Proverbs 6, 6 to 8 says, go to the aunt, thou sluggard, consider her ways and be wise, which having no guide, Overseer ruler provided her meat in the summer and gathered her food in the harvest Albert Einstein said in relation to compound interest he who understands it earns it He who doesn’t pays it today.
I want to talk about financial independence a little bit and how financial independence is a function of savings more than anything else. If you stick around to the end, I got a resource to show you. And I’ll give it to you and then it might be helpful, but first a little about fire. Maybe you’ve heard of the fire movements, financial independence, retire early.
F I R E. It’s probably been around for a long, long time, but it was, I first heard about it really around the 2012 timeframe. There’s a guy named Jacob Lund Fisker. Who wrote a book in 2010 called Early Retirement Extreme. He has a website today and according to that website he has 160 years of income saved.
So, I think he’s kind of a Dutch, kind of a little bit weird kind of guy, but really highlighted the point and made it clear for me.
The guy who popularized it a little bit more at least for me, it was a guy named Mr. Money mustache a guy named Pete out of Longmont, Colorado, kind of popularized it a little bit more.
But it was there through them that I realized that financial independence is a function of savings more than anything else, even income. And so, to help highlight this a little bit, I want to go back a couple of decades and explain something called the Laffer curve.
So, let’s understand the setting of the 1970s, the late 1970s. The economy was a mess, stagflation, high unemployment tax rates were out of control. For example, in the year I was born, 1977, you can see that the lowest tax rate was 14 percent, and the highest tax rate was 70 percent with 23 various rates in between.
That’s a lot of tax rate. Talk about difficult tax planning. But a decade later, one year after Ronald Reagan’s famous 1986 tax reform, we can see now that there are only five brackets with the lowest being 11 percent and the highest being 38. 5. Legendary lore states that the Laffer curve played an important role in the reduction of taxes and simplifying of the tax code.
It was first drawn in a restaurant according to lore by a guy named Arthur Laffin. So let me draw this a little bit to help you understand What the Laffer curve is.
So, the Laffer curve is based upon X, Y axis, where on the X axis, we have tax rate, the rate. Of which taxes are curb. And so, zero to a hundred would be the maximum 50 would be the middle, again, 1977, they went from 14 to 70%. And then on the Y axis is we have essentially government revenue, how much money the government is breaking in from taxes.
So general theory would go something like this. The higher the percentage, the higher the money coming in. But what Arthur Lapper determined was that’s not the case at all, but rather the curve would look something more like this. Because if the tax rate was zero, obviously there would be no income, right?
You weren’t trying to make any tax money off the rate because the rate was zero. But that same principle would be true at a hundred percent because if the government took A hundred percent of every dollar you made what would be your incentive to go? work Zero, you wouldn’t get any money on it. So what author labra was trying to explain is the higher the rates you’re not getting more revenue.
You’re getting less revenue at this rate then you would otherwise. And some point in here is where we’re trying to get to, to the actual highest amount. So, the point is the extremes. At this point, we will get no revenue. At this point, we too will get no revenue.
Now we can argue about the skewness or the kurtosis of the curve, but that would miss the point, right? What we’re focusing on is kind of the end and the extremes. The interesting thing is that this concept though can also be applied to financial independence. Financial independence is the idea that you are not dependent upon income to sustain your living costs, right?
You’re not dependent on it. You might still work, but you’re not dependent upon it. You have enough savings or assets that will generate the income that you need to live. So, if we apply this same idea to financial independence, the core idea of the financial independence is you have enough capital revenue.
You don’t need to work. Now it’s, it’s obviously more complicated. Retirement planning is a lot more complicated than that, but just go with me to help illustrate this. And again, Let’s go back to another drawing.
so again, applying that similar concept to financial independence, we again have an x y axis where on the x axis is years to financial independence and the y axis would be savings rate, the percentage of our income that we’re saving, right? So go from zero to 100. 15 being ideal for baby step four for retirement and years to financial independence obviously could go from zero to You know 40 years is a typical working career could be longer things like that.
So again, applying that same concept Let’s look at the extremes if you’re saving a hundred percent of your income How many years would it take you to get financially independent? Well, it’d be zero because you You’re saving 100 percent of your income, which means you’re not spending any of your income, which means you have income from other assets.
So, you could, in theory, retire now.
So, if you’re saving 15 percent of your income, it’s going to take about 40 years, a lifetime, essentially, to have enough money to replace what you’re then spending. You’re spending 85 percent of your income. So, the curve, again, while not exact, would be something like that. Meaning that the higher the rate, the less time it would be to achieve financial independence.
The lower the rate, the longer the time it takes to achieve financial independence. And if you save nothing, you know, that line keeps on going down, down, down, down, down. And essentially, in perpetuity, you’ll never retire because you’re saving nothing. zero percent of your money.
So, this shows us how, like the Laffer curve, that financial independence is a function of savings rate, And the higher or lower the savings rate has a direct correlation upon the number of years, short or long, until you can achieve financial independence.
So, here’s a spreadsheet to give us a little bit more information on this. So across here, we have a couple of things, how much we’re making in terms of percentage and the idea of our savings rate. So again, if you’re saving a hundred percent of your income, that means you’re not dependent upon any of it to spend because you’re saving all of it, which means essentially you are getting your income from other assets, and you can retire now.
The next illustration here is the idea if you’re saving 95 percent of your income, that means you’re only need 5 percent to then spend to support your income. Well, if you’re saving 95 percent of it, how many years would it take you to get that other 5 percent and then be financially independent? 1. 5 and we can see as your savings rate decreases.
