“Great! Now I know how to make my nest egg last for my early retirement. But what if I don’t care about retiring early or saving up enough to become financially independent? I love my job and want to do it forever! YAY WORK!“
That’s great! You’re either lying to yourself (and me), or you may be one of the very tiny minority that honestly feels this way, and I might be just a little bit jealous.
REALITY CHECK: Your Job Doesn’t Love You!
So, you love your job. But what if your job doesn’t love you? We’ve all seen those commercials where a business person or factory worker comes home to their spouse all dejected looking. They had been working for the same company for some 20 odd years and were suddenly laid off, no pension, no benefits, etc.
You don’t want to be that person. And if you do happen to be that person, you will want to be well prepared for when that happens to you.
In the 10 years I’ve worked in my current profession, I’ve been through three layoffs, two of which directly affected me. People with as much as ten years seniority weren’t safe. Let me tell you, it sucks. Apart from the wonderful and ever existing possibility of getting laid off at your job, here are some other things for you to consider:
- What if you get ill or disabled and aren’t able to work?
- What if you need to take significant time off to care for a family member who becomes ill or disabled?
- What if a political party gets voted into power and makes vast cuts to your area of work?
- What if your job gets in the way off other things you would love to spend time with (spouse, kids, hobbies, etc.)?
These are just a few of the situations that can happen. You are not invincible, and like most jobs and professions, you’re probably replaceable. But you don’t want to be replaceable. You want to be adaptable, efficient, and resilient.
Becoming financially independent helps protect you and provide you with these skills. It allows you be less reliant on your job, and become more independent in life. It gives you more choices and the freedom to make those choices.
Saving a Mountain
In Part 1, I said that the key to FIRE is to spend less than you earn and invest the difference. The shorter your time frame for saving, the less significant that the investing part plays a role. Since we’re aiming for a speedy FIRE, we’ll be focusing on the “saving” part; the framework behind “saving a mountain”. But don’t neglect investing or dismiss the power of the resulting compound interest, as it will be of great assistance in speeding up your journey to FIRE.
“Alright, so you previously said I needed to save 25x my yearly expenses to become financially independent and make the 4% rule work. Soooo, how do I actually save that much? And how do I do it fast and efficiently for an extremely early retirement? That’s probably a mountain of money right?!”
Your savings rate is the single most important factor in how long it will take you to reach financial independence. This is the percentage of your net (take home) income that you are able to save each year. Ie: if you make $50,000/year net, have expenses of $45,000/year, you are able to save $5,000/yr. Thus, your savings rate is 10% of your income.
How long would it take you to reach 25x your expenses based on your current savings rate? Let’s use the power of math to find out!
The Power of Math
If you spend 100% of everything you make, then you will never save anything, and thus never reach your 25x target. If you spend more than 100% of your income, then you’re becoming indebted, and that is the worst place you want to be.
On the flip side, if you spend 0% of your income, then you’ve already reached your 25x goal. However, I can’t say I know anyone who lives on 0%. It’s the in between that gets interesting.
Common “wisdom” suggests saving 10% of your income each year for retirement. Doing it this way, how many years will this take you to reach 25x your expenses? To make it simpler, how long will it take you to reach even just 1 year of expenses? The answer is: ~7.5 years (assuming investment returns of 5% post inflation. If you didn’t invest, it will take 9 years ($5,000 x 9 = $45,000). Remember when I said to not neglect the investing aspect?).
Almost 8 years of working to save up one year of expenses. And the goal is to save x25 your yearly spending. You’re going to be working a long, long time at that rate.
The following chart visually shows what the effects are of different saving rates while on the path to financial independence. (Investment returns are assumed an average of 5%/year)
At the 50% rate, it would take you 17 years to reach 25x your spending. If you increase your savings rate even more, to 60%, 70%, or even 80%, this drastically reduces the time it will take. This works on any income, whether you make over $100,000 or $20,000. Pretty cool, eh? Say goodbye to NEEDING to work for the traditional 30 to 40 years of expectation that we’ve been so conditioned to.
Imagine, starting your career at say, age 22, and saving 50% of your yearly spending. You would reach FIRE at age 39! That’s decades sooner than the traditional “retire at 65”!
Maximum Return For Least Effort?
Like many things in life, there tends to be a point of maximum return for your efforts, and also a point of diminishing returns. In the chart above, the right hand column shows the effects of increasing your savings rate on the amount of time to reach financial independence. Note the increase from saving 5% to 10%. For such a seemingly small change, it has an enormously powerful effect; it gets you a huge decrease of 15 years off your retirement date for very little effort.
The point of diminishing returns starts around the 50% savings mark, where increasing the next several 5% jumps only accounts for a decrease of 2 years per each jump. The closer you get to saving 100%, the more challenging it can become to reaching that end without using some ingenuity and inventive ideas.
For most people, the 50% rate is entirely realistic and achievable, and with a 17 year working timeline, it’s not too bad at all. Although the higher rates are also reachable, it is generally easier with a higher income due to a basic threshold cost of living (and thus expenses) that we all require, such as food/housing/utilities/transportation, etc.
This is not to dissuade you from striving to reach as high as possible, but that if the best you can achieve is 50%, then that is definitely quite respectable and will get you where you need to be in a very reasonable amount of time. Now, if you are netting $100,000/year and can’t reach above 50%, then there’s something seriously wrong, and it’s time for some self-reflection.
