Originally published 2020, updated September 2022
In personal finance, The Good Old Days were actually The Bad Old Days.
In the Bad Old Days, before people knew about financial independence, there were financial advisers who acted as The Gatekeepers to investing.
People did not know how to invest themselves (sadly, many still don’t) and you had to speak to The Man in a suit if you wanted to invest and build wealth via the stockmarket.
The Essential Innovation of Financial Independence
The Financial Independence movement taught people that they could invest their own money (without gatekeepers) using a low cost global equities tracker fund. That was a good thing (and still is).
But the essential innovation of the Financial Independence movement was to join the dots between the amount you saved and invested (rather than spent) and the time it would take you to get to financial freedom.
At a 10% savings rate, it takes ~50 years to get to financial independence. But if you could dial up your savings rate to 50%, you could reach financial independence in ~17 years.
Here’s the graph that showed me how powerful your % savings rate is:
On the y axis we have the time until the person reaches retirement. Or more accurately financial independence, the position where work is voluntary.
On the x axis we have the % savings rate, the proportion of post tax salary that a person is able to save and invest. As we go from left to right, the savings rate goes from 5% of post-tax income (68 years to financial independence) up to 50% (where it takes 17 years to get to financial independence) and beyond.
Financial independence showed us the trade-offs that were possible. Knowledge is power and this knowledge gave us new and maybe better choices.
It also gave us the 25x rule of thumb which says that you are financially free (and work is now optional) when you have invested net worth of 25x your annual spending.
In other words, if you cut your annual spending by £1,000…either on fund management fees or on groceries or whatever… you bring the finish line for “enough” closer by £25,000. That’s quite the multiplier effect.
On it’s own, frugality won’t get you all the way to financial independence but it’s sure as hell a good place to start.
Money is The Power to Control Your Own Life
Money is the power to control your own life. Without money, you will always be at risk of being pushed around by life and by other people. This is the power of FU Money.
Without a freedom fund, your boss owns you. Having a six month freedom fund means being able to quit on your own schedule or at least wait for a good job to come around after you get laid off, rather than having to take the first one that comes along. That can be life changing. The bigger the freedom fund, the more time, options and runway you have.
This is not just a financial thing. But money is a big part of it. You can’t be truly fearless without some degree of financial security. Especially if you are providing for a family and people depend on you.
The importance of saving
I sometimes think that saving has a PR problem. It needs a makeover.
Saving is often seen as something that’s a bit boring. But its the foundation not just of your financial security but your freedom and life choices.
When you have a secure financial base, you can go on the offensive and take the fight to the enemy. You can afford to take more risk in 2 key areas of life:
1.Investing risk. You can afford to take more risk in terms of your allocation to risk assets such as equities, property etc. Remember: first things first…clear that expensive debt and get a cash emergency fund in place. But after that, you can afford to be braver with your money, take more equity risk and buy into the stockmarket.
2. Career risk. Saving for financial security also frees you to take more (intelligent) career risks. CEOs and investment bankers don’t have secure jobs, they have well paid jobs. People with their own small business don’t have secure jobs but, if they get it right, there is no cap on their earnings. If you are doing it right, more career risk should mean higher expected rewards.
Your % saving rate is the most important number in personal finance. It’s the most important metric for you to track.
How do you calculate your savings rate? If you move half of your salary (after tax has been deducted) to your investment account (aka your compounding machine) each month, that’s a 50% savings rate. Yes, you can make it more complicated than that (depending on how you treat pension contributions and so on) but it’s better to be roughly right than precisely wrong.
Remember that debt repayment (e.g. the capital element of mortgage payments) counts as savings. You can increase your net worth either by reducing debt or by increasing your assets. In my book, capital investments (e.g. loft conversions and extensions) in a house that you are planning to sell at some point and get a return on your investment also count as saving (rather than consumption).
Isn’t it strange how your % saving rate is far more important than your % investment returns?…and yet % returns are what people focus on and obsess about (actively encouraged by the financial services industry).
It’s really easy to get decent investment returns with a global equities tracker. I’ve always invested a big chunk of my portfolio actively but my pension savings were 100% global equities tracker funds. Why take unnecessary risks with your long term capital? Your primary focus should be on earning and saving more rather than risky or complicated investing.
I still remember the lightbulb moment when I realised that there’s no point in earning a higher income if that doesn’t lead to higher % savings rate. Your income (expressed as £/$/€) doesn’t directly affect when you can retire. Higher income just allows you to save a higher % of your income whilst still enjoying life…and that’s the key.
To show you how these numbers are built up, here’s the maths for the 50% savings rate (~17 years to financial independence). The numbers in this old example are too low but they scale: it’s the percentages that matter. A 50% savings rate means it takes 17 years to get to financial independence regardless of the actual amount you earn.
In the example above, our investor reaches financial independence in year 17 when their invested net worth exceeds 25x their annual spending and their withdrawal rate is below 4%.
