RPF0163-Savings_Rates
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00:00:46.000 | Today on the show, we dig into the impact of savings rates on time to financial independence.
00:00:55.000 | One of the most powerful concepts on how you can quickly become financially independent, no matter how old you are or how rich you are.
00:01:24.000 | Welcome to the Radical Personal Finance Podcast.
00:01:26.000 | My name is Joshua Sheets and today is Wednesday, March 4, 2015.
00:01:31.000 | On Wednesdays, we dig into technical financial planning, but we're going to keep it a little bit more lighthearted today.
00:01:36.000 | I'm sick and tired of talking about college accounts or retirement accounts or anything like that.
00:01:40.000 | So we're going to dig into savings rates and talk about how you can utilize the theory of hardcore savings to become financially independent.
00:01:51.000 | [Music]
00:01:56.000 | If you are well-versed in the world of the financial independence early retirement literature and basically that world of people, then the concepts presented in this show will not be new or – it won't be new or surprising to you in any way.
00:02:12.000 | But if you're well-versed in the world of mainstream personal financial advice, this show might be a bit of an epiphany for you.
00:02:20.000 | It certainly was for me.
00:02:22.000 | And in today's show, I'm going to build off of a concept that I first read in Jacob Lund Fisker's excellent book entitled Early Retirement Extreme and also pay tribute to a more accessible article written by Mr. Money Mustache called The Shockingly Simple Math Behind Early Retirement and share a little bit of the back story on how I arrived at these concepts and then share them with you in hopes they could be useful to you.
00:02:50.000 | You might have heard my story, but essentially I spent years interested in mainstream personal finance.
00:02:57.000 | And a standard aspect of mainstream personal financial advice is to save 10 or 15 or maybe even 20 percent of your income toward your retirement.
00:03:07.000 | And I would spend hours browsing at Barnes & Noble or browsing my library and reading book after book after book on how to get rich.
00:03:14.000 | And all of these books seem to agree on the idea and concept of saving 10 to 15 to 20 percent of your income toward retirement.
00:03:22.000 | So that's what I set out to do at an early age.
00:03:25.000 | At 18, I opened a Roth IRA and I started working to divert – I think if memory is correct, something like 15 percent of my income into that account.
00:03:32.000 | It wasn't much.
00:03:33.000 | I was doing other things.
00:03:34.000 | I was paying for college classes and I never was able to consistently do all of 15 percent.
00:03:39.000 | But that was kind of what I was doing.
00:03:41.000 | I would sit down with the sample budget calculations, for example.
00:03:45.000 | I remember years – during the years of my later years of college, sitting down and working on the 80/10/10 budget where you spend 80 percent.
00:03:54.000 | You set 10 percent aside into this category and 10 percent into this other category or other things like that.
00:03:59.000 | When I would sit down and set up my 401(k) contributions at my employer, I would sit down and I would target that 10 to 15 to 20 percent range depending on what was going on in my life at the time.
00:04:09.000 | There were times in which I was paying off debt, so I would make different choices there.
00:04:13.000 | There were other times when I was saving for a big expense.
00:04:17.000 | And so these numbers varied, but I always had in my mind the concept of saving 15 percent.
00:04:22.000 | And this is a standard concept.
00:04:25.000 | Just as an example of what is, I think, generally accepted in the industry of personal financial advice, I went to my bookshelf and I pulled off my old copy of The Automatic Millionaire by David Bach.
00:04:38.000 | This was the book that put David Bach as a financial guru on the map.
00:04:42.000 | My copy, I had it soon after he published it, I think, and he's since gone on to take – okay, 2004.
00:04:49.000 | Yeah, so mine is dated from that time.
00:04:52.000 | It's been on the bookshelf ever since and he's since gone on to publish another 10 or 15 or 20 versions of this book with various twists.
00:04:58.000 | But I pulled it open this morning and he starts off by talking about the latte factor and making it automatic.
00:05:04.000 | And then he talks about learning to pay yourself first and here he talks about the formula of how much money you should save in the context of this paying yourself first chapter.
00:05:13.000 | And here are his categories.
00:05:16.000 | So if you want to be dead broke, he says, "Don't pay yourself first.
00:05:20.000 | Spend more than you make, borrow money on credit cards, and carry debt you can't pay off.
00:05:25.000 | If you want to be poor, think about paying yourself first, but don't actually do it.
00:05:29.000 | Spend everything you make each month and save nothing. Keep telling yourself someday.
00:05:34.000 | Middle class, if you want to be middle class, pay yourself first 5 to 10 percent of your gross income.
00:05:40.000 | Upper middle class, pay yourself first 10 to 15 percent of your gross income.
00:05:44.000 | And if you want to be rich, pay yourself first 15 to 20 percent of your gross income.
00:05:48.000 | If you want to be rich enough to retire early, pay yourself first at least 20 percent of your gross income."
00:05:54.000 | And that's it. That's the advice.
00:05:57.000 | And so with the 20 percent number being the top range, if you want to retire early, save at least 20 percent.
