21 March 2014

All of the money stuff I sometimes talk about, condensed

A lot of my personal friends and family have heard me mention something regarding saving money and investing, probably remember hearing me referencing "Mr Money Mustache" or "Jacob of Early Retirement Extreme".
Chances are, though, you chalk it up to one of those random Bakari nutty things, or maybe you even glance briefly at one of the links I send you, but it's long and there's like 300 other articles, and you don't have time for all that.
I'm going to try to explain all that stuff in a condensed and untechnical manner.
Of course, the majority of my readers who I don't know in real life found me through MMM, and all of y'all feel free to skip this post, as you won't learn anything new - it might be perfect for forwarding on to your own friends and family though who haven't come around yet.



Very early on into adulthood I discovered that I don't particularly care for employment.
Its not just about the work itself - it doesn't matter how much fun, how creative or rewarding or self-directed the job is - its just the fact of being forced to be some specific place doing some specific thing for almost exactly 1/2 of your discretionary time (factoring in mandatory lunch hours and commute time), for the majority of your life.
Luckily, I grew up poor (there were 73 of us, living in a cardboard box), plus I self-identified as an environmentalist since about age 9, plus being non-conformist, all combined to make rejection of all forms of materialism come naturally.
I never felt much need for "stuff".  Living in my RV felt plenty luxurious enough.

Psychologists say that money spent on experiences produces more happiness than money spent on stuff - but I've found there is a practically infinite supply of entertaining and educational and downright amazing and wonderful experiences to be found for free almost everywhere I look.  No, not even that - I frequently don't even have to look; often times they come to me!  Sometimes when I was looking for something else, other times they just literally come seek me out.
I've never even had the desire for the stuff most American's spend money on: cable TV, a new car, fashionable clothes, or a "phone" that is really a tiny computer.  So, after food and rent, I never had all that much to spend money on.

And here is the point of all that backstory:
 
 
I discovered early on that if I don't spend a lot of money, then I don't need a lot of money, and if I don't need a lot of money, I don't have to spend so much time working.


So that is what I did for the next 10 years.
I might work full time somewhere, but I'd get bored after a few months, and quit, with no backup plan. Other times I'd work part time, maybe two or three very part time jobs, or maybe just show up sporadically to my supposedly full-time job. I built up a ridiculous resume of jobs - experiences (that I got paid for). I traveled across the country, I went to school purely to learn interesting stuff with no intention of leveraging a "career" out of it.

I made a couple of less than ideal financial decisions here and there, but managed to pay very little in interest, never miss a payment, and keep my credit score high.
And I had lots of free time, whether I was working or not, to play, to spend with my partner, to read and learn, to go on bike rides and camping trips.
Not that I ever thought debt was no big deal, but between moving cross country, college, buying a bigger RV, and getting divorced, I hit a peak of debt (around 10k), and decided to focus seriously on getting rid of it.
Older and more mature, the day I made my last payment, I also opened an IRA - 18 February 2010

Along the way, one of my blog posts caught the attention of Kirsten Dirksen of Faircompanies.com, who asked me to write for her, and then later did a video interview of me when she was in the country.
Which got moderately popular (a good quarter million views in a couple months), which resulted in a number of internet fans who found me on facebook - one of whom suggested I look up Jacob Lund Fisker of ERE, who also lived in an RV at the time.  Well, it turned out he also lived in the Bay Area, and was planning a get together soon, we met, I started reading his blog posts... it couldn't have come at a better time.
Having recently paid off the last of my debt and opened an IRA, it was perfect timing for the message.
It turns out I was on the right track, but I missed an important detail.

Allow me to summarize how many, if not most, young people look at money:

Retirement is something that happens when you are old.  If we are lucky, it will still be at age 67 by the time we get there.  By that time most of your life has gone by and if you don't have major health problems, at the least you are too weak and tired to do all the sort of things you want to do now.  Hell, you don't even know for sure you'll live that long, so it doesn't make any sense to put off living life to the fullest now.
Of course you aren't stupid either, you aren't going to spend money frivolously, and its good to have some savings in case of emergency, maybe even a retirement plan, but that all has to be balanced with enjoying life today.
 
That's more or less how most people I talk to look at it.
It's how I looked at it.
The philosophy is good.
It's the underlying assumption that is mistaken.
Its a totally understandable mistake, because every one else around us takes it for granted.
Here is the enormous underlying mistake from the paragraph above:

67 is when social security starts paying out.  That has nothing to do with when you retire.  Retiring can happen much sooner, or much later.  Its simply a function of when (if!) you have enough to live on without having to work.