This means that you can bring the finish line closer either by saving more or spending less. These two approaches work hand in hand. You are gonna need to work both sides of this equation.
If you are just starting out, don’t let the high percentage savings rates put you off. I accept that for many people these figures will not be achievable (or at least not yet and not without a crazy level of frugality). I’m sharing them because they illustrate powerful concepts.
What’s interesting about the shape of the graph is that it’s non-linear (i.e. curved) so that the time taken to get to financial independence falls rapidly as the % savings rate is increased. You get a BIG improvement (in speed to FI) when going from a savings rate of 10% to 20%.
Less so when going from 50% to 60%. If that marginal increase in savings rate makes your life miserable, then it would be a mistake for you. Everyone has to figure out their own “sweet spot”. This is a very personal consideration for everyone so I’m not saying what is right or wrong, I’m just illustrating the trade offs.
Whenever you mention 50+% savings rate, you trigger a bunch of people. But bear with me and over time you might just be amazed at what is possible for you.
2020 provided a fascinating illustration of what is possible in terms of increasing your savings rate. The total savings rate across the UK shot up from less than 5% to ~30% during lockdown as many more people discovered Monk Mode.
What seems impossible for you right now may be possible for you in a few years time. Where attention goes, energy flows. Or something like that.
What are your assumptions?
Models are simplified versions of reality that illustrate important concepts. The assumptions that sit behind these illustrations are:
- you never do any more paid work;
- you never get any state pension or other benefits;
- 5% real (excluding inflation) investment returns; and
- a safe withdrawal rate of 4%.
These calculations are all based on the idea of a safe withdrawal rate. In most scenarios in the past, this has meant that the retiree actually end up dying with a large pot: there is no de-accumulation where investment returns are 5% and you are only spending / withdrawing 4% per annum. For people who want / expect to run down their pot during retirement, these calculations may be too conservative.
This is not deprivation
When people see graphs like the one above, a common reaction is: I don’t want to give up all the fun in my life!
The implicit assumption is that everyone is spending efficiently, consciously and mindfully. That’s just not true. I could give you a million examples but here is just one. I recently bought a navy blue cap for £2.99. Price is what you pay, value is what you get. I could have spent £45 on an almost identical cap. You choose the price.
I hope you can see that buying the £2.99 version is not deprivation.
It’s the sum total of thousands of decisions like this over the years that leads to results so good that it almost seems like magic. This is The Aggregation of Marginal Gains.
Don’t get me wrong
Saving is a wonderful thing. But even the best ideas can be taken too far. It has to be sustainable and you have to enjoy the journey or else you won’t stay stick to The Path.
Plugging the leaks in your spending bucket and saving money is super-important but don’t be penny-wise, pound-foolish. The problem for extreme frugalistas is that they won’t spend any money on health, self-development or education. Example: if you are saving money by not buying books that could change your life, that’s a rookie mistake. Invest in yourself.
Not everyone can be a high earner or reach financial independence by 40 or whenever. But everyone can learn to get better with money.
Amazing things are possible over time once you get started on The Path.
I write a new article each week that goes out by email (most won’t appear here on the blog) so the best way to get new content is to sign up to my email list:
Love the logo
Thank you for helping “able people become more (c)able”
Nice hat TEA just promise not to model a Nick Leeson look in it
This post contains a really important and well-written message, not just for young people, but also those in their late forties and fifties trying to work out how to avoid working for ever. It’s a message of hope and self-reliance that bears repeating since it is still not mainstream thinking (I really don’t know why not) so thank you for keeping on with this core message TEA. In a sense everyday is a marshmallow test and if you pass often enough you reach financial independence.
I wonder if you have come across the Paradox of Thrift (https://en.wikipedia.org/wiki/Paradox_of_thrift). It says that saving benefits the individual, but not society. Are people that seek FI actually being selfish? I suspect it depends on the degree to which you do it. If you have a high paying job for 10 years and a high savings rate and then stop contributing to society after that – is that selfish? If everyone followed the Early Retirement Extreme philosophy, what effect would that have on the global economy? – and passive investments?
What if the Department of Education put this stuff on the national curriculum? What effect would that have on the economy?
If you work for longer, but secure a retirement while you are still healthy enough to enjoy it – fair enough. Of course you can also contribute to society after you retire – as you are doing in spades.
But the situation also has a climate change dimension. Reducing some types of consumption has a beneficial effect on climate change e.g. not going on family holidays to the other side of the world. But there are types of consumption that have much less effect on climate change.
Hi Barn Owl – thanks for the comment.
Yes, I came across the paradox of thrift during my economics degree. It’s one of Keynes’ 1930s depression insights…everyone saving more at the same time is a problem in a deep recession if the government doesn’t step in and boost demand through spending more than it raises in taxes.
I think we can all agree that governments learned that lesson!