00:06:04.000 | And in my mind, I always bracket it with 20 percent as a really great savings rate.
00:06:08.000 | And there are various well-meaning people.
00:06:11.000 | I'm sure most of us have had a well-meaning aunt or uncle or grandfather or grandmother or parent even or older mentor, somebody who came by and said, "Listen.
00:06:22.000 | If I were you, I would suggest that you save X percent of your money for retirement."
00:06:27.000 | Usually that number is somewhere between 10 to 20 percent.
00:06:29.000 | So this gets really locked into my head as a 10 to 20 percent number.
00:06:34.000 | But I never knew where it came from. I never understood it until I read Jacob Lundfisker's book, Early Retirement Extreme.
00:06:42.000 | And if you're new to the show, I would recommend to you that you go back and listen to episode 3,
00:06:48.000 | which was my book review of Early Retirement Extreme in the very early and pretty awkward days of the show.
00:06:53.000 | So you can find that at RadicalPersonalFinance.com/3.
00:06:56.000 | And then also episode 25, which was an interview with Jacob Lundfisker.
00:07:00.000 | And you can find that at RadicalPersonalFinance.com/25, also linked in the show notes for today's show.
00:07:05.000 | This book opened my eyes to a different approach.
00:07:11.000 | Now, I had been reading Jacob's blog for a little while at that time.
00:07:14.000 | I'm not exactly sure when I read the book. He published it in 2010.
00:07:20.000 | I must have read it soon after that.
00:07:22.000 | But remember this for context. I was already working as a new financial advisor.
00:07:27.000 | I was already supposedly somewhat knowledgeable about money, investing, retirement, things like that.
00:07:36.000 | And I had never considered the possibility or the impact of saving a higher dollar amount until I read his book.
00:07:44.000 | And I have a few theories on why that might be.
00:07:47.000 | And I'll just share them with you.
00:07:50.000 | I wound up – these are my theories, but then I went and found – I read Jacob's book.
00:07:55.000 | And as so often happens, I found out that he had similar theories.
00:07:58.000 | And so I have to also give him credit.
00:08:00.000 | I don't know whether he gave me the theories or whether I had them first.
00:08:02.000 | I never – they're not highlighted in the book.
00:08:04.000 | But here are the reasons and the theories behind why I don't think I ever understood it.
00:08:09.000 | And the reason is because when I was younger, we never – I never really was connected to the amount of money that I was saving.
00:08:16.000 | I was a diligent saver, but my parents taught me to go out and open up a savings account.
00:08:21.000 | And that's a great idea.
00:08:23.000 | So I opened a savings account.
00:08:24.000 | But how much interest do you actually earn on a savings account?
00:08:26.000 | And how much money as a young boy or girl are you actually putting into there?
00:08:32.000 | Well, for most of us, it's not much, a few hundred dollars.
00:08:34.000 | I remember I was probably fortunate enough at some point – I broke through high school.
00:08:39.000 | But then after that, at some point, you have $1,000 in your savings account.
00:08:42.000 | Well, if you're getting – today's world, let's say that you're getting 2 percent interest on that money.
00:08:49.000 | So you have 2 percent interest.
00:08:50.000 | That's $20 in a year.
00:08:52.000 | Or let's say we're in a different savings environment.
00:08:55.000 | You're getting 4 percent interest on $1,000.
00:08:57.000 | That's $40 in a year.
00:08:58.000 | And you see that come in on your monthly statement.
00:09:00.000 | Divide that by 12.
00:09:01.000 | That's $3.33 of interest on a monthly basis for money in the savings account.
00:09:06.000 | So we don't ever think – I never thought much about the interest being small –
00:09:10.000 | excuse me, about the interest being a big impact.
00:09:13.000 | It never really affected me that much because I just thought, "Well, yeah, it's just some interest.
00:09:17.000 | But it's not enough to do anything with."
00:09:19.000 | I never thought how I could live on the interest and be financially independent.
00:09:22.000 | It just didn't really occur to me that much.
00:09:25.000 | Number two problem with this approach was that the money was locked away digitally.
00:09:29.000 | So there's a concept, which I'm going to cover in detail in just a moment,
00:09:32.000 | but essentially that if you're saving – let's say that you're saving half of your money.
00:09:37.000 | So you earn 200 – you're living on as a young person $500 a month.
00:09:42.000 | And you earn $1,000 and you save $500.
00:09:45.000 | By definition, what that means is you could not work for a month
00:09:49.000 | and you'd have a month's worth of savings set up.
00:09:52.000 | But because all of my savings were digital, setting aside in a bank account,
00:09:55.000 | because that was the prudent thing to do, right?
00:09:57.000 | We don't keep cash in a modern US-American society and most Western societies.
00:10:00.000 | We don't actually live on a cash economy.
00:10:03.000 | We just save money. We get it in the bank, get it in the bank, get it in the bank,
00:10:05.000 | lest it be stolen or lost or spent or something like that.
00:10:08.000 | And so we're very disconnected from our money.