“50%? I can’t even save 10%?” Well, then it’s going be really hard to retire very early, or ever, with your current lifestyle and spending habits. You need to change that. You can change that.
“Yes, I can change, but I still don’t know how I’ll ever achieve these crazy high savings rates? Typical wisdom only tells you to save 10 to 15% of your income and even that’s hard!“
How to Spend Less than You Earn.
If you ever hope to reach FIRE, then you not only have to spend less than you earn, but significantly less. This is accomplished by two ways. Increasing your income OR decreasing your expenses. Doing both maximizes the time to early retirement, but it’s not always realistic for everyone. One way is harder, and one is easier.
The Harder Way
Increasing your gross income is harder. Why? Well, there are several approaches you can take, but they usually come with some barriers and challenges. The biggest income leaps usually take the most time to procure, and time is our most valuable resource.
You can pick up a 2nd job, or a 3rd job. Or you can pick up more overtime at your current job (If it’s available). You can work a side gig on the weekends. You can go back to school to get retrained, though that also costs money and usually quite a bit of time.
All of these ways also take a large increase in energy expenditure. Many jobs have built in raises to them, which can help increase your savings rate, but a lot of times they don’t even meet inflation.
The Easier Way
The easy way is to decrease your spending. It’s the option that is the most immediately in your control and also the most effective. You can become more efficient by changing and reducing your spending habits to become more value oriented and efficient.
This has several powerful effects. You will need to save less for retirement because you will be spending less, thus it will take less time to reach FIRE. You will pay lower taxes in “retirement” because you’ll need less income. You will qualify for MORE tax benefits and potentially get more from social security programs at a lower income tax bracket. The easy way will save you time, money, and energy.
The Bonus Easy Way:
The “harder way” that I mentioned early was about increasing gross income. But there are ways you can increase your net income. Using tax reduction strategies such as charitable donations, RRSP contributions, medical deductions, etc., will not only reduce your tax burden and thus raise your net income, but also likely bring in more with social security programs like child care benefits.
Efficient and Value Oriented Spending.
Many people believe that if you “go on a budget” or try and cut down on expenses, that they will be living poor, have a terrible quality of life, and be miserable. But this is not in fact true. Living well within your means does entail the word “well”, and that should be taken to also mean “quality”. Many of the financial changes you can and will make should be based on what you value and that also adds value to your life. Unfortunately people make decisions based on things that they “don’t really” value, or “thought” they would value, but just turn out to be throwing money away.
Prioritizing things that you value over ones you don’t will curb wastefulness and increases your savings efficiency. That’s where the big changes come. Spending efficiently on things that you find true value in, and eliminating the wasteful excess.
Wants and Needs
Steve Jobs put it so eloquently: “People don’t know what they want until you show it to them.”
You are being marketed to ALL the time by hundreds of thousands of companies that are trying to get you to part with your hard earned cash, convincing you that you NEED to buy their products when you actually don’t!
Knowing what you really NEED versus what you WANT is a super important self reflective skill to have and to continue to develop. This will help you focus your spending into areas that bring you actual joy instead of meaningless distraction and waste. It does take some insight and personal self-reflection, but it will pay you back dividends in the long run.
Adding Up Potatoes
But of course spending less to save more is easy enough to say. In practice, what effect can it have on your savings rate?
Here’s a small example:
You bring home $40,000/yr after taxes. Some of your regular expenses include:
- Daily Timmie’s coffee on the way to work: $2/day, 5 days/week, 48 weeks/year:
–Total: $480/year, or 1.2% of your income. Small potatoes right? - Cable/Internet/Phone package: $150/month
–Total: $1800/year, or 4.5% of your income - Insurance (car/auto/life): $250/month
–Total: $3000/year or 7.5% of your income. Now we’re getting a medium sized potato.
With just these three items, you’ve reached 13% of your disposable income, or $5280/year. This potato is getting pretty large now. Some of these expenses are better to be cut out and eliminated altogether, however, we’ll start slow.
With a small amount of effort, you can easily cut these expenses at least in half, if not more, thereby increasing your savings rate by 7% with virtually no changes in quality of life. All it takes is some simple changes such as brewing your own coffee (much tastier anyway), changing cable to streaming services (No commercials!!!), and price comparing for insurance.
Cutting those expenses in half will give you an extra $41,000 over ten years*, and significantly decreasing the time it takes to reach that FI point.
The interesting thing about this concept is that is gets more powerful the lower your income is. If you’re spending the same amount on those 3 expenses, but only make $30,000/yr net, then your actual spending represents almost 18%. Cutting those expenses in half now becomes even more valuable and lets you save 9% extra of your income/year. That’s pretty sweet.
The Wrap Up:
You may really enjoy your job, and there’s absolutely nothing wrong with that. However, life entails a lot of risks, variables, and unknowns. Financial Independence helps to mitigate those factors and is well within your reach if you so choose to pursue it. This framework will assist you in “saving a mountain” and demonstrates how living well within your means will get you to where you need to be; into FIRE. We’ll get into some more strategies later on. But until then, just remember this:
Even small changes are powerful.
*The $41,000 over ten years is based on 8% average yearly returns, before inflation
