Thinking Outside the Box Archives - Ms. Financial Literacy

savings rate

In this post I discuss the connection between savings rates and years to achieving financial independence. I use my family’s financial situation as an example to illustrate this powerful connection. By the end of having read this post (and the previous one), I hope you’ll be inspired by our story and begin to adopt a similar mindset (a.k.a. financial independence thinking). This post is a follow up on a previous conversation, Create and Live by Your Own Financial Rules. If you haven’t read the post, I recommend reading it first to get a better idea of what I’m about to share here.

Update:

I shared few more financial numbers since I published this article. The first one is on applying the 4% withdrawal rule and the second one is on our estimated (updated) annual expenses.

Saving Aggressively Toward a Financial Goal without Having a Financial Plan

It wasn’t until the middle of 2016 that my husband and I became aware of the financial independence movement. Knowing what we know now, we both have been living our lives by that camp of thought; we just didn’t know.

Very early on in our marriage (we got married in 2010) we casually discussed about early retirement, but we didn’t have a concrete financial plan. We didn’t have a budget or track our expenses. However, we were tracking our net worth.

In some ways we were big spenders. We dined at $$ restaurants every weekend and took five to six weeks of vacations each year (including trips to Western Europe). We also spent a lot of money on groceries. We tried to eat organic food whenever possible (this has been a high priority in our household since year 2011).

In other ways, we were extremely frugal. We made our lunches during the week. We did price comparisons when we shopped. In 2009, I was driving a 1985 Honda Civic. My husband was driving the same model that was made in 1995. We didn’t care for having the latest gadgets. My husband didn’t have a phone data plan until year 2013! I got mine in December 2012.

On average, we saved 60 to 70 percent of our net income. Our financial goal has always been to retire early and travel around the world. However, we didn’t know how much money we would need. We also didn’t bother with doing the math. Somehow, we knew we would just get there, way before we turn 65. We knew about passive income but we weren’t maximizing our investment potentials. We felt like we had a lot of time allowing our net worth to grow organically (with some, but not much efforts).

From year 2008 to 2011, our combined income was under $110,000. While my graduate fellowship covered my tuition and other educational expenses and provided health insurance coverage, the stipend was just enough to pay for basic living expenses. It was only in 2012 that I started contributing to our retirement savings. That was also around the time when we moved to San Francisco. While our combined incomes jumped, our expenses also went up.

One day in year 2013, my husband and I resumed our early retirement talk. We projected we would be able to reach our financial independence number and retire from our day jobs in our early 50s. But, there was still no concrete plan. In year 2014, we changed our retirement target age to mid-40s. We realized that if we would to work until our early 50s we might not be dipping into our retirement savings at all. We would have worked for too long! With that realization, we said to each other, “Why not stop working earlier?” At the time we thought we would need about $3 to $4 million in net worth in order to retire early (living in San Francisco inflated our $ target). But really, that was just a random number we came up with. Forwarded to year 2015, we still didn’t have a concrete financial plan to reach our financial goal. We just continued to save aggressively and kept seeing our net worth go up.

We Found Our Roadmap to Early Retirement

Then, around middle of 2016 we learned about the financial independence online community and we became enlightened. For the first time we felt like we’ve found the roadmap to early retirement! Ever since then, we’ve spent hours calculating our numbers, reallocating and rebalancing our investment portfolio, optimizing our lifestyle and started talking in details about life during early retirement. I will talk more about this roadmap in a future post.

Our financial independence (FI) goal is to save 33X our annual expenses. Our current monthly expenses are about $5,000. About 35% of that goes to childcare. It’s a big splurge for us, but totally worth the money. We value being able to go the gym together every Sunday morning and going out for jogs few evenings throughout the week. We value not having to wake up in the early morning and having to get our daughter out the door to go to daycare. She’s usually still asleep when we leave for work. Nowadays, with the higher cost of living and raising a child, we’re saving about 50% of our net income.

Once we leave our 9-5 jobs, we will no longer be paying for child care. This would drastically drop our annual expenses down to $50,000 or less. Through the financial independence community, we learned that if we choose to live the lifestyle similar to many of the early retirees we will reach financial independence while in our early 30s (this is our average age; my husband is 5 years older than I am). If we want to continue living our current lifestyle into early retirement, then we’re looking at doing that while in our mid 30s (before year 2020). After some number crunches on the calculator, we should be able to reach our financial independence number by year 2018.