00:10:11.000 | That might be different than if, as an example,
00:10:14.000 | we lived in a place where it's normal to have a cash economy
00:10:17.000 | and you were paid in crisp currency of some kind
00:10:20.000 | and then you spent whatever currency you needed on each of your expenses.
00:10:23.000 | Well, over time, you would build up an envelope or a cash box
00:10:26.000 | or a bag or something.
00:10:29.000 | You would build up some amount of money.
00:10:31.000 | And you could actually look at that money and you could interpret it
00:10:34.000 | in the context of what you were actually spending.
00:10:37.000 | And you might actually realize that if your expenses were the equivalent of $500 a month
00:10:43.000 | and you had $6,000 set aside,
00:10:45.000 | you might realize that you didn't have to work for a year.
00:10:47.000 | Well, I never realized that.
00:10:50.000 | It might sound foolish. Maybe everyone is smarter than me.
00:10:52.000 | But I never realized it because my money was always tucked aside.
00:10:55.000 | It's kind of fake money. It's just digital money.
00:10:57.000 | It's numbers on an account and didn't really mean anything to me.
00:11:01.000 | The other mistake was that when I really started saving,
00:11:04.000 | I set all my money aside in retirement accounts.
00:11:07.000 | And so worse than having the money tucked aside in a digital savings account,
00:11:13.000 | it was tucked in a retirement account where I can't access it.
00:11:16.000 | Now, because I consumed most of the world of personal finance,
00:11:18.000 | I learned that that was important.
00:11:19.000 | It was important to put money distance between me and my money.
00:11:21.000 | And that's true.
00:11:23.000 | And I learned and I schooled myself, "You never touch retirement accounts.
00:11:26.000 | You never touch retirement accounts.
00:11:27.000 | You never, ever, ever touch retirement accounts until you're retired."
00:11:30.000 | And so I adopted that as a philosophy and I said,
00:11:33.000 | "I'm never going to touch that retirement account."
00:11:35.000 | The problem is then by ignoring it completely, those numbers are not real.
00:11:39.000 | So not only can you not spend them – not only can you not see them,
00:11:42.000 | but now you can't spend them.
00:11:44.000 | And so it has no real impact on my thought process.
00:11:49.000 | And I was trained to look at the long term.
00:11:52.000 | So I was trained by personal finance literature to look at the long term.
00:11:56.000 | And then every time you look in the personal finance literature,
00:11:59.000 | you always see a chart that's focused on age 65.
00:12:01.000 | So as an example here in the automatic millionaire,
00:12:04.000 | he gives an example of somebody starting to invest at age 15 and at age 19,
00:12:09.000 | at age 27 with a 10% annual return.
00:12:12.000 | Those numbers are all calculated at age 65.
00:12:15.000 | And I think this is helpful.
00:12:17.000 | I do the same thing on the show.
00:12:18.000 | You'll often notice frequently I'll do a 30- or 40-year calculation
00:12:21.000 | because that over time is where you get the impact of compound interest
00:12:26.000 | over that major amount of time.
00:12:28.000 | But because I was always focused on 65,
00:12:30.000 | I'm putting money aside in retirement accounts,
00:12:31.000 | I never connected with what my actual savings was doing.
00:12:35.000 | I either had retirement money or I had short-term expense money,
00:12:40.000 | saving for a trip, saving for a thing, an item to purchase, something like that.
00:12:44.000 | I never connected the savings to my actual life.
00:12:47.000 | And it never dawned on me that I could be financially independent
00:12:50.000 | except at an old age until I read Jacob Lund Fisker's book.
00:12:56.000 | And his way of presenting it completely adjusted my way of thinking.
00:13:01.000 | I don't think I'm alone because in the years that I worked as financial planning,
00:13:05.000 | and I'll tell you in a little bit how I've integrated this into financial planning,
00:13:09.000 | but I've discovered that nobody thinks in terms of financial independence,
00:13:13.000 | but everyone thinks in terms of I just know I need to save money.
00:13:16.000 | So we're saving money 15% for the long term.
00:13:19.000 | Nobody thinks in the short term.
00:13:22.000 | But yet how powerful is that?
00:13:25.000 | So I'm going to share some concepts here from early retirement extreme,
00:13:28.000 | and I'm on about page 195 if you want to see the section that I'm pulling from.
00:13:33.000 | It's at the very end of the book where Jacob says this,
00:13:37.000 | but it's under a section called "Making Money Work for You."
00:13:40.000 | And he starts off with the concept of financial ratios,
00:13:46.000 | and he talks about what financial ratios mean within the context of your expenses.
00:13:53.000 | So in financial planning advice and personal finance literature,
00:13:57.000 | you often hear about the concept of an emergency fund,
00:14:00.000 | having a medium-sized amount of cash set aside that can fund your expenses.
00:14:06.000 | So if we're going to recommend that we're going to save 10% of our income
00:14:10.000 | and that's going to be going toward our emergency fund,
00:14:14.000 | then if we save 10%, then it will take us 9 months of savings to equal 1 month of expenses.
