14.Do it yourself. You can save money by doing your own taxes and changing a tire, for example. Use online tutorials to make things like this easy and cost-effective.
15.Monitor your bank account and see if you are using the correct account. Try to find a bank account with the lowest fees for your needs. The average American pays $329 a year in bank fees, so find a lower-fee account or an account with no fees.
16.Take care of your body. Medical costs in the U.S. are high, so staying healthy is good for your wallet. Exercise and eat right.
17.Be smart with your wedding. The average wedding cost is $28,000.
18.Live at home for as long as you can. Oh, and your parents can tolerate it! Offer to pay an amount to offset some expenses. You save a lot of money this way instead of rushing to move out the first chance you get. I lived at home until I was 27.
19.Use Gasbuddy.com to save on gas.
20.Monitor your bills. If something seems off, call the company to confirm the charge. For example, with my cell phone bill recently, I noticed I was paying a $15 a month fee even though I was below my data limit. By catching the mistake early, I saved $180 a year.
21.For dental work, if you do not have the cash to pay for your copay upfront, ask to space out the treatments or negotiate payment plans with the dentist for extensive work. It is better to make payments than to put it on your credit card where you will be charged interest unless you can pay it back within the month. Consider going to a dental school clinic where you may pay as little as a third of what a traditional dentist would cost and still receive excellent care.13
22.If you own multiple vehicles, calculate if you really need the second vehicle. If it is not being used regularly, sell it to save on costs.
23.Take advantage of happy hour if you are going out with friends. The cost savings will add up.
24.Unsubscribe from email newsletters of your favorite stores. Unfollow any brands or stores that trigger you to spend more money. Delete your credit card information from all apps and online stores to make it harder to spend.
25.Unfollow people on social media who make you feel like you need to spend to keep up.
26.Negotiate your cell phone plans, insurance, and bank fees. Shop around and compare prices. If you find a lower price, call up your provider and ask if they can match it. If they say no, say you want to be a customer but are willing to switch. For bank fees, ask if they will waive the fee. This tactic works wonders. Between getting lower rates on my cell phone plan, insurance, and bank fees, I save over $1,540 a year, which can grow to $262,581 over 30 years in the stock market, or $689,260 in 40 years.
27.Avoid decision fatigue. Research shows that making a lot of decisions can lead to detrimental effects on your finances. Simplify your life and automate a lot of small decisions, e.g., what to eat for breakfast or wear the next day, to be able to have the mental energy to make larger decisions. Alternatively, make your big financial decisions in the morning to avoid fatigue and making the wrong decision.
28.Practice meditating. Science14 proves that meditation will increase your willpower.
29.Develop a routine. Routines can prevent you from becoming tempted to spending money. As Jocko Willink, ex-commander of Task Unit Bruiser, the most decorated Special Operations Unit of the Iraq War, once said, “discipline equals freedom.” In this case, a routine gives you the freedom to hit your financial goals.
30.Sign up for free customer rewards programs, but be careful about store credit cards.
31.Invite friends over instead of going out.
32.Create a visual reminder of your debt. Put it on your fridge or somewhere you will see often. It will provide motivation.
33.Take public transportation if it is not too far of a commute.
34.Cut your own hair. This will be easier if you have a simple haircut.
35.Use your public library to read books. Some offer their services online, which makes it easy and convenient.
36.Switch to term life insurance. See Chapter 7: Have Insurance Just in Case.
37.Bundle your insurance policies. If you are buying auto, home/renter’s, and life separately, bundle them with one company to save 10% to 20% or more for each policy bundled.
38.Install CFL or LED lightbulbs where it makes sense. Energy-efficient bulbs may cost more upfront but save you money over time.
39.Take advantage of price matching. Amazon does not always have the lowest prices, so shop around.
40.Do your Christmas shopping on Black Friday. I do each year and save a lot of money.
41.Wait a day before you make a large purchase. Impulse buying is a major reason why our savings are not where they should be.
42.Consolidate your banking to take advantage of bundle discounts. For example, you may get credit card fees waived if you have a mortgage with the same bank.
43.Make your own coffee or take advantage of the office coffee maker. You can save up to $15 a week or more.
44.Ditch cable. I have a Netflix subscription instead, saving over $500 a year.
45.Cut the land line. Having a cell phone subscription these days is more cost-effective and convenient.
46.Avoid shopping hungry. You are more likely to buy more junk food at the grocery store if you are hungry.
47.Buy generic. The product is likely the same except in price.
48.Join the Dollar Shave Club or a similar service. Razors are a fraction of the typical cost.
49.Vacation off season. I often like to travel during shoulder seasons. That way I can still take advantage of decent weather at a fraction of the price of peak season.
50.Sign up for flight alerts to find the best deals. The best one I saw was going from Calgary to Tokyo to Sydney round trip, business class for $1,000. Regular price would have been over $5,000.
