“People ask me all the time how we got four surplus budgets in a row. What new ideas did we bring to Washington? I always give a one-word answer: Arithmetic” – President Bill Clinton
The above chart demonstrates the power of saving. If your expenses are 100% of your take home pay, then you will have no savings. Without savings, you will not be able to put money to work to generate a return for you. This means you cannot stop working, otherwise, your cash flow stream will end and you will not be able to meet your expense obligations. Conversely, if you only spend 10% of your take home pay, and save the other 90%, you can effectively be financially free after 1.6 years of work assuming a steady 7% real rate of return on your savings per annum and no future increase in your expenses. If you only spend 50% of your take home pay, and save the other 50%, you can effectively retire after 15 years of work (once again assuming a steady 7% real rate of return on your savings).
I Can’t Only Spend 10% (or 20% or 50% or 80%) of My Pay, It’s Crazy!
Saving a good part of your take home pay is a great way to secure your financial future. But based on a lot of feedback in my personal life in discussions with family, friends and colleagues as well as comments I’ve read on blog posting suggesting a high rate of savings, people tend to say things along the lines of “it can’t be done, I can’t spend only 30% (or 50% or <insert a percent here less than 100%>). It’s crazy.” Another comment I’ve read online goes “I make $50,000 and cannot survive on $25,000.” My question to you is why not? It is more a function of choice on how much you spend than it is a situation that is forced upon you.
Many people survive on $25,000 per year (or $15,000 or $50,000, etc). In fact, my folks raised a family of 5 on that amount. Sure, it wasn’t easy for them and they made sacrifices on what to spend their money but, at the end of the day, they were able to raise three well-adjusted children into adulthood. Saying I can’t survive on $25,000 is as out of touch with reality as an NBA basketball player saying I can’t survive on $21 million over the next three years because I have a family to feed a-la Latrell Sprewell.
I also think back to my own situation. My living situation was different back then than what it is today. Out of college, I made a fraction of what I make today but was able to still save because I adjusted my living situation to the income generated. As I made more money, I increased the amount of money I spent (but always less than the increase in earnings).
Additionally, what is crazier: to scale your life style appropriately today so you can gain financial freedom tomorrow or spend all your income today and work into your 80s or 90s in order to put a roof over your head and food on the table when you are battling old age and potential health issues.
Have Your Money Work for You
While it is an important part of the equation to financial freedom, savings (or limiting your expenses) won’t be enough on its own. You also need to invest the savings to generate a return. There are many ways to generate a return on your investment but it is harder to generate a steady stream of income year in and year out amounting to 7% per year in today’s low interest rate environment. Stocks in the long run might produce a 7% return but there is volatility. You might be down 10% one year and be up 20% the next year. It is hard to be dependent on equity returns if you need a steady cash flow stream to meet your daily needs. Buying bonds might be a challenge here as well given the current low yield environment. High yield bonds are yielding less than 7% on average and you will be exposed to interest rate risk. If the interest rate environment continues to be depressed over an extended period of time, then the yield might even be lower. I think if you don’t mind a bit of work, buying rental properties is the way to go. Sure there is exposure to property price fluctuation but you are not buying for that purpose. You need a cash flow stream and rental income is a great way of obtaining it. In addition, rent is a great hedge against inflation. As inflation increases, your rental income should increase accordingly as well. You will be collecting a stream of rental income on a monthly basis in order to pay for your living expenses. If the property price depreciation, it doesn’t matter too much to you because your dependency on the property is the rental income. As long as the rental income comes in, it doesn’t matter how low the property price goes. With this in mind, you can surely hold onto the property for a long period of time. In the long run, the chances are in your favor that the property price will appreciate.
Look Mom, I’m Retired at 30
So is it possible to retire at 30? Absolutely, if you start work at 22 after undergraduate school and spend 30% of your take home pay and invest the other 70%. In fact, you should be able to retire before 30. Let’s assume you graduate from college with a degree in computer engineering and you are able to land a $80,000 per year job (which is about the median starting salary for a computer engineer in 2013 according to the US Department of Labor). Your take home pay should be about $57,000 a year assuming if you live in New York. You can spend $17,000 a year and be able to retire by 30 and continue to spend $17,000 a year assuming a real rate of return at 7%. Now if you think living on $17,000 a year is tough, now imagine if you marry your fellow computer engineering classmate and your better half is also stocking away $40,000 while only spending $17,000 a year. Now as a couple, you have $34,000 in cash to spend annually which should afford a comfortable living.
To the audience: How much do you save a year? What percentage of take home pay is it? Was it hard for you to save this amount?
Many people work hard to better their physical and mental health. What about their financial health?
I started this blog back in 2019 to help people better their financial health as well.
My financial journey began with tens of thousands in student loan debt. Over the span of 20 years, I am close to achieving financial independence.
I truly believe anyone can get to strong financial health. Hopefully, this blog can help you on your financial journey to greater wealth and financial independence.
You can read more about me here.
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