00:14:23.000 | If by definition we're earning $1,000 a month and our expenses are $900
00:14:29.000 | and we're saving $100, then over the course of 9 months' savings,
00:14:34.000 | we'll be able to accumulate 1 month's worth of expenses, an emergency fund.
00:14:40.000 | Now, interestingly, this should be instructive to you as to why most people don't have emergency funds.
00:14:46.000 | If this is the standard example, save 10%, and if the expenses that we're actually needing to spend are 90%,
00:14:53.000 | then let's say that you are giving somebody advice to accumulate a 3-month emergency fund.
00:14:58.000 | Well, 9 times 3 equals 18. It could be 27.
00:15:04.000 | My elementary school times tables are fading. 9 times 3 is 27.
00:15:09.000 | So that means that if somebody is going to save at that rate,
00:15:12.000 | it will take them 27 months of focus to accumulate a 3-month emergency fund.
00:15:18.000 | What if the advice is a 6-month emergency fund?
00:15:20.000 | It takes 54 months of focus, 4.5 years of focus to save toward an emergency fund.
00:15:30.000 | That's not including retirement. That's not including anything else.
00:15:34.000 | Who in our modern society is able to focus on one individual financial goal for,
00:15:39.000 | in the case of a 3-month emergency fund, for over 2 years or in the case of a 6-month emergency fund,
00:15:45.000 | for 4.5 years without changing goals?
00:15:51.000 | That's such a massive amount of time in our current context, the way we view time.
00:15:56.000 | That's why very few people ever accomplish this goal.
00:15:59.000 | We're generally taught to think of our expenditures as compared to a ratio of our income
00:16:06.000 | and simply to spend based upon in a proportionate manner to what our income is.
00:16:11.000 | Responsible planning is spend 80% of your income, spend 90% of your income.
00:16:14.000 | Even if you're able to save 20%, consider that to save 20% of income –
00:16:20.000 | if you're saving 20% of your income, to accumulate 4 months – excuse me,
00:16:25.000 | 1 month of income in an emergency fund requires you 4 months of savings.
00:16:29.000 | That's a not insignificant amount of time.
00:16:33.000 | So to accumulate 6 months, that's still 2 years of savings at a 20% rate.
00:16:38.000 | And when have you ever heard anybody advocate saving higher than a 20% number?
00:16:44.000 | I never did until I've read Jacob Lundfisker's writing.
00:16:49.000 | I never did.
00:16:51.000 | I always thought I was doing the responsible thing.
00:16:54.000 | So my point is that it's generally disconnected.
00:16:57.000 | We never accumulate the money because we're not really focusing on the actual impact
00:17:00.000 | and it's very difficult at those low savings rates to make progress quickly enough to actually feel it.
00:17:07.000 | Now compare for a moment if you switched to a 50% savings rate.
00:17:14.000 | So if you're saving half of your income, that means that for every month of working,
00:17:19.000 | you're accumulating 1 month of financial freedom, ignoring any interest.
00:17:25.000 | So if your expenses are $500 a month and you earn $1,000, for every month you work,
00:17:31.000 | you've accumulated 2 months of expenses, this current month plus another month.
00:17:35.000 | That's very different because if you say now to save a 3-month emergency fund requires simply 3 months,
00:17:41.000 | that makes a lot of sense or a 6-month emergency fund requires 6 months.
00:17:45.000 | That makes a big difference and a lot of sense in your thought process.
00:17:53.000 | And this leads to the concept of just simply intermittent work, which most people don't think about.
00:17:59.000 | Jacob profiles this in his book with a chart and says,
00:18:02.000 | "Now if you work with a savings rate of this percent for 1 year,
00:18:05.000 | how many years do you need to work before you can take a year off?"
00:18:08.000 | So if you have a savings rate of 1%, you need to work for 99 years until you can afford to take a year off.
00:18:15.000 | This again ignores any interest earnings on your savings.
00:18:19.000 | If you have a savings rate of 5%, then you need to work 19 years before you can take 1 year off.
00:18:26.000 | If you have a savings rate of 10%, you need to work 9 years before you can take 1 year off.
00:18:32.000 | If you have a savings rate of 25%, you need to work 3 years before you can take 1 year off.
00:18:39.000 | Now what's interesting is if you have a savings rate of 50%, as we talked about,
00:18:43.000 | you need to work 1 year before you can take 1 year off.
00:18:48.000 | If you have a savings rate of 75%, you can work for 1 year and take 3 years off.
00:18:56.000 | And if you have a savings rate of 90%, you can work 1 year and take 9 years off.
00:19:05.000 | Now before you just criticize me and say, "Well, no one saves 90%," ignore that.
00:19:08.000 | I'm talking about the concept.
00:19:11.000 | I urge you to consider the concept because I never in my life grasped that concept when I was younger and studying personal finance.
00:19:17.000 | I never grasped the idea that, well, if I saved 75% of my income, that for every year of working I could take 3 years off.
00:19:24.000 | Whoa, that's kind of interesting.
00:19:29.000 | And it makes the concept of financial independence accessible because we're focusing on what we can control more easily.
