In a very long period of my life I thought that in order to become rich you need to earn a lot of money. When I started to study have the financial independent I found that this wasn’t the whole truth. The most important part to become financial independent is to spend less.
If we have two people. One is earning 500.000 $/year, the other make 50.000 $/year. If they both save 10 % each month they will have the same retirement date.
Because their 10 % is going to fund 90 % of expenses. It doesn’t matter what the amount is. The percentage is what we are looking for.
If we instead could live on 50 % of the income our situation will look like this:
Which is WAY BETTER!
“What about the rate of return then? That must be an important factor.”
It clearly shows us that when we can save +60% of our income, the rate of return is less important.
And if you have read my other article on How I’m Retiring in 5 Years or Less you can tell that I sometimes recommend people to leverage their investing. If we save and invest +60% of our salary, and we borrow the same amount to invest for. This means we hit our retirement number in half the time. And do some time diversification. If we have more money in the market early, they will make dividends, and they will have more time in the market to prove their performance.
The average savings rate here in europe is around 5 %*. And if we look at the chart above we will never be able to fund. Even if we have the same rate of return as some of the best investors in the world like Warren Buffet. He has averaged around 20 %/year. If we earn 50.000 $/year and we are saving the 5 % of our income and get a ROI on 20 %/year we will be able to retire in 25 years. While this seems like a relative short time period. We need to get the same ROI as the best investor in the world.
Yes you can be the next Warren Buffett. But I think you will have a higher chance of winning the lottery. If we instead save a large amount of money. And maybe leverage. We now have the odds with us.
Buying stuff if often something that we find convenient. But there is a difference between really wanting a thing, to really need it. becoming financially independent is more about how little you can live on rather than how much you make. So if you can spend as little as 1000 $/month, you can become financial independent extremely fast.
What we humans is good at is adapting. It is the best gift humans have been dealt, but it can also be the worst thing happening to us. No matter if it is a good or a bad thing we end up adapting to cruising back to happiness level we were at before an event happen to us.
Let’s say that everything is working out perfect out for us. We have no major problems in our life. One day a terrible thing happens to us. Our immediate response is to become sad/mad/angry/depressed. But as times passes by, we cruise back to the level of happiness we were at before the depressing event occurred to us. This is the good thing about adapting. We can lose a leg, but still be as happy when had both of our legs.
Another situation would be if we have an awesome life. Nothing seems to be disturbing us. One day we end up buying a lottery ticket when we went grocery shopping. This happen to be the lottery of a gazillion dollars. Now we are driving around in Lamborghini’s, owning mansions and we are never going to cook your own meal again. Even in this situation we will adapt. We will cruise back to the level of happiness before we won the lottery.
When we realize that chasing material things doesn’t equal to higher happiness. We can settle down. Focus and what actually does bring happiness. And do that.
Happiness is not tied up to money. There is a lot of people happier than we are, owning less stuff than we do. So why trade your expensive time for some money, and use them on stuff that doesn’t give you anything than a short boost. A couple of weeks from the purchase we will at the very same state before we bought it.
The modern system where we go to school, get an education and work for the rest of our lives is not mandatory. And it is time that we break this cycle. We should see our youth to trade your time for money, claim your eternal freedom back. By not spending that hard-earned money. Make your money work for you, and not the other way around.
We don’t have to spend our entire youth doing this. If I had the information I have today, I could have been financial independent before my 25th birthday. Never have to worrying about earning another dollar. And not through starting a huge company, and working my self to death. It would have been by being conscious about what I would spend my money on, saved and invested it.
Some people would call it extreme to work hard, save and invest for a couple of years, living frugal and focus on happiness itself. I call it extreme to buy shit that don’t make us happy, in order to work at a desk for their entire life.
Vilfredo Pareto was an Italian economist back in the early 1900.
He discovered that 20 % of the population owned 80 % of the wealth. (I think it was in Italy). People have later on applied this 80/20 principle to other stuff. Like 20 % of the carpet will get 80 % of the walking. Or 20 % of Nike’s shoes is giving 80 % of the revenue. This is some examples.