Granted it’s worse in a recession. but surely everyone saving more is a problem for the economy at any time, in that it reduces consumption and hence company sales.
Taking it to extremes, what would happen if everyone followed the same path as Jacob Fisker of ERE fame? The workforce would drop, companies would shrink and investment returns would go negative. The traditional FI route would not be viable and people would have to go back to work.
Why worry about something that’s never gonna happen? 🙂
@diskrog I had forgotten that MMM article, thanks. Not sure he completely answers it.
@TEA I do support your article, we have way too few people following the FI path at the moment. I painted the extreme picture to make the point that this is not just a recession issue. I think there would be an economic effect if say 1% of the workforce disappear after 10 years of working and declare FI, especially as they will likely be some of the more talented individuals. For the individual FI is a good goal, if it becomes a common one, then the policymakers need to work out the effect on the economy and fix it with incentives I guess. So much has been said about FI, I thought I might explore another angle here in the comments.
Does the type of saving change the selfish aspect?
E.g. Investing in companies, instead of hoarding the cash, encourages them to innovate and employ people.
Also – consuming less does still mean some consumption. So the market can aim their products/services at things that FI people do spend on.
All so true.
For some people ,including me, it’s just common sense. Spending within your means and budgeting and saving. But there appears to be lots of people who just carnt see it. There brains are wired differently. It’s sad really for them cos they are stuck on the hedonic treadmill. Spending for happiness, getting drunk for happiness, having to work hard to support these sad lifestyles. Then when you try and explain theres another way they are so resistant to it and call us lucky. Maybe we are lucky as money management and sense comes naturally easy to us but like TEA says they should be open to listen and learn. Often they are not.
hey barney. nice article. i work in a factory and though i have a technical education it is basically a blue collar job that pays pretty well in the u.s.a. i am living proof that people like factory workers, nurses, police, and firefighters can get to financial independence. we spent plenty of money on things we care about but saved and invested aggressively at the same time. sure, we eat well and don’t look much at prices at the grocery store, but our house cost was very modest and we drive our cars 10+ years. you don’t need to have a high paying tech job to get there. it took us 15 years and having enough to retire makes work more enjoyable and relaxing. keep dispensing the truth!
Thanks for providing the proof, yours is a great story Freddy (and not a bad stockpicking record either!)
Love the website – apart from the “Now that’s what I call music…” posts 🙂
I don’t think the link to the spreadhseet at the end of the article is working at the moment.
As always excellent piece. My favourite part “Money is the power to control your own life.”
I always have a chuckle when I know I should not about the wave of saving articles & advice when a crisis hit like in 08 & now. As a human being I don’t enjoy anyone suffering even if an arsehole.
Saving now is like googling for a life jacket on the titanic post iceberg. You need to save constantly in the good times & analyse your expenditure every month or quarter. Trying to save now if your salary has been cut is a still smart, but I think the point has been missed.
Keep the articles coming even if 1% of the population get it & avoid consumerism you have made the world a better place. Even had my 9 year old son read the Money is the power to control your own life piece & the hat choice.
👍 good for you & your son Michael
Ha ha, I can relate to the hat buying. Love the 2.99 hat.
Several years ago, friends of ours showed us new engagement and wedding rings they just bought. They have been married for 12 years already. They said they wanted to upgrade their rings. The wife told me I should buy my wife a new engagement ring and to not be cheap. I looked at her in disbelief. Needless to say, we did not upgrade. It was not being cheap, we already had the rings and it meant something to us from where we started years ago.
We are financially set, while they constantly are juggling finances. It is what it is. We are still good friends to this day, but different wavelengths financially.
Brilliant. I laughed at the friend’s wife trying to convince you to join the madness train. I stopped giving my friends advice years ago & I just let them crack on. I think deep down they know they are out of control, just cannot stop until the train wreck.
A lifetime ago I used to have to send out repossession letters for a sub prime lender.
Unlike the daily mail articles it was not drunks, gamblers or flash Harry’s , but people who had lost their health, job or partner.
Any thoughts on the Great Reset and proposed redistribution of our wealth when we go full-blown global communist?
Or have I spent too long on Twitter?
I think its as simple as, “if you spend what you earn, you will work forever”. I can’t remember who said it, but its pretty true. Money is time, and time is money. If you spend all of either, then you have none of the other. I wonder those who earn average pay (and above), really think they can’t save 20%+, or maybe just think they have “earned” the right to spend it.
Thanks for the great post.
Pursuing FI really allows us to ask questions that others on the working / spending treadmill don’t have the leisure to consider. What am I going to do with the freedom I’ll have? What does it mean to be ‘wealthy’? Now that the question of earning to survive is solved what aims do I want to have?
It’s easy to get drawn into the pursuit of accumulating but forget to ask what it means to be truly wealthy in life. Having the opportunity to explore this question is the result of building up to FI.
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