Financial independence in 4 Steps
Recently, I had a friendly reader ask a few questions about getting started in a "Save Me" kind of life. Here's an imitation of her explanation of her current situation and some of her goals.
Man in the Mirror,
I am nearing graduation for my graduate degree and I know I need to start thinking about my financial life and how to Save Me! I don't have any consumer debt and, thanks to the generosity and planning of my parents, no student debt.
Financial independence and even early retirement appeal to me, but giving back to my family and the greater community are bigger goals for me. How should I get started?
Yours in savings,
In this post, I will set out to help ensure that the basics are set out just right. In the future, we can explore many of these topics more at length. Here is my four step plan.
STEP #1: Save More Than You Think You Need & AVOID ALL CONSUMER DEBT
With graduation approaching, you may be convinced that you'll need fancy new clothes and shoes, an expensive new car and lots of gas to feed it, and credit cards to enjoy all of the eating out and drinking a fully graduated adult should enjoy for all of the labors that have gone into completing an advanced education.
DON'T BE TEMPTED!
To get started with any healthy financial life, it is critical to save more than you think and avoid all consumer debt. Credit card debt and car loans are some of the most common ways new graduates fall into debt and that debt is completely unneeded! These types of debt are like injecting whatever healthy income you earn as a newly minted professional with polio and crippling them.
They allow you to literally pay extra money on stuff you can't afford. It's as if you found a coupon that said, "Come on into our place and buy stuff that you can't afford and we'll charge you more than it costs! You're gonna love the way your net worth is in the negative, I guarantee it!"
Once you get over all of the emotions that spending seems to illicit you can start the saving that is needed to bring about financial independence - the true power that is available to all of us in a wealthy country like the United States.
To get started, I recommend a modest amount of savings - enough to cover approximately 3 months of living, (but no more than 6 months as that money can be working harder in an investment account). You can use credit cards as long as you pay them off every month. Never carry a balance and pay interest; if you can't help but carry a balance don't use any credit cards.
Once you have sufficient liquid (i.e. cash) savings to cover an emergency or job loss, you are ready to start saving some real money and getting financially independent.
STEP #2: Plan Spending Habits to Get Financially Independent (and Retire) at your Pace
Financial independence is directly correlated with the percent of income saved, regardless of the actual amount you earn. In general, you should earn as much as possible but the specific number is not critical. To borrow from the venerable, Mr. Money Mustache, there is very easy math for saving for early retirement. The critical thing is that how much you earn is not nearly as important as the percentage of your income you save.
Using an online calculator to crunch a few numbers, we see that saving 10% of that income and spending the rest would require 51.4 years of saving to retire! That is not an early retirement at all! Even at a savings rate of 20%, it takes 36.7 years to retire.
To make things interesting, I recommend a savings rate of 30% or greater to start.
This would allow you to work less than 30 years and continue spending at the same level as when you were working without ever reducing your savings! It may be a bit difficult to save this percentage as you are first getting out of being a student and equipping yourself as a young professional, but if you give it your best effort you may find you accomplish it easier than you thought was possible.
To invest all of the money beyond your small cushion of emergency cash, I recommend a simple strategy:
- Maximize any employer sponsored retirement program that offers a cash match like a 401k or pension. This is free money!
- Store as much money as you are allowed to in a traditional IRA or Roth IRA which are tax-advantaged accounts. You can open one with Vanguard.
- Store the remainder of your savings in diversified index funds in an account at Vanguard. This is a tried and true route that has brought about safe and reliable returns for many Americans.
I highly recommend Vanguard. They are a very special organization founded by a wise man named John Bogle. Their accounts are very safe and reliable options for owning stocks, bonds, and other assets.
For an absolute beginner, you can start with the Vanguard Target Retirement Funds. This is similar to buying all of the stocks and bonds of all major companies/countries from around the world giving you one incredibly diversified and well-performing portfolio without ever having to think about it again - all at an industry low cost!
Vanguard Target Retirement Funds are like magic!
Alternatively, if you want to manually diversify your own portfolio to set your own ratios of assets, you can also get started with the following:
- Total US Stock Market Index Fund (70-100% of portfolio)
- Total US Bond Market Index Fund (0-30% of portfolio).
This makes exciting work for your money!
We will have to take a deeper dive into how the stock market works later, but suffice it say these are well-vetted ways to invest your money.
STEP #3: Get Financially Independent Faster
To expedite the process of retirement, there are 3 tips I highly recommend to help speed up the process:
- Reduce your annual expenses over time. As a direct correlation, as you need to spend less each year, you will need less money to be 100% financially independent, (because your investments will need to generate less to meet your on-going needs).
- Earn a higher income as you become more valuable. Never settle for less than your true worth. As a Saver here at We Save Us, you are ahead of the curve and it is likely your income will exceed the median of this very wealthy country. If you start making more money while also continuing to work at reducing annual expenses you will make financial independence a sure and fast-approaching reality.
- Be happy with what you have and you will never be a slave to things. This allows you to spend less when times are tough to give you extra breathing room. If you can appreciate the things you have, you can spend less and be happier - enjoying the people and nature around you. It is then (and probably way before, too) that you can realize the truly generous country we live in. So much so that there is an excess of wealth which gives me reason to often shop in the trash or Craigslist for many things.
STEP #4: Reach Your Goals. Be Financially Independent. Work... Or Don't. You Choose! 😉
You may have noticed I did not mention giving back any money during the working years of your life. I highly recommend keeping your cash donations to a minimum while you are working toward financial independence. At that time you should be working hard and saving. To give back, you can donate your time and skills to good causes.
Once you have a big enough Savings to live without having to work, you can choose to invest your time, skills, and money into any cause you choose.
You get to write the ticket for your future!
As a quick summary, here are the steps in a bite size:
- #1: Save a quick cushion of cash by saving more than you thought you needed.
- #2: Once the cushion is there for the pushing, invest 30% or more of your income. The bigger the percentage, the faster you become financially independent.
- #3: Earn more. Spend less. Choose to be happy. Get financially independent faster.
- #4: Be financially independent and give back!
In closing, I just want to note that I did skip a lot of little (and a few bigger) details in an effort to create a digestible post with immediately actionable ideas. I hope it helps you as you move forward and plan your financial life. I have many more specific ideas coming soon!
For the rest of you out there, I hope you join Paris, my PYT, and me as We Save Us!
The Man in the Mirror