I encourage you to read Mr. MM’s article on the math behind early retirement. At our savings rate of 50 to 70% over the last 8 years, the math says that it would take us about 12 years (I took the average) to become financial independent. However, the number of years is less for us. My husband started saving and investing years before we met.

Some Final Thoughts

For years, my husband and I knew that early retirement is possible for us, but we didn’t know how to get there or when we would reach that point. And if we would to arrive, what it would take so that we can stay there? All these questions and more became clear to us once we started reading about some of the stories of early retirees.

It’s important to keep in mind that the financial independence community only provided my husband and I with the last piece of the roadmap helping us plan for early retirement. If we had not been saving aggressively in the past 8 years, we would be nowhere close to achieving FI.

Yes, adopting this community’s mindset toward living one’s life does give you an advantage as a starting point. At the same time, you need to do the homework and put in the effort, too. My husband and I have been doing this for the last eight years. I’m sure if you ask any early retirees who are self-made millionaires, they’d tell you that they did not reach FI by being average or using shortcuts.

As I stated in the previous post, if you are thinking about pursuing financial independence, you need to adopt radical ways of thinking, and live your life accordingly. Don’t just blindly follow the shortcuts just because they are easy. Always do your research, do your math and get into the habit asking yourself, “How can I do better?”. Come up with your own set of financial rules that work for your situation and make sure those rules align with your short- and long-term financial goals and values. Be open to revising the rules once you find them too comfortable. Be radical with your way of thinking (not just in money terms, but your values, too), your creativity and money strategies (e.g., How are you managing your money? How can you do a little better?). You don’t have to follow the conventional path if being average is not what you want.

Readers, prior to having read this post (and my previous one), were you aware of the connection between savings rates and years to reaching financial independence?

How do you approach your savings rate? Do you have to work hard at meeting that goal?

What do you think about Mr. MM’s math concepts behind early retirement? I would love to hear from you at the comment section below.

Spread the message. Encourage others to begin their financial learning!

financial rules

Readers, do you manage your finances following some conventional financial rules (of thumb)? If you want to pursue financial independence, in this post I encourage you to do your homework and think outside the box. Don’t always rely on shortcuts when managing your finances.

Each time I get a little sad when I hear on the radio or podcast, or read in a magazine or newspaper publication, or get asked by a friend, “How much should I save each month?”. My immediate reaction is this, “Why do you need someone else to tell you how much you should save? Why should you allow someone else to tell you how to manage your finances? Just so you don’t feel guilty about spending 30% of your after-tax paycheck on disposable things (based on the 50-30-20 rule of thumb)? Why subject yourself to financial rules of thumb that limit your savings rate? Shouldn’t you try to save as much as you can?”

My Views on Financial Rules of Thumb

This is not to say I’m a complete opponent to financial rules of thumb. I understand that not everyone is as financially savvy or financially confident as I am. Hence, for those people, I acknowledge that financial rules of thumb can serve a purpose in their financial planning. Those people need to start somewhere, and financial rules of thumb can give them a good anchoring point. Yes, anchoring point (as you’re starting your financial independence journey), that’s what these rules should only be.

Think of the rules as training wheels on a bicycle. As a child masters more riding skills, it’s important to adjust the training wheels higher off the ground, and keep doing this until the child feels confident riding the bicycle without the training wheels. Similarly, as we progress on our financial learning journey acquiring more financial knowledge, skills and wisdom, we need to leave the conventional rules of thumb behind at some point, and gradually transition into making our own financial rules.

Another caveat I have on financial rules of thumb is this: if you use those rules, remember to treat them only as rough guidelines. Don’t use the rules as shortcuts when managing your finances. The rules should not replace the need to do research, do math, or evaluate if a short-term financial decision is in alignment with long-term financial goals (e.g., “Yes, I can afford to spend 20% on housing, but I can also save extra $500 toward my retirement saving if I only spend 15%”.). As with any rules, always question the rule’s limitations.

Unfortunately, many people take financial rules of thumb at face value. As long they are following the rules, they think they’re doing well financially. And if they would to be saving a little more than the recommended (say, 25%), they think they’re doing great. And why wouldn’t they when they see one financial media article after another from people and/or institutions of authority recommending similar numbers? You can see examples here, here and here.

It’s easy to have other people (or institutions) do the homework for us, and follow the crow when we don’t know what’s financially possible (see here to find out for yourself). Even someone like Joshua Sheats (the voice behind Radical Personal Finance podcast) didn’t take the time to question the 10 to 20 percent savings rate rule of thumb. Despite his in-depth exposure to the personal finance literature and having built a career as a certified financial advisor, it took Joshua years to have realized the connection between his savings rate and the amount of money he had. In this podcast, Joshua shared with his listeners about his own frustrations and what he started doing in recent years as a result of having Jacob Lund Fisker’s Early Retirement Extreme and the Mr. MM article referenced above.

