- I don’t have enough money to invest…. Get ACORNS -it’s a micro-investing platform where you can invest in the sharemarket for as little as $5 a month!
- I don’t know how to save… You don’t need to! Splash out on the future you by spending on yourself first and put your cash into difficult to access high-interest savings or investment accounts.
- I spend all my money shopping… Cut up your credit cards and store cards. Only carry cash. How easy is it to spend now?
- I don’t have time to sort out my finances… Start small – 5 minutes a day writing down your expenses. Consciousness is a key. A few hours now tracking expenses, writing up a budget and automating your investing is like paying yourself thousands of dollars per hour in future gains. Not doing it means your pissing that money away.
- I don’t know where to start… Start with taking lunch and a refillable bottle of water. Put the money you would have spent into a HISA or old-school piggy bank.
- But the market will crash… It will. Take a breath. Then stick to your plan. Sharemarket dips are an opportunity to buy in at lower prices, and they have invariably recovered. No one retires early from the interest on CD/savings accounts.
Are there any other big financial roadblocks you have simple answers to? Let me know!
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.
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.