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Wednesday 12 February 2020

How Long To Financial Freedom?

It's got nothing to do with how much
you earn
So you want to be financially free? Of course you do, who doesn’t!

Okay, so the next question you probably asking is how long is that going to take you?

Well that depends on how much you earn, right? The more you earn, the faster you can become rich, and the faster you can tell your boss what you really think of Hawaiian shirt day. Right?

Wrong. Very wrong!

Here is something for you to ponder…

Imagine that you are a top rated doctor earning R200k a month. You have the usual 6 luxury vehicles and 4 houses with matching golf course memberships. You know, all the normal stuff that comes with the territory. The result is that you spend R200k a month.

Sounds like a pretty epic life. But you know what? I wouldn’t wish it on anyone!


Because if you spend everything you earn, you will never be financially free.

Now, this example may be a little extreme, but it illustrates a very important point – the time it takes for you to achieve financial freedom has absolutely nothing to do with how much you earn, and absolutely everything to do with how much you spend.

In fact, how much you spend versus how much you earn is the only factor when it comes to figuring out how long it will take you to be financially free.
  • If you are spending everything you earn (as in the example above), you will have to work forever. You are a financial slave to your job, and without it, you will be sunk.
  • On the other side of the spectrum, if you happen to be in a position where you don’t need to spend anything of your income, then it means you have already achieved financial freedom, and you could quit your job right now if you wanted to.
Now most of us are somewhere in-between these two extremes of being able to quit your job right now, and needing to work forever. And that’s because you are saving a portion of your salary every month and putting it towards your retirement. The amount of savings you put away as a percentage of your income is known as your savings rate (here's a more detailed explanation on calculating your savings rate.)

Your savings rate is a really (really really) important number for you to know and to try improve, because it is the only thing which determines how long it is going to take for you to become financially free.

To see how this works in practice, the chart below shows the number of years it would take to achieve financial freedom, according to your savings rate. You can hover over each of the bars in the chart to see the detail on the number of years required to achieve financial freedom according to the given savings rate on the bottom axis.

Assumptions: 12% returns, inflation at 6.28%, investment amount required calculated using the 4% Rule

Some interesting observations from the chart above:
  1. For those of you with a very low savings rates, some massive strides can be made by simply upping your savings rate by a few percentage points. For example, you can slash a massive 14 years off your financial freedom date by upping your savings rate from 1% to 2%. (Of course going from 94 to 80 working years is still not going to cut it, but because the chart is exponential, there are some huge gains to be made at the low end).
  2. If a working career is considered to be 40 years, you need to save at least 16% of your income to make sure you will have enough at retirement age.
  3. Saving 42% of your income, will allow you to halve the usual 40 year working career that most people accept.
  4. If you can save half your income, you can be done with work in 16 years. This means a 21 year old could be financially free by the time they are 37 years old!
  5. The really hard core savers can quit their jobs in less than a decade by saving 2/3rds of their income. This may seem like a real stretch, but a middle income couple, starting early, could pull this off (by focusing on the expense triangle of doom for example) and be done with their jobs even before they have kids…
  6. This chart assumes that you currently have 0 investments. If you already have some in the investment kitty, then you will definitely be able to achieve financial freedom faster than what the chart suggests.
But I guess the obvious (but also maybe not so obvious) conclusion from all of this is this:

You don't need a high income to achieve financial freedom, you just need to make sure you are saving some of your income every month.

Nowhere on the chart is anything about how much you need to earn. The only factor is your savings rate. The bottom line is this:

The higher your savings rate, the faster you will achieve financial freedom.

In other words, your savings rate is where it's at!

And there are pretty much only two ways to increase your savings rate:
  1. Earn more
  2. Spend less
A lot of people focus on the earning more part. Now there is nothing wrong with this, but just keep in mind that it is quite an inefficient way of doing it, because you load yourself with an ever increasing tax burden for every extra rand that you earn. In addition, earning more often leads to spending more, and so it may not do anything for your savings rate.

I can appreciate that earning more money is a really attractive prospect, and it certainly seems far more glamorous than getting down and dirty into your spending, but you should only focus on the earning side once you have got a handle on your expenses. 

Spending less is super efficient - you get to keep ALL of your savings (tax has already been paid) and it will immediately give your savings rate a kicker. Less spending means more to invest, and every rand that is invested instead of spent, pulls that financial freedom date a little bit closer.

The equation is actually pretty simple:

Till next time, Stay Stealthy!
 - ~ - ~

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