When I learned that even Joshua (whom I admire in the realm of personal finance) at one point used the rule of thumb to guide his savings rate and didn’t even question its limitations, I can only imagine how many other “users” aren’t aware of each rule’s caveats. Yes, Joshua was still saving a good percentage of his income, but according to his podcast, he could have done better. As such, when one applies financial rules of thumb managing his/her finances, the act itself is serving as a double-edged sword. One the one hand, the user does get some forms of boundaries (e.g., what percentage to save). On the other hand, a typical user might not intuitively think about flexing beyond the boundaries and consider other possibilities (e.g., How would my financial situation improve if I save 50% of my income?).

Our Story

Then, there’re people like my husband, who wasn’t aware of financial rules of thumb when he started working full time. This can be a financial disaster for some in the long term if they save only 5% of their take-home income or not save at all (or even have a negative savings rate). It was a different story for my husband. Mr. FL has always been a smart, frugal person. He doesn’t fall into greed and he has very little desires (that require spending money). Even though he didn’t know much about the stock market in his early 20s, he was very good at accounting and he had solid financial goals. So, Mr. FL just saved as much he could toward reaching his financial goals. From what I know of him, even if he had known about the financial rules of thumb, he would’ve never subjected himself to them.

As for myself, I wasn’t aware of financial rules of thumb until I was in my mid-20s (thanks to all the news media exposures on Yahoo Finance). Even after that, I didn’t revise my approach to managing money, especially when it came to savings rate. For one, the rule of thumb on savings rate was too easy for our situation. The recommended savings rate ranging anywhere from 10 to 20 percent of one’s after-tax income, while our savings rate was at least 50% (and as high as 70%) all the years throughout our married life thus far. And we didn’t want to spend more money. Second, we thought it was silly letting some financial rules of thumb dictate how we manage our money. At the time, we were both already financially savvy and we mostly knew what we were doing. We liked the financial progress we were making, and we weren’t going to let some rules of thumb allow us to think twice about how we’ve been managing our finances. This is especially important when (third reason) most of the rules on savings rate were too conservative for helping us achieve our financial goals (e.g., early retirement in our early 50s). Such financial goals were radical in mainstream America, and when pursuing radical goals, it was important that we apply the same attitude (being radical, that is) toward our lifestyles (e.g., maximizing our savings rate).

What I Learned from My Parents

While growing up my parents weren’t the kind that would purposely sit me down and give me a talk about money. And I thought money was just not to be talked about. However, that didn’t stop me from paying attention to how they were living their lives. Aside from having learned about frugal habits from my parents, I also observed (and overheard conversations between my parents) that my parents were very great savers. At the end of each month my parents would sit down and sum up their incomes. Then, they would allocate a pile of bills to pay rent, a pile to pay for utilities, and a pile to spend on groceries and necessary household items. I noticed that they didn’t set aside money to spend on clothing, eating out, or vacation. Those were not necessities in the household. As an adult, my parents’ money behaviors left profound imprints on my relationship with money.

Nowadays, both Mr. FL and I are very happy about our financial situation. And I’d like to attribute a big part of our financial success to having had the smarts and intuitions early on in our adult years to have created our own set of financial rules of thumb. To us, having been oblivious to the conventional set of financial rules of thumb, has truly been a blessing in our household.

Readers, if you’re thinking about or already on the path pursuing financial independence and early retirement (FIRE), you need radical ways of thinking, and live your life accordingly. Conventional financial rules of thumb can hinder creativity or thinking outside the box. If your goal is FIRE, don’t take the easy way and let others do the homework for you. Financial independence thinking is about thinking outside the box and being creative and radical with our money.

In my next post I will share our financial independence journey, and how having a savings rate of 50% or more over the past 8 years (the time Mr. FL and I’ve been together) has been helping us getting close to FIRE. Over the years, we’ve been seeing a strong connection between our savings rates and years to reaching financial independence.

I would love to hear what you’ve to say or add.

Are you aware of some of the conventional financial rules of thumb? If so, when/how were you exposed them?

Do you have your own set of financial rules/mantras/philosophies you live by each day? How have those rules been serving you?

Spread the message. Encourage others to begin their financial learning!