instead takes on additional work which increases their income by 20%, and they don’t increase any expenses, their savings rate is only 16.5%. Looking at the calculations above, its clear to see you will be retiring before your mate, even though they’re on an income 20% higher than yours.
What is best for you will depend both on your current level of income and expenses, and which approach to increasing the savings rate is most easily attainable whilst maintaining a sufficiently good quality of life. Though for many people, myself included, there are ample opportunities to reduce expenses and improve our savings rate to achieve our wealth and retirement goals sooner.
A simple calculator play around with to understand the impact of savings and expenses can be found here – http://mustachecalc.com/#/calcs/time-to-fi and I have a bunch of other useful tools described on my page: 10 great tools for crunching the numbers.
As a 9-5er, Sunday is about reading, walking, picnicking with friends, nursing a hangover, catching up on sleep and laundry. But a really great Sunday can also help set you up for an awesome and wealth-wise week. Here are a couple of things I try to do most Sundays to fire me up for a new week:
- Make a big batch of lunches (45minutes – save $45) – I love cooking and I love cooking beans, which are an excellent food to reheat at work with some rice and smoky hot sauce. As part of Sunday dinner prep, I throw the rice cooker on (best $15 you will ever spend), and then chop up onions, garlic, veggies, fry it up with choice spices (cumin, smoked paprika, cinnamon, oregano), add some tinned tomatoes and tinned beans, and after about 30mins of cooking you have excellent lunches for the whole week. Just whack a serve of rice and beans into five tupperware containers and bam, healthy, cheap lunches for the week! If you don’t like beans and rice, there are heaps of other options – sandwiches, pasta, curries – whatever you like cooking and love eating. Either way, you will save heaps by not paying for lunch at work and likely eat a much healthier meal.
- Stock the fridge with healthy and nutritious snacks – I tend to do a shop on Sunday and try to make sure there is a good abundance of fruit, nuts, veggies and dips in the fridge to make sure that I have plenty of great snacks to take to work and avoid the mad rush to the takeaway kebab joint in the afternoon when a 5pm-hunger starts to kick in.
- Put a water bottle in your bag – you never know when you will need a drink, and there is pretty much always a tap to be found somewhere to fill up. This always saves me cash as I never need to buy bottled water and reduces my impact on the environment from massively energy intensive and wasteful plastic bottles. Win-win!
- Check your expenses for the week and put that into your spending account – I like to take a few minutes to think about what I will be spending during the week (groceries, petrol, pub meal etc.) and just transferring that amount into my debit card account. This allows me to pre-plan and figure out strategies to reduce overspending (for example, if I know I will be meeting friends at the pub in the evening, I might decide to have dinner at home first then only have a drink when I’m there to avoid the $20-odd cost of the meal).
- Make a mini-FIRE goal – financial independence and early retirement (FIRE) is a stretch goal of mine, so to motivate myself I set a little financial goal for myself that week to help me along that journey – it might be an action related to a bigger monthly/yearly project to build new habits or simply something I’ve been wanting to try out to see how it fits with my life. It also helps to reinforce why I’m spending the time to do the things above.
- Get to bed early! – there is nothing worse for destroying self-control and laying the groundwork for credit card carnage than tiredness. With weeks seeming ever more busy, I find that if I don’t get a decent sleep on Sunday, it is extremely hard for me to catch up during the week. It definitely can be tough to get to be early on Sunday when you’re beginning to think about work, plan the week but still trying to enjoy the weekend. I find that making sure I get some decent exercise in, some sun if possible, limiting alcohol and screen-time and eating relatively early all set me up for an excellent Sunday sleep.
Is there anything you get up to on Sunday that sets you up for a stellar week? I’d love to know!
When making larger purchases it can be useful to think about the costs and benefits for your future-self to decide whether something is worth having. For something to be worth spending money on, the cost to your future-self should be less than the anticipated benefits.
For example, if I spend money on something NOW worth $10,000, that is $10,000 worth of investments that I forgo. By spending rather than investing, I reduce the future value of my investments. At a modest 6% return, that means in 30 years, my future-self has $57,500 less money than if I had invested. That equates to working an additional year to reach financial independence (which my future self is unlikely to want to do!).
To determine if this purchase is really ‘worth it’, then the purchase should add more than $57,000 of additional benefit to your future self in 30 years. If it doesn’t then it is probably not worth your current-self spending your future-self’s money and time!
What types of spending does this apply to? Education, cars, technology, houses, any sort of asset or career building investment, really anything that is not recreational. ‘Joy value’ is very hard to quantify, and whilst it is definitely worth considering how much you spend on leisure and whether you could get equal enjoyment out of cheaper pursuits, it can be a fine balance between constantly trying to determine if leisure spending is wasteful and actually just enjoying yourself!
So when making spending big next time don’t just consider you, think about how your future self will be impacted by what you’re about to do.