00:19:40.000 | So if the three things that are mainly impacting the amount of money we have for the purpose of financial independence is
00:19:46.000 | the amount that we put into the account every month or year, the interest rate that we earn on the account,
00:19:53.000 | and the length of time in which that account is invested, the one that's the easiest to control is how much we put in.
00:20:01.000 | It's harder to control the percentage rate of return that we earn on our investments.
00:20:06.000 | It's also actually not possible to control how long the money is invested simply because time is marching forward progressively.
00:20:12.000 | We can, of course, control what we put in and leaving it alone, but we can't actually control the amount of time.
00:20:17.000 | Compound interest is powerful because of time, and time, I've not figured out a way to adjust it.
00:20:23.000 | It's just marching forward.
00:20:26.000 | But I can control how much I put in.
00:20:31.000 | I never just considered that I could save more than 20%, but wow, you're telling me that if I work for half a year and save 50%,
00:20:39.000 | then I can not work the second half of the year?
00:20:42.000 | Now, of course, weirdly, I was doing that when I was working my way through school.
00:20:46.000 | I was working during the summers.
00:20:47.000 | I was working on Christmas breaks and spring breaks, things like that, and then that money was stretching me,
00:20:51.000 | but I never identified it as a concept because I never identified it.
00:20:55.000 | I never really recognized that I could manipulate it.
00:20:59.000 | I urge you to consider that.
00:21:01.000 | Now, remember again that that discussion that we've just had doesn't account for interest.
00:21:07.000 | And I think that's OK.
00:21:10.000 | You've heard me mention on the show before when people often write a question and they say, "Well, Joshua, how can I afford to retire?"
00:21:19.000 | One way I think it's valuable to look at that is to ignore the concept of gaining investment interest
00:21:25.000 | because when you add in the concept of how much am I going to earn on my investments,
00:21:29.000 | oftentimes that makes people feel very uncomfortable with what number to use and how certain that is.
00:21:36.000 | But if you take a million dollars and you just simply say, "Yeah, I spend, say, $30,000 per year,"
00:21:42.000 | and you say, "Assume that you just stick the money in the bank and you're not going to have any investment earnings,
00:21:48.000 | but you spend $30,000 per year," then by definition, you have accumulated 33.3 years of income at that level, $30,000 per year.
00:22:03.000 | That should give you a much greater sense of confidence and security to recognize,
00:22:08.000 | "I've got a 33-year runway to make my decisions even without interest."
00:22:15.000 | Now, of course, you could make poor investments and you could lose the money,
00:22:19.000 | but oftentimes it's very simple and we don't think about that.
00:22:24.000 | We don't think about the fact that if I just have a couple years of expenses tucked away,
00:22:28.000 | no, I'm not financially independent for the purpose of being able to live off of a portfolio for the rest of my life,
00:22:33.000 | but I can quit my job and go travel for a year or two and then come back and earn some more.
00:22:38.000 | Lots of people do that, so I don't have to stay stuck in this job I don't like.
00:22:43.000 | I don't have to stay stuck in this lifestyle that I didn't intentionally choose.
00:22:48.000 | I can make a change.
00:22:50.000 | That's a powerful freeing concept.
00:22:53.000 | Now, when you bring interest into it, it's even more powerful.
00:22:58.000 | Now, it does get more complicated because we have to assume, well,
00:23:01.000 | what kind of investment strategy we're going to pursue, what's a reasonable rate of interest,
00:23:04.000 | and then how does that affect our portfolio?
00:23:07.000 | Those are important questions.
00:23:09.000 | But even if we just take some simple conservative assumptions and we add in investment returns,
00:23:14.000 | it makes a powerful, powerful difference.
00:23:16.000 | In his book, Fisker, Jacob Lund Fisker walks through the detailed formulas.
00:23:21.000 | It's very useful, but most of you are just simply going to gloss over those couple pages of formulas.
00:23:26.000 | I gloss over those couple pages of formulas.
00:23:28.000 | I look at them to make sure, okay, I get it, but it's difficult reading.
00:23:33.000 | But the key is that he gives a chart after showing the formulas,
00:23:37.000 | and the chart illustrates that at various rates of savings,
00:23:42.000 | it illustrates how many years under an investment return,
00:23:45.000 | how many years you need to save in order to be financially independent.
00:23:51.000 | Generally, when we're doing financial planning, most mainstream financial planning is primarily focused on the length of time
00:24:00.000 | that your account is invested and partially on the rate of return.
00:24:05.000 | But by flipping and including in this formula the context of how much you're saving,
00:24:12.000 | Jacob gives us an ability to focus on something that we can actually control, and this is powerful.
00:24:18.000 | Now, at this point in time, this is where the chart is hard to actually convey to people.
00:24:24.000 | But some years later – actually, not years later, but soon after the – two years after the book was published,
00:24:32.000 | the blogger Mr. Money Mustache published an article entitled "The Shockingly Simple Math Behind Early Retirement."
00:24:39.000 | What he did was he took that chart, adjusted for investment returns,
00:24:46.000 | and then focused on how many years of savings at different savings rates would be required
00:24:54.000 | before you're considered to be financially independent.
