Last week I gave a talk to a room of people about 3 numbers that can change your life. And I’d like to share them with you…
I’d been invited to speak in London to a team in a large American multinational company. I was asked by a reader who I’ve got to know a bit recently. He’s a really good bloke and an unusually enlightened manager that wanted to help his team.
He’d been struck by the lack of unbiased financial guidance they were receiving from financial advisers that the HR department recommended and so he invited me in so the team could hear what The Escape Artist had to say.
So I had to create some content for my talk. Good manners dictated that I avoid banging on smugly about how awesome it is never to have to work again. I also avoided encouraging the inmates to rise up, overthrow the guards and burn down The Prison Camp. After all, The Escape Artist is not a revolutionary communist and was brought up by his Mum to be polite.
So instead I gave a brief talk about 3 numbers that can make you a millionaire. You may have read some of this before. But there’s a big difference between a) having read something and b) taking action to follow it through to its logical conclusion.
Here are the 3 numbers, illustrated with fictional characters.
1) The age you start saving
We are told by the media that there is something called a “Pensions Crisis” and its impossible to save enough for retirement because we live too long and earn too little.
But meet Kate…a bright school leaver who gets a job aged 18. Unusually, Kate does not go to university to learn how to eat vodka jelly but instead gets a job that pays, say, £16,000 (~$23,000) and lives with her parents for the first couple of years before sharing a cheap house with roommates.
As a result, Kate avoids taking on student debt…which is great because having debt is like your compounding machine getting stuck in reverse gear, pushing your net worth backwards. Instead, Kate is able to start saving after the first 6 months.
Over the next 7 years, our heroine does well and learns stuff at work that actually helps her in life. Things like how to work hard, deal with people and use basic arithmetic. And she does not spend all her salary on knick knacks. Instead she saves, paying herself first every month, setting up a direct debit to stash £167 per month for a total of £15,000 over that period.
Kate focuses on what she can control and directs her monthly savings into a low cost equity index tracker. Kate doesn’t waste time on pointless speculation about what future equity returns might be because who knows? Kate understands that shares have traditionally delivered the highest returns over long periods and can’t see why that won’t continue.
Kate saves £2,000 per year until age 25 when she stops and doesn’t touch it for 40 years. Fortunately, Kate’s TV is broken so she doesn’t see the circus clowns encouraging her to panic when the stock market falls. When valuations are lower, she gets more shares for her money.
Kate is lucky to start investing at a favourable point in history where people, for the most part, focus on innovating and creating wealth rather than fighting wars to colonise and exterminate each other. As a result, Kate gets roughly the same annual return (~10%) as the S&P 500 has done over the last 100 years or so.
Kate never really earns big money. She’s only human so she sometimes wonders what it would be like to earn a lot or win the lottery. But something inside tells her that spending doesn’t equal happiness so she just focuses on living a good life and improving the things she can.
At age 65, Kate fires up her laptop and is pleasantly surprised to see that her £15,000 of contributions have grown to just over £1 million. True, inflation means that a million pounds isn’t worth as much as it used to be. But, based on a 4% withdrawal rate, this is probably enough to provide Kate with £40,000 per year (inflation adjusted) for ever.
That is fine for Kate who just wants enough to buy champagne from Lidl occasionally and buy presents for her grandchildren without worrying if she can afford it. So she retires.
Being a cautious sort, she spends less than £40,000 per year and lives for another 15 years until the age of 80, by which time her portfolio has continued to grow to £1.25 million.
On her deathbed, peacefully surrounded by her loved ones and having achieved everything she really wanted in life, Kate realises that she could have spent more time in the office and afforded to buy more i-shite. But she’s just fine with that.
2) The investing costs you pay
Meet Keith. Keith is an intelligent and successful guy working in the City. Keith is kept very busy by his full on job. He gets up early in the morning, goes to bed late at night and works hard for his success.
Keith has done really well in his career to date. He progressed quickly up the ladder of seniority and is one of the younger senior managers in the firm. The good news for Keith is that he earns a salary that is very high by the standards of 99.9% of the world’s population. The bad news is that Keith doesn’t feel like he is rich, partly because he is surrounded by other high earners who are fronting and maxxing and partly because his spending inflated as his salary grew.
Now you might imagine that if you earned a salary like Keith’s you would be set fair and financially independent in just a few short years.
Unfortunately, Keith is too busy to get rich. He has an elaborate and expensive infrastructure to maintain. He has outsourced everything to an army of cleaners, gardeners, tradesman, nannies and financial advisers.
Like most highly paid people, Keith works in a highly specialised niche. This allows him to earn a lot but unfortunately he has not applied his talents to managing his own money. His portfolio is being “looked after” by a wealth management firm…in much the same way that Dracula would look after someone else’s blood bank.
Keith has done well and has accumulated a portfolio of, say, £750,000.
But unfortunately Keith has no idea that he is paying £18,000 a year (2.4% per year) in fees. The fees are automatically deducted (silently and invisibly) from his portfolio and, strangely enough, this £18,000 total doesn’t seem to appear anywhere on the reams of
crap paperwork he gets sent by his financial adviser.
It gets worse because those fees grow and compound over time. In year 20, Keith will be paying extra fees of about £43,000. On his current trajectory, Keith is going to pay pointless extra fees of well over £1 million (shared between his financial adviser and other financial intermediaries such as fund managers, brokers and strippers) over his lifetime. This is money that will not go to the family he works hard to provide for.
The Escape Artist has previously talked about this with Keith. In response Keith shrugged and sighed. He’s busy and he’s not a fund manager: what else can he do?
The Escape Artist respectfully pointed out that if Keith were to fill in a simple form he could move his money to a low cost broker and invest it in a simple portfolio of index trackers where he would pay fees of just 0.15% per year and make an extra £16,875 in the first year alone. Over 25 years, this would be a risk free way of making an extra million pounds in today’s money.
Keith’s response to this was:
Yeah, good point. I really should get round to doing something about that…but I’m a bit busy right now.
That was some time ago.
Keith is still busy working in The Prison Camp.
3) Your savings rate
Perhaps one of the reasons that Keith never filled out that form and collected his free million pounds over time is that it seemed too good to be true. Or perhaps Keith was confused about something else that The Escape Artist had told him?
You see, Keith and The Escape Artist used to work at the same firm together. They both had the same title and grade. But Keith knows that he was paid more than The Escape Artist.
So whilst what The Escape Artist said sounded logical, Keith can’t help but feel a sense of cognitive dissonance when The Escape Artist talked about being able to afford to retire in your early 40s (or even sooner). How on earth can someone who was paid far less than him afford to stop working? It just didn’t seem to make sense.
But this mystery is not difficult to solve. For every £1 you reduce your spending, the amount you need for “enough“, falls by £25 (assuming a 4% safe withdrawal rate).
Having a high income only helps you get to financial independence to the extent that you save more. Yes, good investment returns help, no doubt about that. But the key to getting to financial independence quicker is increasing your savings rate.
You can use the FI-o-meter to run the numbers for yourself. But here are the key points:
- At a saving rate of 10%, you are setting yourself up to have to work for 50+ years.
- But at a saving rate of 50% you get to financial independence in 19 years (if you start with nothing).
- And if you can manage a 75% savings rate, it takes only 8 years from a standing start to get to financial independence.
If you haven’t seen this content before, you may (like the inmates I spoke to) be a bit shocked and wonder: why has no one has told you this before?
The answer is that there is no real money to be made from telling people this stuff.
But it’s the truth.