Many financial planners recommend that you save 10% to 15% of your income for retirement, starting in your 20s. That plan is not going to work if you want to achieve financial independence in your 30s or 40s (or probably your 50s) unless you make the lottery, achieve a very high rate of return on your investments, or receive an inheritance from a rich uncle. If you want to guarantee achieving financial independence in your 40s without relying on something extraordinary then I recommend you save at least 50% of your after-tax income.
A person graduating from college in 2019 can definitely achieve financial independence by age 45 if he/she implements some prudent saving and investing habits. Recent data shows a 22 year old college graduate makes on average 50K in his first job out of college. If this graduate, let’s call him Joe, received a 3% increase to his salary every year, saved and invested 50% of his after-tax income, and achieved a 6% annual rate of return on his investments, then Joe would have an investment portfolio equal to approximately $1.25 million by age 45. Based on the 4% rule I’ve discussed here and assuming Joe has $50K in annual expenses at age 45, Joe would have an investment portfolio equal to 25 times his annual expenses and using the 4% rule achieved financial independence. But if Joe had only saved and invested 20% of his after-tax income, then his investment portfolio would be a little over $500K at age 45 and Joe would have only saved 10 times his average annual expenses (a good start towards achieving financial independence in his 60s but not what you want if you are reading this article). If Joe was determined to achieve a greater level of financial independence by age 45, or achieving financial independence earlier in his career, he could save and invest 70% of his after-tax income and have an investment portfolio equal to approximately $1.75 million at age 45.
Save and Invest Most of Your After-Tax Income to Achieve Financial Independence in Your 40s
Your savings, converted into investments, is the dry powder you need to build your assets/investments into something that allows you to achieve and maintain your financial independence. I saved and invested between 30% and 70% of my after-tax income almost every year I worked for someone and by age 43 I had achieved financial independence. Life is different than a financial calculator and so my income was not always predictable and my investments did not always earn as much as I hoped (some years they earned more than I anticipated). However, I started off my work life by living very modestly while my salary was low, and after I started to earn more money I never allowed my expenses to increase to the point where I could not save a significant percentage of my income. I was frugal compared to my friends/colleagues while I was single, my wife and I had a smaller home and older cars than most of our friends and peers, and to this day my kids have less “stuff” than the other kids that live in our neighborhood. That being said, I was fully aware of those small sacrifices and today it feels good to be financially independent in my 40s.
How did I save 30%-70% of my income until I achieved financial independence?
Here are some ways I did it and how you can do it:
You have probably heard the saying “Pay yourself first.” I agree wholeheartedly with that statement and I literally established a separate checking account to deposit a fixed amount of savings every time I got paid by an employer. Over time the balance in this savings account would grow and it felt good to see the balance go up over time. I never took out cash from this account to pay for expenses and if I found a good investment I would use the cash to make an investment. Seeing the tangible results of your financial discipline is important and having a specific account with your savings added to it is a great way to see the results.
Avoid the big ticket expenses
Big ticket items are a great way to keep someone from saving a lot of his/her income and I’ve written a post on those big ticket items you should avoid/minimize. Too many people use their savings or put down the credit card for these types of expenses and they dig financial holes that take a while to climb out of.
Live frugally until your income increases
Assuming you have minimized student loans, most people starting out may not have a lot of money but they also don’t need to spend a lot while they are getting started in their career. You should keep your expenses down after getting your first job and save as much as you possibly can. Sharing housing, avoiding the first new car purchase, minimizing costs when you go out with friends, etc. are things young people can do to get off to a good start. I bought my first property three years after graduating from college because I saved most of my income from day one and I had saved the down payment by the time I was 25. As you get more experience in your career and become more valuable to your employer your income should grow and allow you to increase your expenses without sacrificing saving a significant portion of your income. I increased my expenses over time after I got married and then after my wife and I had kids but we always lived well below our income so we could continue to save/invest.
Increase your income
I’m going to write a post on this soon but if you want to achieve financial independence and avoid eating homemade mac and cheese for the next 10 years then you need to increase your income over time. A lot of people talk about side hustles. I believe that you need to increase your experience and value in the area that generates your main source of income. Over time being invaluable to customers/employers/etc. can significantly boost your income.
Save 100% of any bonuses or other windfalls
If you are employed by a company that gives annual bonuses or periodic commissions then treat those payments as found money and try to save 100%. During my 20 years of working I probably received annual or quarterly bonuses of some type over half of the time. I saved/invested most of those bonus payments. Occasionally I would use some of a bonus to pay for something I wanted to do or buy but I always saved a big portion of my bonus payments.
If you get married, both people should agree to a financial independence goal and work to achieve it
Money problems are a big reason people divorce. Most people interpret “money problems” as a couple not having enough money. However, I think the problem starts when two people have different financial goals. If you want to achieve financial independence by 40 and your partner wants to have a big house and new car as soon as you can afford it then you might be in for some conflict. Achieving financial independence is a big goal and if you and your life partner are pulling in different directions it’s going to be tough to get there. My wife and I are both low maintenance and are generally aligned with spending habits. We talk about finances and our goals and it has been really important to our success as a family. We don’t always agree on every expense or decision but we are aligned on our big picture goals. This is very important!
If you are reading this article and you are already spending too much to save 50% of your income then you need to do one of three things: 1) increase your income; 2) lower your expenses; or 3) increase your income and lower your expenses. There’s no magic pill and you can’t go back in time but I’ll be writing articles on my blog on increasing your income and lowering your expenses. For now, I’d focus on implementing the steps I highlighted above. Good luck and get to saving and investing!