00:24:58.000 | This chart is so easy to grasp that I found tremendous uses for it in teaching people about savings.
00:25:07.000 | I will reproduce it for you in the show notes, and I will link to his original article.
00:25:12.000 | But it's a powerful, powerful article and powerful concept.
00:25:17.000 | So that you are aware of the assumptions in the chart, here they are.
00:25:22.000 | The assumption is that you can earn a 5% real rate of return, so 5% rate of return after inflation during your savings years,
00:25:32.000 | and that you're going to live off of 4% of the portfolio value,
00:25:37.000 | and also that you want the investment account to last forever into perpetuity.
00:25:42.000 | Now, this is very simplified, but catch the concept, and then those of you who are extremely detail-oriented
00:25:48.000 | want to come back and nitpick all the details, you can do that and you can reproduce your own charts.
00:25:53.000 | But here's the key. I'm going to walk through some savings rates and how many years you need to work
00:25:58.000 | until you're financially independent.
00:26:01.000 | If you save at a 5% rate, saving 5% of your annual income, you will need to work for 66 years,
00:26:09.000 | and then at that point in time, you will be financially independent.
00:26:13.000 | If you save at a 10% rate, you'll need to work for 51 years.
00:26:19.000 | If you save at a 15% rate, you'll need to work for 43 years.
00:26:25.000 | Now, interestingly, let me ask you a question. Have you ever wondered where that 15% savings rate
00:26:31.000 | that's so often recommended came from or where that 10% to 20% range came from?
00:26:35.000 | This is where it came from. Because when you run enough of these analyses and you find out
00:26:41.000 | that somebody is saving 15%, how long does it take for them to become financially independent?
00:26:45.000 | 43 years. Take 65, subtract 43, you're age 22.
00:26:52.000 | That's why as a financial planning industry, we recommend to people who, when they graduate from college,
00:26:58.000 | save 15% of your income towards retirement. Why does Dave Ramsey recommend save 15% of your income
00:27:03.000 | towards retirement? If you come out of college at 22 years old, you went at 18 to 22,
00:27:09.000 | and you come out, and if you save 15% of your income toward retirement, then at age 65,
00:27:14.000 | you'll have enough money to last you for the rest of your life.
00:27:17.000 | Now, he's actually much more aggressive with his rate of return assumptions,
00:27:20.000 | but that's a reasonable way to get to it. Interesting, huh?
00:27:26.000 | And what you find is when you do enough sophisticated, carefully planned out
00:27:30.000 | with financial planning software retirement illustrations, you wind up with numbers of income
00:27:35.000 | that are pretty much close to this. Let me continue on.
00:27:38.000 | If you'll save 20% of your income, in 37 years, you'll be financially independent.
00:27:42.000 | If you'll save 35% of your income, in 25 years, you'll be financially independent.
00:27:50.000 | Here's where it gets interesting. If you'll save 50% of your income, in 17 years,
00:27:58.000 | you'll be financially independent. If you'll save 75% of your income, in 7 years,
00:28:05.000 | you'll be financially independent under these assumptions.
00:28:08.000 | If you save 100% of your income, you're now financially independent by definition.
00:28:14.000 | Where it gets really fun is in that 50% to 75% range because many people want to retire early.
00:28:23.000 | I cannot tell you how many times I have done a fact-finding appointment
00:28:27.000 | or have reviewed a fact-finding document that other financial planners have gathered
00:28:32.000 | wherein the person that they're interviewing and talking to says, "I want to retire early.
00:28:37.000 | I want to retire early." Then the natural next question is, "Well, what is early?
00:28:41.000 | I want to retire at 50." You ask, "How much are you saving?" "I'm not," or, "I'm saving 2% of my income."
00:28:46.000 | First of all, nobody sits down and calculates how much they need to retire.
00:28:50.000 | Second, nobody sits down and calculates how much they need to retire early.
00:28:54.000 | Worse, when you do as a financial planner, you usually come back with dollar figures.
00:28:59.000 | You need to save $3,642 per month to reach this goal.
00:29:04.000 | What we need to do as financial planners is come back with percentage figures.
00:29:08.000 | Now, I learned to do that from this chart. This chart was so powerful to me.
00:29:12.000 | I said, "That's what I did." From then on, I talked about percentage figures, especially with younger clients.
00:29:17.000 | If you're 20 years old, you want to be financially independent in about 10 years.
00:29:21.000 | You need to save 65% of your income for the next 10 years, and you'll be financially independent.
00:29:26.000 | Now, why does this work? A big thing I would like you to make sure that you recognize,
00:29:31.000 | and many people are not okay with this assumption, the reason that this formula works
00:29:37.000 | is because it's accounting for both a decrease in income and the growth of the investment portfolio,
00:29:45.000 | meaning that if I'm earning $100,000 a year and I'm living on $25,000,
00:29:49.000 | then by definition, under these assumptions, after seven years, I'll have saved 75% of my income.
00:29:55.000 | After seven years, I'll be able to continue living on that $25,000 a year budget.
