Is your savings rate preventing you from retiring when you want to?

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Savings rate is the all-important factor in determining financial freedom 

Only having recently discovered the FIRE (Financially Independent / Retire Early) movement myself I’m quite interested by all the different stories of those who are either working toward or have already attained financial independence. I thought to myself that I would like to set some goals and get a rough idea of what to work towards each year based on a target retirement age. I’m in my early thirties and one could argue that this is way too early to even worry about such matters…True, it’s impossible to plan for all the eventualities of life but I think it’s a good idea to at least have a plan. I was curious and I wanted to see how difficult FIRE is to achieve and what would be the all-important factor.

After doing a quick google search I found a handy calculator, which does a reasonable job of estimating retirement age given only a few basic assumptions.  The statement at the top of the site could not be more true:

“Compound interest is powerful but takes a long time. To retire in 5 or 10 years the most important number is not your return on investment. It’s your savings rate”

Time to FIRE calculations

Essentially the calculator uses your income with a savings rate to calculate time taken to achieve financial independence. The default values for the calculator are an after-tax income of $50,000 and an incredible savings rate of 60%. The after-tax income value strikes me as a reasonable assumption but as for the savings rate – 60% seems quite high and I was sure I was probably not hitting this. Based on these numbers I could retire in 12.4 years even with a net worth of zilch right now. So, to get a more plausible answer I decided to ascertain a rough idea of my savings rate.  To do this I took my entire years’ worth of account balance changes for 2018 and crunched the numbers myself.

My after-tax income was $ 54,000 and I saved $ 12,000 of it. Feeding these two numbers into the calculator gives me a savings rate of 22%. Based on having nothing to my name right now I’m on track to retire in 35 years. Although this may seem quite disappointing at first glance; one must remember that at this point, I would be truly financially independent and could sustain myself indefinitely. Most people who set themselves up for retirement assume that they will dig into their saving gradually over time.

Of course, there are many factors not taken into consideration, some of which can throw these calculations out quite dramatically.

  • Promotions and pay rises are an important one – wages do generally increase over time and are generally much higher later in people’s lives even accounting for inflation. Job security may not be guaranteed either – you may not collect income at certain points in your life due to being jobless
  • Returns on investments – the calculator assumes a fixed 5%. Returns are of course generally much more volatile in reality unless it’s fixed interest investments. The stock market has historically yielded above this.
  • Kids – having children – I would love to have children and kids are expensive. It would be very difficult to quantify this expense and perhaps doing so is going a little far.
  • Illness – out of pocket expenses for medical bills – these are often unpredictable but a necessity and would be near impossible to account for.

Despite all the assumptions and the simplicity of the calculator, the fundamental message is clear – the savings rate is ultimately the single biggest factor which influences your financial freedom. In effect, the reason this is the case is actually two-fold. The first one is actually quite obvious – you save more of your income. The more you save, the more money there is to invest to be compounded gradually over time with interest from investments that it is put towards. The second is that if your savings rate is lower – your living expenses are lower and your lifestyle is more affordable. This means that it takes a shorter amount of time until you have enough investment money that it earns the necessary interest periodically to cover the cost of living.

Live within your means & invest in appreciating assets with a good track record

This is an important message. Some people just spend what they have, with out much thought to how much gets saved. People often find it surprising that some the winners of  lotto jackpots can be in debt several years later. Or how a big movie star such as Nicholas Cage, who has earned hundreds of millions from acting, eventually filed for bankruptcy. In both instances, the savings rate was practically zero possibly coupled with some negative return investments. And with that sentence, the second important message. Seek out positive return, safe, diversified investments with your savings. Refrain from investing heavily in speculative assets – like cryptocurrencies. This can be very hit and miss.

What’s a good savings rate?

I started to ponder whether a savings rate of 22% was actually any good. I don’t believe myself to be particularly frugal and I had seen many in the FIRE community reaching savings rates of around 50%. After doing a little research I began to realise that savings rate is actually a function of quite a few difference variables – income, age, country etc. Having said that I was above average. In Australia – it’s a mere 2.4% currently. This is the lowest it’s been over the last 10 years; however, it was actually practically zero around the turn of the century. The US fairs a little better, with a current savings rate of 6%. 

Improving my savings rate.  But at what expense ? (pardon the pun!)

Ultimately savings rate is an individual variable and everybody has a unique situation, but we can all make adjustments should we wish to lift our number. Obviously increasing our savings rate is great but it’s a bit of a balancing act really. Tightening up too much and not spending will make us miserable – there’s no point forcing yourself into a state of frugality that has led you to a point where you’re eating 2-minute noodles for dinner every night just to save on the weekly shopping bill. Being should mean moderating on luxuries and impulsive purchases. We would love a holiday – but there are cheap destinations and expensive ones – as an Australian, going to the Maldives or Iceland is quite taxing financially and should be as a one off, while cheap holidays to local destination such as Tasmania are much more affordable and I could budget to do something like this every year while not hurting the savings rate too much. But what about not taking a holiday? Some people do this too – and this is even better for the savings rate… But is this sustainable for you? I think we all need a break here and there and enjoying your money is an important aspect of earning money too.

In order to boost my savings rate, here are some steps I intend to take…

  • Eat out less. I probably eat out 2-3 times per week and average $100 a week. This is about $5000 a year so I would like to slash this in half.
  • Change my mobile plan – it’s currently $30 a month and I never get close to using the data or talk/text allowance. I’ll reduce this to a $ 10 a month plan – it sounds pathetic but it’s all I need! This saves a couple of hundred a year.
  • Change my energy provider. My current energy provider isn’t cheap – even though I thought they weren’t bad  – but I know people paying half for similar usage. This is potentially several hundred dollars of savings.
  • Change my internet plan – If I turn the data usage down, I can save $ 5 a month. I could change plans to save more but the internet runs well and I have had bad experiences in the past.
  • Spend less on holidays – admittedly next year is a big one – about $ 10,000 in total. I haven’t had any since 2016 so it really three years’ worth but more than $ 3000 per year is probably too much. I’ll set it to a maximum of $ 2000 per year holidays from now on.
  • Less food wastage – I do find a throw a bit out. I intend to eat what I have in the fridge and not waste any from now on.
  • Earn extra income – I’m already embracing side hustles as an effective measure of boosting savings.
  • Selling items that I don’t need – I have so much stuff I barely use & I could free up a bit of cash to save while reducing clutter.

Achieving the elusive 50% savings rate.

Although at first glance the idea of saving half seems like it wouldn’t be too difficult, I just feel like this is going to be a near impossible challenge. In terms of the savings I mentioned above I may be able to squirrel away another few thousand getting me a savings rate of 28%. If I manage to make $ 5000 extra income, which is possible through side hustles, I would reach 35%. With $ 10,000, which is perhaps a little of a stretch – close to 40%. Despite this I’ll shoot for the stars and try and hit 50%.

I have seen many bloggers analyse individual monthly savings rates – but the results can be quite volatile. One month your hit with a whole heap of once a year bills and you monthly saving rate is 3%. The next there’s barely an expense and you at 65%. Instead, I’ll look at the rolling sum of income and expenses and track the cumulative savings ratio (YTD) , and see how I track throughout the year towards the target of 50%.

Conclusions

Your savings rate is the most important factor in determining your path towards financial freedom, especially in the early stages since it takes a long time before investments can generate the necessary returns to make themselves a self-sustaining source of income. It’s important to live within your means but to not overdo frugality. There is a balance between saving and living humbly as opposed to inflicting misery upon yourself due to an overly restrictive lifestyle. Moderation and lack of desire for excess, is the key.

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