All of our previous posts have focused entirely on earning. This is because there is no ceiling to the amount you can earn and there is a floor to the amount you can save. No matter what you do you’re going to have to pay for food, shelter, utilities, taxes and other necessities. That said… We’re going to outline our views on saving money in general since the topic has come up many many times. To reiterate. We don’t care much for saving because all of your energy should be spent creating recurring income. If you’re working 60-80 hours a week you wont have time to waste your money in the first place and by the time you make your money… well you won’t need to worry about saving. Funny how that works.
Five Point Summary
1) Saving 10% is a Scam: The general rule of thumb is to save 10% of what you earn. What they don’t tell you is this sets you up for a very long and dire path to mediocrity. The math doesn’t help you because you’re constantly increasing your annual spending in the 10% scenario. Lets look at the simple math.
Joe makes $90K per year. To make the math simple lets say he sees a take home pay of $60K. This means he would save $6K a year. He is going to see a wage increase of 10% per year and he will continue to save 10% of his income. This sounds logical until you put the numbers into a spreadsheet.
In Year 1, he will save $6K… fast forward to year 10 and that $6K is just 4.3% of his annual spending habits.
Our readers are smart so everyone can see the problem with a fixed percentage savings method. The fixed saving percentage makes every *prior* year less meaningful because it accounts for a smaller and smaller percentage of your new standard of living.
If joe was making $60K and gets a 10% raise each year he is now making, ~$155K. If he is spending 90% of that income, his annual spending is now $140K… the original $6K is just 4.3% of his annual spending habits.
2) Focus on Annual Spending Multiples: This is the fastest way to see an acceleration in your real net worth. Your real net worth is how many years you can live if you don’t do anything. It does not matter if you’re making $50K or $500K because your real net worth depends on your annual spend. To put some brackets around it, 20x annual spending is rich, 10x annual spending is comfortable and 1x annual spending is an abysmal disaster.
There are many families that have high incomes and practically no net worth. If you’re in a major city with a $400K income. But. Are forced to send your kids to private school and have a $10K/month mortgage… You’re going to be saving a dismal amount of money.
3) How Much Should I Save? We get this question a lot. Our answer puts point 1 and point 2 together to come up with a general rule of thumb. You should find a way to increase your standard of living and you should never see a decrease in your savings (in terms of annual spending). A good and aggressive rule of thumb is this: every year you work should result in a year you do not need to work.
This usually means you don’t get to spend a lot of money when you’re young. Specifically, if you’re out of college with a good income (lets call it $100K gross), then you’re not allowed to spend more than 1/2 of your take home pay from day one. In about two years you should see income acceleration from the 60-80 hours a week you’ve been working and you’ll be expanding your real net worth rapidly.
Assuming you start earning a living at age 21, you’ll be rich at age 41. You’l have 20 years of living expenses. If you start a business and create multiple streams of income you’ll reach this mark significantly earlier (it won’t even be close to 41).
4) 10x Annual Income as the Inflection Point: If you’re following along and don’t quite make it to becoming rich by age 31… it’s all but guaranteed (just don’t mess it up!). Sure there are no guarantees in life but it becomes quite difficult to fail. If you have 10x your annual spending in investment vehicles this means you’re going to put another 0.5 years away if you do practically nothing. A 5% return, which is extremely reasonable in a basket of bonds and equities, will lead to 0.5x years of annual income for you. If you simply save your allotted 1 year of income you’re at 11.5x already! Compounding becomes a rigged game… In your favor.
5) Pay the Price Upfront: While everyone else enjoys blowing their paychecks at the bars and the clubs you’ll be busy visiting the bank and your local brokerage for a couple of years. The funny thing about the math is you won’t miss out on much because 22-24 year old kids partying in the club are not interesting to 1) the owners of the club and 2) the most attractive women at the event. So you’re not missing out on much at all.
In addition, the amount you can spend will accelerate after you simply pay the toll up front. If you can put away 2 years of living expenses in your first two years out the gate, your discretionary spending can ratchet up without much impact to your future.