00:30:00.000 | This is why most of the time people don't use these charts is because most people have this idea that I want to spend more money in retirement.
00:30:07.000 | Our culture is built around the concept of I want to have a comfortable retirement,
00:30:11.000 | which means for most people, I want to spend way more money than I'm spending now,
00:30:15.000 | which is flatly impossible for the vast majority of people.
00:30:19.000 | Most traditional retirees, aged pensioners type of scenario, do not spend more money than they were when they were working.
00:30:28.000 | Most of them are broke and they're forced to live on much less money.
00:30:31.000 | Now, certainly some do, but it's a very difficult assumption to put in there,
00:30:35.000 | which is why most retirement analyses that financial planners present to younger people
00:30:41.000 | or to frankly to most people except for the very few diligent saving affluent are useless
00:30:47.000 | because they have assumptions, they have numbers in them that the person is never going to do.
00:30:51.000 | It comes back to the things I've repeated again and again on the show.
00:30:54.000 | People who have the money to retire choose not to because they don't want to retire.
00:30:57.000 | The people who are desperate to retire seem to never accumulate any money because they're spending all their money,
00:31:01.000 | so they never have the discipline and the diligence to save the money for retirement.
00:31:04.000 | Now, of course, there are some that actually do want to retire and save the money toward that.
00:31:08.000 | You can be that if you want to.
00:31:10.000 | But in a general societal perspective, that's why our system is so broken.
00:31:15.000 | I choose not to worry too much about the system and I commend to you that you not worry about the system.
00:31:21.000 | Worry about yourself.
00:31:23.000 | If enough people worry about themselves and over time, the so-called system improves and gets fixed
00:31:30.000 | because it's just a reflection of who we are as individuals.
00:31:34.000 | This chart, I hope that you grasp the power.
00:31:39.000 | If you have a goal of being financially independent, what this chart does for you is it puts it into your hands.
00:31:46.000 | You can sit down and you can say, "Here's the date that I want to be financially independent."
00:31:53.000 | Let's say that you're 42 years old and you've always said, "I want to retire early."
00:31:56.000 | Say you're thinking of 55.
00:31:59.000 | Take 55, subtract 42, you have 13 years of savings.
00:32:03.000 | Go to this chart and figure out how much of your income do you need to actually save.
00:32:08.000 | The answer is somewhere between 55 and 60 percent of your income.
00:32:13.000 | Shoot for 60. That gives you 12.5 years under the terms of this chart.
00:32:17.000 | Now, the power is in your hands to go to your budget and say, "How can I live on 60 percent of my current income?"
00:32:26.000 | That's what you can control and affect the easiest.
00:32:30.000 | In the short term, cutting expenses is incredibly powerful, incredibly powerful.
00:32:36.000 | All of us can cut expenses.
00:32:40.000 | Now, it's up to you which ones you choose to cut and which ones you choose not to cut.
00:32:44.000 | Each of us is going to have something different in our lives that's important to us.
00:32:50.000 | That's your job.
00:32:52.000 | But this puts it back in your hand and it puts you focusing on what you can control.
00:32:58.000 | See, if I just came to you and I said, "You've got to pay me $3,000 a month into your investment account," I don't know what to do.
00:33:05.000 | But if I go back and say, "Look at your budget and figure out how to live on 60 percent," that's powerful.
00:33:09.000 | I remember one financial planning meeting that I had which was so – I don't know how I met the gentleman.
00:33:15.000 | But we had lunch and he just was desperate for help and we had lunch.
00:33:19.000 | He sat down and was doing all these different things.
00:33:22.000 | He said, "I just want to retire."
00:33:24.000 | I sat down and in 20 minutes, I laid out a very simple doable plan that didn't involve any black magic in the investment box,
00:33:32.000 | didn't involve any fancy financial planning terminology.
00:33:36.000 | It was all focused on adjust your expenses, build a lifestyle that you love, adjust your expenses to this level,
00:33:43.000 | take advantage of these massive earnings and create an intelligent investment plan off of them.
00:33:49.000 | He walked away from the lunch appointment almost with stars in his eyes.
00:33:53.000 | It was really neat to see somebody just change and understand for the first time how the numbers work.
00:34:00.000 | For the first time, applying this concept of financial planning, if you're a financial planner, you're interested in financial planning,
00:34:08.000 | I would commend to you that you spend time talking with people about this concept before you show them some detailed chart
00:34:14.000 | with a need to save $3,642 a month.
00:34:19.000 | Focus on this.
00:34:21.000 | This is actionable.
00:34:23.000 | This idea of saving a percentage of your income is actionable.
00:34:30.000 | It's actionable. It makes sense.
00:34:33.000 | Now, some people, many people, most people in fact are still not going to do it and that's okay.
00:34:38.000 | Let them live their lives how they want to live.
00:34:41.000 | But I lament the fact that I didn't know about this when I was 15 years old.
00:34:46.000 | If I had known about this when I was 15 years old,
00:34:49.000 | I think it probably would have dramatically changed what I did with the first 10 or 15 years of my earning lifetime.