And let me cut off objections preemptively here, by emphasizing a word from my last paragraph:

"...have enough to live on without having to work."
Maybe you really enjoy your job.
It may be fun, and/or meaningful.
As of now, lets stop using the word "retire".  Lets substitute "financial independence" instead.
Not having to work means that if you get bored, you can do something else, with no stress during the transition.  It means if your boss is a jerk, you quit.  It means you can start your own small business, doing what you love.
If you already love what you do, but your company is small and on the brink, you can take a voluntary pay cut.
If you love what you do, and your employer is a soulless corporation, you can use your salary to buy expensive toys, vacations, or donate to charity, or whatever you want, because if you are already financially independent you don't need to worry about rent or food or transportation or health care.
In a word, it means "Freedom".
Would you rather have more freedom in your life, or less?


"Yeah, all that sounds great, Bakari, but it is totally unrealistic"

Ah, you'd think so, wouldn't you?
Now we get to the fun part.
I'm going to leave out all the math, and all the stock market/investing stuff.  I'll point you to some MMM posts that go into detail if you want to learn a little more and go a little deeper, but for now just trust me on the numbers.
If you invest wisely (and that doesn't mean "picking the right stocks", it means taking the safe, easy, average, middle of the road route) then once you have saved up 25 times your annual spending, you are set for life.
That's actually a really really important summary, that deserves an inset section


Once you have saved 25 times your annual spending, you are set for life.


( http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/ )

That's secret ("secret") number one.
Here's another:

Under capitalism, money that is invested creates its own money.  Then that new money also creates new money.  Then that new money creates even more new money.  This cycle repeats indefinitely.

An early MMM analogy is to think of each and every dollar bill you have as a potential employee.  If you spend it, you have essentially fired a reliable worker.  If you invest it, it will produce a small percentage of its own value for you, 24/7, forever.  Give it enough time, and that dollar will make you a new dollar, just by sitting there not being spent.  Then, if you only spend the new dollar, and leave the original alone, you just got something for nothing.
It gets better.
If you put away five bucks a week, starting at age 18, you will have more money at (official) retirement age than you would if you put away 30 times as much - $150 a week - but didn't start until 10 years before you retire.

In the former, you only put away $260 a year, for a grand total of 13k of your own money (spread out over 50 years)
In the latter, you spent $7,800 a year, for a grand total of  78k.
You spend 6 times as much, and have less to show for it!

All that extra free cash in the former is coming from interest and dividends, compounding and snowballing on themselves.  The new money creates new money which creates new money which creates...
But what if you put away $150 a week, starting at age 18?
Well, then you would be a millionaire just a little after your 50th birthday.
Literally.
That's just math.

But lets go back to the first secret again; once you save 25 times your annual spending, you are set for life.
If you can spend less than 40k in one year, then you don't need to be a millionaire in order to be financially independent.
Given that 40k is substantially more than median individual income (and only slightly less than median household income, which on average has more than one earner), I'm going to say it is not a particularly bold claim to suggest that it is possible - nay, downright easy - to live on less than 40k per year.
(Remember, we're talking spending, not income, and you can subtract any spending on savings, as well as any spending directly related to employment, such as commuting or work clothes, from what you need once you are financially independent).
If, for example, you can live comfortably on under 20k a year, then you don't even need one half of a million in order to be financially independent for the rest of your life.


Here's the other big mistake that people tend to make:
We think in terms of what we can afford.  When we have some extra cash, we think about what we can spend it on.  Money burns holes in our pockets.

I don't hold it against you.  Its human nature, and I'm just as guilty of it as anyone else.  Most of my working life I made only enough to cover my expenses, however much that was, and if I happened across a nice large lump sum I thought "what fun and cool thing or experience can I buy with this?"
That reasoning means we tend to spend however much we have.
In other words, maybe you were actually fairly comfortable when you were only making 23k per year, but you just switched to a better job, and you moved in with your partner so your rent is half as much, and so all these opportunities open up of stuff to buy and trips to take, maybe you get your internet speed one tier higher, since you can easily afford it, maybe you eat out a little more, get a latte at Starbucks twice a week, and before you know it, you're breaking even again.
   
There's a term for that: "lifestyle inflation".
  
Hedonic adaptation dictates that it soon becomes the new normal, and provides exactly zero happiness above baseline.

Suppose when life changes allow you to have higher income and lower expenses, you threw all the excess into investments?
Suppose you make a point of lowering expenses, cutting out anything that doesn't truly make your life better in a tangible, ongoing way.
Could you save 10% of your income?
25%?
50%?
75%?
90?
90%??!? Lets not get ridiculous here.  We aren't all stock brokers and corporate lawyers and software engineers.  Sure, if you make 6 digits each year, it would be totally possible to live a comfortable life with all the modern amenities (like cars and internet) on 10% of your salary.
Here in the real world, 1/2 of all American who work make less than 30k per year, and even bike-riding, 30-year-old-truck-owning, RV-trailer-living Bakari can't see living comfortably on three grand a year.
Ok, ok, so lets step back a couple lines.
How about 50%?
This still probably sounds a bit extreme - at first...
 
