To achieve financial independence, we need to save and invest. The more you save, the quicker you’ll get there. Unfortunately, the personal saving rate in the United States is quite low. Normally, it is under 10%. At that rate, it will take nearly 50 years to become financially independent. That’s why most normal workers won’t be able to retire early. If you want to join the FIRE (financial independence retire early) movement, you need to increase your saving rate drastically. A mere 10% won’t cut it.
Personally, I encourage everyone to shoot for 50% saving rate. This is a good compromise between the length of time (how long you need to work) and how much you can realistically save. At 50% saving rate, it will take 16 years to reach financial independence. That’s a long time, but not really that long compared to a normal working life (40+ years). Reaching financial independence could be shortened further by working part-time, a pension, outsized investment gains, and many other factors. The point is to shoot for 50% and you should be able to retire early in a very reasonable timeframe. Even if you don’t reach 50% saving rate, you’ll be better off than almost every household in the US.
Saving 50% is possible
We all know it’s good to increase our saving rate. However, saving 50% looks very daunting when you’re used to saving around 10%. You’ll have to save 5 times more! Who can afford to save that much? Today, I’ll show you how to get there. It will take time, but saving 50% is possible.
1. Cut back a bit
The first step is to track your spending. This is a very difficult step for most people. In my younger days, I never tracked my monthly expenses. It was a good month whenever I spent less than I made. This is perfectly fine if you want to live a regular lifestyle and plan to retire at a normal age. However, you need to be more diligent if you want to achieve financial independence while you’re young. When you don’t pay attention to where your money goes, you tend to spend more.
I suggest tracking all your expenses on a spreadsheet for a few months. It really isn’t that hard since most of us charge everything on credit cards. You can just look at the monthly statement and transcribe the charges. This will show you where the money goes. Once you become aware of exactly where you spend, you can prioritize what matters to you and cut back on the things that don’t make a big difference in your life. You can strategize and figure out how to reduce your monthly expenses while minimizing the impact on your happiness.
This is just a start, though. You can become frugal and boost your saving rate quickly, but there is only so much you can cut. We don’t want to be extremely frugal because most people can’t last long in that state. You want to find a comfortable lifestyle that you can hold the line at for many years.
2. Minimize lifestyle inflation
The second step is very simple. Once you’re in a comfortable spot, stay there and avoid lifestyle inflation as much as possible. This concept is simple, but it is very difficult to execute over the long haul. Most households have a low saving rate because they spend more as their income grows. Everyone wants to reward themselves for working hard and making more money. That usually means spending money on nicer stuff. However, freedom is a better reward. If you can minimize lifestyle inflation, you’ll be able to save more and reach financial freedom much faster than any regular person.
3. Increase your income
Here is the really hard part. The first 2 steps only hold the line. You might be able to boost your saving rate to around 20% by becoming more frugal. However, you need to make more money to really increase your saving rate.
Let’s look at an example.
*Saving rate = saving / income
$12,000/$60,000 = 20%
Lena makes $60,000 per year. After cutting back a bit, she can save $12,000. Her saving rate is 20%.
$32,000 / $80,000 = 40%
After a few years, Lena makes $20,000 more per year because she worked hard and got a few good raises. Luckily, she read this post and minimized lifestyle inflation over the same period. She channels all of her raises toward saving and investing. As a result of her dedication, her saving rate increases to 40%. It’s getting close to 50%.
Investment generate passive income
Let’s see how we can push her saving rate closer to the 50% mark. First of all, Lena invested all her savings over these few years. We’ll assume 7% gains for the sake of simplicity.
|Accumulated savings||+ 7% Gains|
|Year 2||$20,000 + $12,840||$35,139|
|Year 3||$28,000 + $35,139||$67,559|
|Year 4||$32,000 + $67,559||$106,528|
After 4 years, her investment portfolio grew to $106,528. This portfolio generates passive income for Lena. We’ll assume she invested in a good low-cost index fund and her yield is around 2%. This is part of her income. We can add this to the equation too.
Passive income = about $2,000
Lena’s saving rate = $34,000 / $82,000 = 42%
This passive income doesn’t make a big difference at the beginning. Here, it just raises Lena’s saving rate by 1.5%. However, it will become a bigger factor once her portfolio is more substantial. Lena can also invest in a rental property or real estate crowdfunding to generate more passive income. However, let’s stick with the stock market for this post. It’s simpler for most people. Anyway, her passive income should be much bigger after 10 years or so. It will help boost her saving rate tremendously.
One last way to boost Lena’s saving rate is to hustle more. She can pick up a gig or two to generate some extra income. These days, nearly half of Americans have side hustles. Lena can become an Uber driver, deliver food, or take care of pets while their owners are on vacation. The amount of income varies greatly depending on the gig, but I think Lena can easily make $6,000/year on the side.
*If Lena is young, I highly recommend investing in herself instead of spending time on side hustles. She can get additional education, earn a certificate, or learn new skills. If her main career is good, then focus on getting promotions and moving up the ladder. Getting a raise/promotion in your main career is better than making money in the gig economy. On the other hand, if she doesn’t like her main career, she should try to focus on building her brand. She can start a blog, write a book, or start a YouTube channel. These brand building side hustles can become a new semi-passive income way to generate income. Young people should focus on entrepreneurial side hustle instead of working as a gig drone.
Everything adds up
So Lena did all these. Let’s calculate her saving rate.
Saving = saving from job + passive income + side hustle = $32,000 + $2,000 + $6,000
Income = active income + passive income + side hustle = $80,000 + $2,000 + $6,000
Lena’s saving rate = $40,000 / $88,000 = 46%
Well, we couldn’t get all the way to 50%, but you get the point. If Lena keeps this up, she’ll get to 50% saving rate after several more years. Her portfolio will grow every year and generate more passive income along the way. If her side hustle goes well, it’ll bring in more income as well. In the first few years, the saving from her main job will dominate the number. However, the passive income and side hustle income will keep growing. Eventually, she won’t need the income from her job anymore and she’ll have a choice to retire early or keep working. That’s what FIRE is all about. It gives you more choices.
Last year, we saved 58% of our income. It took us many years to get to this point, though.
In conclusion, it will take time, but saving 50% isn’t impossible. Keep investing and your passive income will grow to help carry the load. The right side hustle can help a lot as well. The key to this whole thing is to minimize lifestyle inflation. Most people spend all they make. You won’t achieve financial independence if you spend like that.
Image credit: Micheile Henderson
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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