00:34:56.000 | Really would have.
00:34:59.000 | It would have changed the course and the trajectory of my life.
00:35:02.000 | Now, we can't go back and change it.
00:35:05.000 | I'm implementing this today to change the course and trajectory of my life.
00:35:09.000 | But this is a powerful concept.
00:35:12.000 | I hope that you grasp the power of this concept.
00:35:16.000 | Certainly, anything that I present in such a simple way or anything that isn't presented in such a simple way is not technically perfect.
00:35:25.000 | There are other considerations that you'll have to think through.
00:35:29.000 | But start here.
00:35:31.000 | Don't get caught up in all of the details.
00:35:33.000 | What about social security?
00:35:34.000 | What about life expectancy?
00:35:36.000 | What am I going to invest in?
00:35:37.000 | What about safe withdrawal rates?
00:35:38.000 | Any of that stuff.
00:35:40.000 | Those things have their place and have their day that you need to consider them.
00:35:44.000 | But start here.
00:35:46.000 | Because everything is contingent upon how much money you actually have saved.
00:35:50.000 | It's very frustrating to me when I see people that are focused on how do I optimize the perfect last little thing in my portfolio allocation,
00:35:58.000 | and they're just putting such a tiny amount of money into it.
00:36:00.000 | It's practically meaningless.
00:36:02.000 | Focus first on savings rates.
00:36:04.000 | Build a plan that you're happy with based upon savings rates using this simple understanding.
00:36:11.000 | And then deal with the more complicated after effects.
00:36:16.000 | I think that's enough.
00:36:17.000 | I'm going to leave it there for today.
00:36:19.000 | Sit down.
00:36:20.000 | Look at your own situation and understand what percentage of your own income are you saving.
00:36:26.000 | Take a look at the chart.
00:36:27.000 | Compare it to how long it's going to take you to become financially independent.
00:36:31.000 | Ask yourself if it's easier for you to make some changes with the spending rate or just find out if you're happy with your results.
00:36:41.000 | It's up to you.
00:36:42.000 | Each of us is responsible for our own lives.
00:36:44.000 | Thank you so much for listening.
00:36:46.000 | Share this if you like this concept.
00:36:48.000 | Please share it with some younger people.
00:36:50.000 | Teach this chart to as many teenagers as you know.
00:36:54.000 | It'd be better if you're early teens, but teach it to as many teenagers as you know.
00:36:59.000 | I know a lot of young moms and dads who would love to just have a couple thousand dollars a month of income coming in.
00:37:08.000 | That would dramatically change their situation.
00:37:11.000 | It really would.
00:37:15.000 | Thank you so much for listening.
00:37:16.000 | I appreciate your being here.
00:37:18.000 | If you've found benefit in this show, please consider supporting the show on Patreon.
00:37:22.000 | You can find that link at radicalpersonalfinance.com/patron.
00:37:26.000 | We have a bunch of bonuses and goodies and things that are there for you.
00:37:29.000 | Feel free to check them out and see which of those things is appropriate for you.
00:37:33.000 | We'd love to have you supporting the show there.
00:37:35.000 | Again, if you haven't read or if you haven't – first of all, if you haven't listened to Episode 3 and Episode 25, go back and listen to those.
00:37:40.000 | I think you'll find them useful.
00:37:42.000 | If you haven't read Early Retirement Extreme, I highly recommend it to you.
00:37:45.000 | Listen to my book review of it in Episode 3 to get a real flavor of it, radicalpersonalfinance.com/3.
00:37:51.000 | And then go and buy the book.
00:37:53.000 | It's an excellent investment.
00:37:55.000 | You're going to get far more out of it than it costs you.
00:37:57.000 | I'm actually for the first time tongue-tied.
00:38:08.000 | I think I'm just going to pull this down, start the disclaimer and go out.
00:38:12.000 | Usually I have something to say and for whatever reason today I'm off my game.
00:38:16.000 | Thank you all for listening.
00:38:17.000 | We'll talk with you later.
00:38:18.000 | Absolutely.
00:38:19.000 | Thank you for listening to today's show.
00:38:22.000 | If you'd like to contact me personally, my email address is joshua@radicalpersonalfinance.com.
00:38:29.000 | You can also connect with the show on Twitter @radicalpf and at facebook.com/radicalpersonalfinance.
00:38:36.000 | This show is intended to provide entertainment, education, and financial enlightenment.
00:38:43.000 | But your situation is unique and I cannot deliver any actionable advice without knowing anything about you.
00:38:51.000 | Please, develop a team of professional advisors who you find to be caring, competent, and trustworthy.
00:39:00.000 | And consult them because they are the ones who can understand your specific needs, your specific goals, and provide specific answers to your questions.
00:39:12.000 | I've done my absolute best to be clear and accurate in today's show, but I'm one person and I make mistakes.
00:39:19.000 | If you spot a mistake in something I've said, please help me by coming to the show page and commenting so we can all learn together.
00:39:27.000 | Until tomorrow, thanks for being here.
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