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Financial Independence is Like a Marathon

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It's gonna feel great to cross that line! Flickr photo by jayneandd

Financial Independence as a race is an analogy that I’ve been thinking about for a while so I thought it was time to share it with all of you!

And before you say “This article doesn’t apply to me since I’m not interested in financial independence,” I would say “unless you plan to work until you die, you will need to achieve it eventually. Why not sooner, rather than later?”

The sooner the better, if you ask me!

Ready… Set… Go!

When running a any kind of race, there are a couple of factors that determine how quickly you will reach the goal line: namely the pace of your run and the total distance. When these two variables are known, it’s easy to calculate your finish time:

Distance / Pace = Time

Similarly, financial independence (FI) is like a race in that it’s a goal you strive for over a period of time. The “distance” is how much money you will need and the pace is how much you save every month/year:

Money Required / Savings per Month = Months until FI

The neat thing about running towards financial independence is that these two variables: money required and savings rate are actually interconnected. When you save more, you are spending less which means you need less money to make ends meet.

“Get to the Example!”

Alright, geez! Relax, we’re just talking here. :)

If we say that you spend $3,000 per month, then that’s $36,000 per year. We’re going to ignore taxes and inflation, which is a tragic mistake - if we were developing your actual plan. But since this is an example, I’m fine with it if you are. :)

The money required is a factor of your return on investment but we’ll use the commonly touted 4% “safe withdraw rate”. To pay all of your bills with investment income at a 4% rate of return, we would need $900,000.  How did I get that?

Income Required / Rate of Return = Money Required

$900,000 is a huge chunk of change and it would take even more if we were including inflation! It could take a lifetime to save up that much money. And that’s why people tend to retire when they are 65 and not while they are 35. Let’s calculate how long that would take.

For this example, we’ll say that you make $4,000 per month. Since we said that you spend $3,000 that leaves $1,000 for saving and investing. That’s a 25% savings rate which is definitely better than what the “experts” tend to say. However, to save $900,000 at $1,000 per month it would take 900 months, or a depressing 75 years.

This, of course, assumes that you have it hidden under your mattress or maybe in an account at a big bank earning 0.1%. Basically, we’re not counting any investment gains or reinvestment of profits. This could drastically decrease the total time required but you’re at the mercy of the market. If you’re lucky, it could take only 40 years.

I don’t know about you, but forty years is a long time to me. Too long to be working, for my taste. That’s why I’m going to show you this neat trick: spend less and you can move the finish line.

Moving the Finish Line

Remember how I said that the money required and savings rate are actually connected? That’s because by spending less, you can save more and improve both variables in the equation.

What if you cut out $100 per month out of your budget? You could cancel your cable, take your lunch to work, or use any number of  tips easily found on other blogs. Going back to our earlier equation, we can see that by spending $2,900 per month, we’d need $34,800 per year. And to get $34,800 per year at 4%, we’d need a nest egg of $870,000. Still a lot of money, to be sure.

How long would it take to save that much? Well, if we saved that extra $100 then we’d be saving $1,100 per month which means it would take about 790 month, or 65 years.

That’s 10 less years of working! Ten years! I like TV as much as the next chap but it’s not worth 10 years of working just so I can watch it in my old, old age.

What if we could slash $1000 from our budget? Cancel cable, get cheaper insurance, make more food at home, drop the data plan on your smart phone… the ideas are endless. If you could cut $1000, then you would be spending $2,000 and saving $2,000 – a 50% savings rate. This is where it starts to get interesting…

$2,000 in spending per month is $24,000 per year. To make that much money at 4% would require $600,000. And to save that much money at $2,000/month would take 300 months, or 25 years. Spending $1000 less per month buys back 50 years of your life, compared to the original plan. And that’s without any investment gains either!

What about making more money?

Going back to the race analogy, if spending less is like moving the finish line, earning more is like running faster.

Let’s say that we keep our spending the same but earn an extra $1000 per month on side. Difficult but not impossible: maybe you could take another shift or work overtime. You could start a business or buy a few rental properties.

We’re still spending $3,000 per month so our target is still a daunting $900,000 but the extra income means we could save $2,000 per month instead $1,000. How long does it take? Exactly half as long as it would have taken when we were saving half as much: 450 months or 37.5 years.

The Bottom Line

So spending $1000 less cut off 50 years and making an extra $1000 per month cut off only 37.5 years. That is why I believe spending less is more powerful than earning more. I’ll leave it as an exercise to the reader what would happen if you did both!

People often cite that there’s only so much you can cut in your budget where as there’s a theoretically infinite limit to how much you can earn. Sure, it’s theoretically infinite but practically, it’s limited. Raising your income isn’t as easy as cutting your spending. Try walking into your boss’s office and asking for a raise. If it works, let me know but my money is that they simply say “No, get back to work!”

You could start that business on the side but there’s risk involved along with a potentially large time investment before you see your first profits. Cutting your cable TV has zero risk, takes 5 minutes, and is in fact more powerful in terms of getting your towards your goal!

Why would you want to run faster if you could simple move the finish line closer? Of course, you could always do both :)

How about y’all? Are you in the spend less or earn more camp?


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