BE FRUGAL BUT NOT CHEAP
Being frugal is different than being cheap. Being frugal means being smart with your money—doing the appropriate research, shopping around, buying used if you can, and asking yourself if you truly need that purchase. It is about having a high joy to stuff ratio. If you have 10 pairs of shoes and wear them all on a regular basis for years, you are frugal. At the same time, being frugal means being able to spend money on others when you are on a date or out with your friends. It means not being afraid of taking your buddy out for coffee or going for drinks after work. It is simply choosing the things you care about to spend money on and saving money on the rest.
The key is what you do between these experiences and ensuring they are not an everyday occurrence. Choose to selectively spend to capture those good times but live according to your financial goals when nobody is around.
Being cheap means trying to save every penny like Ebenezer Scrooge. Do not be like Scrooge. No one likes someone who is too cheap.
Cheap Frugal
Cheap people only care about the cost of something they buy. Frugal people care about the value of what they buy.
Cheap people buy the cheapest thing on the menu. Frugal people are smart with their money, trying to get the lowest cost on things, but spend money on what they really care about.
Cheap people affect other people around them in a negative way and rarely spend money on others. Frugal people are not afraid of spending money on people they care for.
Cheap people keep a tally of everything people owe them. Frugal people do not keep track of what people owe them.
SUMMARY
To look toward the future, you need to make peace with your financial past. This chapter showed you how to calculate your net worth so that you know where you are starting from. It also talked about how using the bucket system for budgeting is far easier and more successful than monitoring every dollar, and how you can set financial goals and achieve them. A quick recap:
•Calculate your net worth so that you know where you are starting from.
•Keep track of your spending for three months using a budgeting app.
•Confront your spending by analyzing your expense
categories.
•Create financial goals:
•Short-term: What will you do today, tomorrow, next week, this month to start making an impact on your situation?
•Medium-term: Set a goal that is at least a year away to aim for. Do you want to have an emergency fund and have a portion of your debt paid off?
•Long-term: Decide what Big Hairy Audacious Goal (BHAG) you want to accomplish with your finances over the next few years. Perhaps it is being debt-free, having a down payment on a house, or paying for your children’s college tuition
•Reduce your spending over time by tweaking your spending habits to achieve your goals.
•Reward yourself once you hit your financial goals.
•Adopt the 60/40 budget (or 40/60) and create the four-bucket system creating separate bank accounts for each:
•Spending Account: For daily expenses.
•Emergency Fund Account: To provide safety money. Save at least $1,000 at first, and then once you are debt-free, build it up to two months of your salary as an emergency fund.
•Savings:
•Short-term: For the occasional splurge, vacation, and down payments.
•Long-term: For your long-term wealth and security.
•Focus on building a $1,000 emergency fund first, and then focus on debt repayment. After that, concentrate on saving.
•Reduce your housing costs to below 25% of your income if you can for the 60/40 budget. Aim for 10% to 15% of your income for the 40/60 budget.
•Save money and time by batch cooking and looking online for recipes.
•Be frugal but not cheap.
•Negotiate to save money and increase your income.
CHAPTER THREE
SAVE 25X YOUR ANNUAL SPENDING RATE
HOW MUCH DO I NEED TO RETIRE?
The most precious resource available is not money but time. Time to do what you really want to do. And, the best way to gain time is to retire earlier. As a result, the first question people usually ask me about personal finance is, “How much money do I need to retire?”
Most financial beginners throw out numbers like $5 million to $100 million. However, the range should be more like $2 million to $10 million. In short: You need 25 times your annual spending rate to comfortably retire. How did I come up with that number? It is all about the 4% rule, or the 4% safe withdrawal rate.
The 4% Rule
Where did this number come from? It assumes that your return on investment for your retirement portfolio rises 7% per year minus a 3% inflation rate per year, giving you a 4% return per year in retirement. As a point of reference, the stock market has risen close to 10% a year historically.
Theoretically, if you then withdraw 4% per year for your retirement expenses, you can withdraw that amount indefinitely. In reality, however, the market moves up and down daily. Over 25 years or more during your retirement, wars, another depression, or a financial crisis could happen. You cannot predict these things in advance. So, what do you do? Some people say that you should only withdraw 2% of your retirement savings and save more than 25 times your income.
Three finance professors at Trinity University conducted the Trinity study in 1998 that showed what the maximum safe withdrawal rate would be for various retirement years between 1925-1955, 1926-1956, 1927-1957, and so on for 44 rolling periods between January 1925 and December 2009. They assumed hypothetical retirees held 50% of their assets in five-year U.S. government bonds and 50% in stocks, which is considered a conservative approach to asset allocation.
What they found is the 4% withdrawal rate is the worst-case scenario.*15 People could have withdrawn 5% quite safely without a decrease in their asset value 20 times out of the 30-year period, meaning a 67% success rate. Withdrawing 4% a year would have yielded a 96% success rate. That being said, criticism around the 4% rule exists, namely:
•The Trinity study does not include mutual fund fees. Depending on the mutual fund, you can pay up to 1% to 2% in fees per year. This adds up to a lot of fees over time.