If you save $40K and spend $40K.. in 3 years you’ll have roughly $150K and your income should rise 25% or more, meaning you’re now spending ~$50K that year. In just 2-3 more years you’ll be able to spend in the $80K range and the game is over.
While the above paragraph is rough math, it clearly shows the power of annual living expenses. You’re going to be spending more and more each year. But. If you started with a high foundation or base amount put away, the compounding and wage increases (your career and your side business) will propel you into the 1% in short order.
Ramifications
We’ve really outlined a basic plan to get relatively rich. You simply work each year to never have to work another year again. That said there are a lot of underlying assumptions about how to make decisions with your personal life based on this philosophy or world view.
1) High Cost of Living City: Everyone wants to live in the cool city. New York, Miami, etc. Does it make sense for everyone? Probably not.
If your main skills are not going to accelerate your earnings in a major city, it is best to avoid living in them. There is no right or wrong skillset. You’ve invested in XYZ skillset and cannot change the past. What you can do… is run the math.
If your line of work is going to cap out at $100K a year… We’d suggest living in a low tax state and decreasing the total cost of living. There is no point in living in a vibrant city if all of your income is going to taxes and rent.
Make some basic guidelines:
– Spending 33% or more of your income on rent is a catastrophe. You want to shoot for 10-15%.
– Commuting is also a fixed cost, add this number to your rent number
– Time spent commuting is also a fixed cost, you cannot do meaningful work on public transit or while you’re driving so multiply each hour by your hourly income (approximate it)
– Take your rent and double it. That will estimate your actual monthly spending to account for necessities, leisure and one time negative events (life is a roller coaster and many things may go wrong)
2) Does a Broad Skillset Make Sense? We’re told to always keep a broad skill set. This means being good at multiple items so you will always have income. The problem with this logic is very simple. If it is easy enough for anyone to learn why will there be openings? If anyone can learn it you could very well find yourself competing with many people for the exact same position (hint hint, if it’s a rule based position that will be automated sooner than later).
Lets put the pieces together, if we know savings rates are a myth and you’ll be choosing your geography *carefully* you’d be a fool to have a broad skill set. Why? You’re not creating a long-term edge over your competition and mathematically we only need to see ~20 years of income in a worst case scenario.
Make Basic Industry assumptions:
– Will my skill set be valuable in this geographic location for the next 20 years?
– Will this geography be the primary hub for the next 20 years?
– Can this skill set be automated in the next 20 years?
If you answer yes, yes, no to the above you’re going to be safe. You’re setting yourself up for a *high probability* win. The future cannot be predicted perfectly but life is probabilities and you’re making the right decision based on your skills.
3) Mental Investment: If you have done the two items above and ascribe to the general world view we outlined in terms of “savings” you’re making it painfully difficult to reverse course after Year 1. If you decide to veer off course, every single cent you spend dilutes your real net worth (annual living expenses saved).
It is really that impactful.
If you put away $200K and decide to start spending $200K instead of $50K… you just wasted three full years of your life. Your net worth is simple a 1 instead of a four or a 75% reduction.
The mental pain will make it a lot easier for you to avoid making useless material purchases until you can officially afford it.
4) Consistency: The only real skill if we read between the lines is consistency. If you’ve ascribed to becoming rich, you only need a modest amount of will power. “is this going to impact my ability to put away 1x of living expenses this year?” If the answer is yes, it goes into the garbage.
As your income rises, you’re also consistently rewarding yourself because it gives you much more wiggle room. Your investments will allow the next egg to grow and this will make it easier to put away another year of expenses every single time.
5) Math Doesn’t Lie: We really didnt have a fifth point because we’ve become extremely efficient in describing complex topics into a few points. If forced to add a final comment it is simply to run the math. Compound interest is only a tool if it is *relative* to your annual spending. Otherwise it becomes meaningless in a hurry (broke NBA/NFL players as an example).
