Ok, so now that the importance of leveraging earnings, let’s take a look at the second lever, savings. Without saving, there is no journey to Financial Independence. If we spend all of the money we’ve worked so hard to earn, or worse, pile on debt to maintain an unaffordable lifestyle, we’re not moving forward at all. As important as it is to upgrade your earnings engine, it does no good if it’s in a broken vehicle. This is why it is crucial to put your turbocharged earnings engine into a high performing savings vehicle.
Engine Size vs Vehicle Speed
A boring machine, a car, and a plane all have at least this one thing in common: an engine. Within each category, they all have various engine sizes and capabilities. For instance, the largest boring machine back in 2013 had an engine that could produce 25,000 horsepower! There are aircraft with engines that produce even more power than that. However, when it comes to speed, it isn’t just the size of the engine that matters, but how it’s used.
While that boring machine may have a 25,000 HP engine, it moves at a whopping 35 feet per day. In the world of personal finance, this is akin to having a 7-figure salary and only saving a couple of bucks every month. If the goal is to get to Financial Independence, you’ll never make it that way! If we put an engine with the equivalent power in an appropriately sized airplane, on the other hand, well then now we’ll be there in no time.
Even if you don’t have a 25K HP engine, you can still choose how you use the one you do have. You could put it into a tiny boring machine moving at a snails pace. Or how about a nice affordable car that cruises down the highway at a reasonable speed? Better yet, put it into a small private plane that will get you there faster than you ever imagined possible. You choose which vehicle you are in by choosing how much of the power in your earnings engine is going to be appropriated towards moving further down the road towards FI. Your ability to save money determines which vehicle type you are driving.
In probably one of the most famous posts in the FI blog-o-sphere, Mr. Money Mustache showed us all how a person’s savings rate, defined as the percent of take home pay saved, is the most important metric when determining how long it is going to take to reach Financial Independence. The higher the percent saved, the less time it takes to reach FI. Pretty simple. For every dollar you save, that’s one dollar less of expenses that you have to cover in retirement. It’s also an additional dollar that you can set aside and invest to cover the expenses you actually do need to cover. A dollar saved is more than a dollar earned!
Late To The Party
Anything less than 5%, and you are more likely to die before reaching the 25x expenses mark. You’re driving a machine meant for digging tunnels, not for speed. That might be okay if you like the grind and you’re only planning to retire for 5-10 years though! However, most people want to retire or have to retire for longer than that, so how are most people in the USA doing these days?
The problem is that the typical savings rate in the US is typically less than 10%. At that rate, with the assumptions made in MMM’s analysis, it is going to take over 50 years to reach retirement. If I had to classify what type of vehicle they’re driving, I would have to go with a tractor. For a savings rate of 5-15%, you’ll get there eventually, and you might enjoy the views along the way, but you’ll hardly have any time to enjoy the final destination when you arrive.
Dave Ramsey recommends 15% as a good savings rate for retirement and I agree that that is a good starting point. A rate of 15-30% is closer to where most people should be aiming for. Driving this standard consumer car of a savings vehicle will likely allow retirement sometime between the age of 50 and 65 if starting at age 22. Not bad. But what about those of us that want to go faster?
Well if you’re aiming to retire before 50 years old, you’re going to need to go fast. If we upgrade our savings vehicle to a solid sports car and save between 30 and 60% of our take home pay, we can get there sometime between our upper 30s and our 50th birthday. And if that is still not fast enough for you, not much beats flying. With a savings rate above 60%, you are likely to reach Financial Independence in 12 years or less! Talk about a quick trip.
Trading in Your Savings Vehicle
Ok, cool analogy. But how do we actually get our savings rate up to these astronomical levels? First, it’s easier to save more if you have more, so upgrading the earnings engine is important. While there are many styles of airplane, there is a minimum amount of power that is needed to get one off of the ground. Secondly, we need to reduce expenses as much as possible to get the most out of the engine we have.
There are several categories of expenses, but the big ones that can be affected are: housing, transportation, and food. There are several other categories that are also worthy of discussion such as education, taxes, utilities, etc. However major gains can be made by just addressing these three categories.
Many people buy more home than they really need, buy brand new cars instead of used, and eat out multiple times per week instead of cooking. And it makes sense too, psychologically. These categories are the major outward facing ways to show you are successful to the rest of the world. But who cares?
Do you really care more about having that brand new Tesla than being able to spend more time on your passions? Do you really care more about having a house with a pool and 3 car garage than having quality time with your loved ones? Or what about ordering takeout every night versus supporting a cause that you don’t have time for right now? I know I don’t.
So boost your earnings, cut your expenses, and live within your means. Step into the savings vehicle of your choosing (please don’t choose the boring machine).
And if you are one of us that is trying to fly, welcome aboard.