There is an 80/20 principle on personal finance.
80 % of our private economy is based on these subjects:
If we can manage to only spend 40-50 % of our take home pay on these three things. Then we are in good shape.
How to spend less on Housing
This is the most complicated of the three of them. It might all so be the most expensive one. The big dilemma is often to rent or to buy a home.
And if you ask me I will say rent, and here is 5 reason why.
Our money is better off in a stock index fund, than a mortgage
A house we live in is not an investment
It is way harder to move from there
We need to do the maintenance ourselves
We have no idea what the housing market will do
Some cities is harder to find a good place to rent. I live in Copenhagen, and it is super rare to find an awesome apartment, where the rent is not through the roof. But at the same time. It is not unusual to pay about 9.000 $/m2 for an apartment if we buy it. Which is insane!
I’m super fortunate to live in 50 m2 apartment I pay 500 $/month for which is super cheap here in Copenhagen. I have lived here for all most 10 years, and have no ambition off leaving anytime soon.
Let’s imagine that you are a humble person. Eager to retire early and live a more simple life. So you don’t want more space than me, about 50 m2. If you are placed in a costly city, an apartment like that would rent for 1000$/month.
A good round number.
Rent 1000 $/month
How to spend less on food
There is one obvious way to spend less on food and is to eat less out on restaurants. I think that we in general love good foods here in Denmark. And I’m no exception. I love good food, and there is good restaurants everywhere here in Copenhagen.
If I want to eat out, I often grab a pizza or a kebab. They cost about 5-10$. Being a weekly thing, it is not something that has a major influence in the budget.
The “not so obvious way” to save money on food is to fast.
Yes – you got that right. Not eating.
“But Loui?? I need to eat to survive?”
Take a look at this documentary on fasting. It is actually healthy not to eat once and a while.
I know that. The case is that people is only getting fatter. And there is a ton of health benefits in fasting. There is difference ways of doing it.
Is where you only eat 500 kcal for to non-consecutive days. And eat normal for the rest of week.
16 is referring to that you fast for 16 hours (including sleep) and eat for 8 hours. Every day. The normal way of doing this fasting protocol is to skip breakfast, and only eat lunch and dinner.
One meal a day. Is a bit tougher than the to others. But by doing this you can feast like king. Check this guy out. He is eating 4000 kcal every night. Feasting like a true king.
With eating less out on restaurants. Some occasional fasting. And eating the rest of your food at home. Spending more than 500$/person is a HUGE splurge to me.
So we will with budget with 500$/month for the food bill.
How to spend less on transport
I can’t count on my two hands how often I see people buying cars higher than their net worth. Which to me is insane. Buying a car is one of the worst investments you can ever do.
As a rule of thump never spend more than 2-4 % of your net worth on a vehicle. I know I’m not going to.
The most affordable and healthy way is to transport your self by bike. We can buy a second-hand bike for 200-300$. If you have to travel long distance go for public transportation. By biking we can also cut out the gym membership.
So let’s say we buy an awesome second-hand bike for 300 $, so the maintenance on it will be about 10 $/month. And because we don’t want to bike further than 15 km, we are going to take the train once and while which will be around 60 $/month.
Transport will then end up in monthly cost of 70 $.
We now look at total budget of:
Housing – 1000 $/month
Food – 500 $/month
Transportation – 70 $/month
In total 1570 $/month or about 19000 $/year
To be financial independent we need to have about 20-30 times our annual spending. It depends on how conservative we are. Which will be about:
380.000 $ – 570.000 $ in portfolio of stocks and bonds.
From here you will have every single basic cost covered. We can then take up 1-2 month of working, just to have some money we can do fun stuff with for the rest 11-12 months.
This budget is above is not very tough. It can be done so much more frugal if we want to. And if we are young, it can make sense to leverage into that savings.