•The Trinity study considers retirement lengths of up to 30 years. If you retire early, you will likely be retired longer than 30 years.
•The 4% rule has not held up as well in other developed countries as it has in the U.S.
•The Trinity study does not assume that retirees plan to bequeath an estate.
•The Trinity study does not consider taxes to be paid on the withdrawn money.
Mr. Money Mustache’s response to those criticisms is that the Trinity study was ultraconservative in their assumptions, assuming retirees never:
•Work another day in their life, either through part-time employment or a side business.
•Collect from a pension plan.
•Adjust their spending to account for changes in the economy.
•Change their spending habits to compensate for price increases.
•Collect inheritance.
•Deviate from their portfolio allocation of 50% stocks and 50% bonds.
•And never do what studies have shown most old people do—spend less as they age.
I will add that the Trinity study:
•Does not consider the ability to move to a less expensive location.
•Does not consider Medicare health insurance coverage in the U.S.
Both our points are that the Trinity study assumes that the income you make stops the second you retire and that expenses and your financial situation stay constant throughout your retirement. Many retirees continue to pursue passions and often have side gigs. A million ways exist to make money in retirement, and chances are that you will adjust your spending as you get older as well. The Trinity study should, therefore, be considered conservative in its assumptions.
WHEN CAN I RETIRE?
The simple answer is: When you have saved 25 times your annual spending rate. What is your spending rate? It is everything that comes out of your paycheck, bank account, credit cards, and automatic payments. I suggest including property taxes and sales taxes but do not count income taxes or other payroll taxes. I also recommend excluding all loan interest, principal payments, and retirement contributions when calculating your spending rate. Why? Because once you become financially independent you will not have loans to pay off, and once retired, you will probably be in a lower income tax bracket and no longer contribute to your retirement account.
Let’s break down the spending rate with an example:
Gross Income: $5,000 a month or $60,000 a year
Monthly Expenses:
•Food: $618
•Entertainment: $500
•Utilities: $80
•Car Insurance: $93
•Gas: $127
•Cable: $99
•Cellphone: $50
•Miscellaneous: $200
Monthly expenses=
$618 + $500 + $80 + $93 + $127 + $99 + 50 + $200= $1,767
Yearly expenses=
$1,767 x 12 months= $21,204
Money needed to retire=
$21,204 x 25 years= $530,100
It seems we would need to save $530,100 to be able to retire, but that is not entirely correct. Our kids will hopefully have moved out, and our everyday expenses will likely decrease. However, we will probably be traveling and spending money on other pursuits, offsetting our reduced spending. So, let’s use the numbers above and calculate the savings rate to determine how long it will take to save that amount.
The savings rate is the percentage of your take-home pay that you set aside as a nest egg for retirement. The savings rate is primarily focused on any long-term savings you may be making.
To calculate your savings rate is easy. Take your gross paycheck and subtract all taxes. This number is your take-home pay. Subtract your spending, and you now have your savings. Note, contributions to a 401(k) or other savings plan should not be counted as an expense. Add back any employer matching 401(k) contributions and divide this by your take-home pay to determine your savings rate.
Saving
s rate=
((take-home pay - spending)/take-home pay) x 100
Take-home pay=
gross paycheck - taxes + 401(k) employer contributions
Take home pay in the above example:
Gross Pay: $5,000 a month
•401(k): $400
•Employer 401(k) Match: $175
•Automatic deduction for student loans: $300
•Automatic deduction for car loans: $300
•Federal tax (at 25%): $1,250
•State tax (at 8%): $400
Take-home pay=
$5,000 + $175 - $300 - $300 - $1,250 - $400= $2,925
Savings rate=
(($2,925 - $1,767)/$2,925) x 100= 40%
It would take 22 years to save16 the money needed to retire, assuming we invest our current savings at a 5% annual return rate.
You might be thinking: Well, that is assuming we make the same amount every year without a promotion or raise. Correct. But you would be surprised by how quickly our lifestyle adapts to increased earnings—new car, house, clothes, iPhone, watch. This is called lifestyle inflation. The more important factor here is not how much we spend but how much we SAVE. Think about it: If you cut out an expense, you are not only saving money this year, you are saving money indefinitely. Suddenly, spending $99 a month on cable does not seem like a good idea, when over 20 years that is equal to $23,760.
Savings over 1 year=
$99 x 12 months= $1,188
Savings over 20 years=
$1,188 x 20 years= $23,760
Using the above example, eliminating that one expense increases our savings rate by $1,188 a year or 3.4%, meaning we can retire 1.8 YEARS FASTER!
If you want a rough guideline as to what savings rate is needed to retire, this chart puts things into perspective:
Savings Rate vs. Working Years Until Retirement17
Savings Rate (Percent) Working Years Until Retirement
5 66
10 51
15 43
20 37
25 32
30 28
Kicking Financial Ass Page 5
