Last week I gave a talk to a room of people about 3 numbers that can change your life.
I’d been invited to speak to a London team of an American multinational company by a reader who is a good guy and an unusually enlightened manager.
He’d been struck by the lack of unbiased financial guidance that his team had been receiving from financial advisers that the HR department had got in.
I had to create some content for my talk but I didn’t play on the whole “quit your job” thing as it seemed inappropriate in the circumstances.
So instead I kept it factual and illustrated the power of getting your financial act together via The 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 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 are the asset class that have 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 making contributions into her pension. She doesn’t do anything else with her pension for the next 40 years. Fortunately, Kate’s TV is broken so she doesn’t see the circus clowns encouraging her to panic or sell when the stock market falls.
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, which she leaves to her children and her favourite charity.
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 shite. But she’s just fine with that.
2) The investing costs you pay
Keith is an intelligent and successful guy who 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.
Keith’s portfolio is being “looked after” by a financial adviser…in much the same way that Dracula would look after your 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 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. So Keith is going to end up losing about £3 million over his lifetime. This is a direct result of the fees taken from his portfolio and shared between his financial adviser and other intermediaries (fund managers, brokers and strippers). This money will not go to the family that Keith 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 an expert on investing: 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. And he would avoid losing almost £3m over 40 years.
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 avoided losing that £3 million pounds 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 I 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 me.
So whilst what I said was logical, Keith was puzzled when I 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. The maths is simple. You probably have enough to never need work again, if you have 25x your annual spending. So if you spend £25,000 a year, you need a portfolio of £625,000 (25 x £25,000).
So for every £1 you reduce your spending, the amount you need for enough falls by £25.
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% or less, 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 17 years (if you start with nothing).
- And if you can manage a 75% savings rate, it takes only 7 years to go from broke to financially independent.
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 me this before?
It’s a good question. The answer is that there is no money to be made from telling people this.
But it’s the truth.