 
For reasons I don't entirely understand, people seem to think money numbers are supposed to be private.  But then, I have never been much of one for secrets, so how about I use me for an example:
Remember, I started saving at the beginning of 2010.  I made $22k that year, after subtracting business expenses.
In 2011 I made $22k again. In 2012, $21k.  This past year was my worst since I began working for myself, (8 years ago), and I only made $13k.
In 2010 my net worth was $0.
Today it is $52,000

("Wait a minute now..." you say, "those numbers mean you have to be living on less than 10 Gs on average each year!" Yup.)

It's not hard.
It is, more than anything, a change in mindset.
Remember that whole thing with my old RV trailer being stolen?
The entire settlement check went straight into one of my IRA accounts.
Remember that giant chicken coop and run I built?
The 2 large I made on that, all invested.
I don't live a deprived life.
I still buy toys now and then, (like my boombox and its battery pack). I have high speed internet, a cell phone, pets, I buy organic food, I eat out and go to the movie theater now and then.
I just try to ration spending, and avoid spending money on crap I know I really don't need, that won't improve my life in any significant way in the long run.
As a result, I am 1/5th of the way to financial independence, in just over 3 years.
At this rate, about 15 years from when I started, I should be there.
I'll be 45 - still young enough to take full advantage of freedom from mandatory employment. 
Just imagine though - if I had started back at 18; I'd be financially independent already!


You aren't me, you don't live how I live, so enough anecdote - lets segue back into some real life numbers.
We were talking about saving 50% of your income, and I was just using myself as an example to prove that even if your income is much lower than average, it is still possible.
In my example of me, spending only about 1/2 of income led to a working career of 15 years.
And there's that sweet math magic again: that number isn't just true for my particular circumstances.
It is universal.

If you only spend 50% of your income, you will have approximately 25 times your annual spending saved up in approximately 15-20 years.

Simple mathematics proves that.
Even without the power of compound interest, if you spend 50% of your income, then for every year you work you buy a year of freedom (think about it for a second).
But add in the money generating money infinite feedback loop, and at 50% every year you work earns you more than a year of freedom, and the earlier you start, the more free bonus time you get.

And here is the really beautiful part of all that, which may be easy to miss:

It doesn't matter how much your income is.  The ONLY variable in that equation is what percentage of your income you spend, VS what percentage you save.
 
( http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/ )


Going back to the philosophical point from near the beginning, but with this new knowledge, we have two potential life paths, especially while we are still young:

  • Path 1: Live simple, so you don't need too much money to live, and take advantage of that by not working too much.
    Spend the occasional windfall on toys and/or experiences.
    Low income, low cost of living, moderate amount of free time and freedom - but you will never retire.
    The same is true if you have a higher income, but lifestyle inflation keeps you spending however much you make.  If your savings rate is zero, you will need to continue working until you die.

  • Path 2: Live simple, so you don't need too much money to live - and work full time anyway, so that you have plenty of surplus to invest.
    Put most, if not all, of your occasional windfalls into your savings too.
    Moderate income, low cost of living - and low free time and freedom, at first, for a few years.  But then, before you know it, TOTAL freedom, and as much free time as you want.  For the rest of your life.

Path 1 is pretty good, beats working a 9-5 for 50 years.  Path 2 is a whole heck of a lot better.
Especially considering we aren't talking about some hypothetical future 50 years from now.  We are talking a short decade and a half.  We are talking "retiring" with the majority of your life still ahead of you.
Don't believe the math?  There are hundreds of people who have actually done exactly what I'm talking about.  A lot of them are on the Mr Money Mustache forums.  Mr MM himself is one, one who uses some of his free time to share all this information with others.  If you want to learn more, his blog is the place to start:

http://www.mrmoneymustache.com/2011/04/06/meet-mr-money-mustache/
 
(if you start here at the beginning, when you finish this post, scroll down a little to the link that says "Meet the Realist")

If you don't feel like reading too much, try maybe just this last link.
Later, if you like, you can read more for all sort of details on how to actually start spending less (with zero sacrifice to quality of life), what specifically to do with your savings to make it start working for you, and answers to all the other questions and concerns and objections you either have already, or will come up with soon.

The really important part is just the concept.  You have it now.  Very minor delayed gratification now, for totally life changing payoff in a few years.  You - you, reading this right now - can be one of those "financially independent" people.  No inheritance, no lottery, no lucky breaks.  Just being moderately frugal, and the math of compound interest.
Start looking at your money differently.

And make sure to come thank me when employment becomes optional for you.

3 comments:

  1. Awesome! now I just need to find out where I am going wrong....I don't spend much, ever....but something is screwy in what I am doing.

    Thanks to you, I am now awesomely employed doing what I like and mad. 23,000 last year, but spent a lot more getting rid of debt etc. I am not really employed "full time" although it feels like it....hmmmm. Thanks, Kari!

    ReplyDelete
    Replies
    1. Getting rid of debt counts as saving. You're on the right track

      Delete

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