The number of years to retirement increases. Now this is based upon a couple of assumptions here making a hundred thousand dollars a year. Interest rate of return of 10 percent and a distribution rate of 5%. We won’t talk in detail of that, but you can see the idea that there’s a chart over time here that the lower the savings rate, the longer it is to achieve financial dependence.
So, I only did this to kind of halfway through, but there’s a second chart over here where you can see You know, the longer extension, if you’re essentially saving 1 percent of your income, you mean you’re spending 99, it’s going to take you 55 years to retire. That’s probably longer than a lifetime, right?
So not very good. But here’s the interesting thing. You say, oh, well, Mike, if I made 100, 000, sure it’d be easy to say, but here’s the key. If I change this to say 40, 000. Nothing changed all those years stayed the same because it’s a ratio. It’s a function. If I said, if you’re making a million dollars a year, right?
Add an extra zero. If you’re making a million dollars a year, it doesn’t change at all because it’s a function of savings. Rate, not income has nothing to do with it. Now, obviously the distribution rate would change. So, if you’re a 4 percent or right there, that has an impact for sure. And so does the rate, you make more better investments.
Obviously, it reduces the time. If you do less, you know, on your investments, it does less over time. So obviously there’s a correlation there.
So, I have a second spreadsheet here, a little more complex, just a little more detail, and I’ll show you how you can get a copy of this. If you want to play around with it and see some options in there. But just again, to illustrate, right. We changed the income to 40, 000. None of the actual points on any of the darts change.
If we change you. Rate of return to 15%, right? We see things change. If you only get 2 percent on, you know, you can compare here. And this gives you a little bit of kind of a under the hood of how these are being calculated of time, value, money, and equations, and the number of years to achieve those.
But and you can just see how long the difference is. Of over time various scenarios. So, I’ll show you how I can make this available to you if you want to, to get this chart where you can calculate your numbers.
Okay, before I tell you how you can get that spreadsheet, a copy of it, if you want, let’s go in the right capital and let’s see how this plays out a little bit for Joe and Jane average.
So, jumping into right capital here, we can see Joe and Jane average a couple in their early thirties with two children, Jenny and Jimmy. They’re basically an average American couple. So, they have a little bit of savings. They have a little bit of debt. They have mortgage, they have a car loan. They have a couple of credit cards, a little bit of student loans.
They own two cars; they own a house. They have a little bit of money in their check and savings. They’re putting a little bit into retirement. They’re just kind of average, not really doing a whole lot of anything. Well, just kind of the bare minimum of everything. They have some goals in terms of keeping some cash on hand.
They want to buy a car every five years. I want to help contribute and pay for their kids’ college and they want to retire around age 67. We look at their income and savings. Essentially, they make a little bit over 80. 1, 000 a year, Joe’s putting in 3 percent just to get the matches for one K Jane’s putting 150 into her Roth IRA because she thinks savings for retirement is a good thing and it is.
They’re spending about 3, 200 overall, not inclusive of their mortgage and their other debt payments. So, let’s see how this turns out for Joe and Jane. And we look at the probability of success. We find out that it doesn’t do very well. Let’s have a. Thousand different possible scenarios.
All thousands of them fail. If we look at kind of a projection of that, they do okay. Then they hit the college years. They do a little bit better and basically first year in their retirement, they don’t make they’re out of money. Essentially. They never achieve financial. We look at the cash flows, you know, they’re kind of going into debt every couple of years for the car.
They’re going into a lot of debt at the college years. And then as we get down to retirement, basically they’re out of money and they don’t do very well. So real straight in here that savings rate Oh, and time have a correlation of financial dependence. So, we currently have them retiring at age 67.
What if we change it to age 80 and we go down and refresh that? What does that do for their plan? Well, it increases it. They have a chance of making it now. Now it’s 10%. Great. Absolutely not, but it’s better than 0%. And what if we couple that with their increased savings? So, we get them to save. 20 percent instead of just 4 percent of their money.
And what does that look like? Well, now they have essentially a hundred percent rate of return and they end up at the end of the plan with 2. 4 million, right? So, we’ve added increased two different things. We increased their savings rate, which is a function of financial independence. And we increased. The time, and we go back and look at now those cash flows in the proposed plan, we can see that they’re adequately saving over time, still have a little bit of debt here and there, or negative cash flows, I should say and, but their plan makes it all the way until end of life where they’re essentially just taking money out of their accounts at that point, but you can see they kind of grow up.
They have millions of dollars later in life, they achieve financial. Cause we’ve added a lot more time to their scenario and savings. Hopefully this helps illustrate a little bit, the idea of relationship between savings and time and how financial independence can be achieved, but it’s a correlation of savings rate.
So, the reality of the situation is there’s a lot more variables again for retirement planning than just these two, but the concept holds the same. You must save money and the sooner you save, the better. So, the more you save, the better as it pertains to wealth, financial independence, and building wealth.
So, for those of you who are on our weekly mailing list, you’ll get a copy of this Excel spreadsheet in there. For those that are not on the list, and you want it, you can send an email, just send an email to mike at true wealth. And just simply put the subject of years, all capital years, Y E A R S. And you’ll get an email back of how to obtain that spreadsheet.
So that you can take it and plug in your numbers, your savings rate, and see the difference. Your micro action for the week. Under this basic premise, determine the number of years, to when you hit financial independence again, this spreadsheet here will do a great job of helping you determine that. If you use some kind of retirement planning software, you can use that.
If you have an advisor, talk to them about that, but it’s something that you want to know. So, do you ever hit the point of financial independence? And if you do, how many years is it? Today we talked about how financial independence is a function of savings. We applied the concept of the Laffer card to show you that there’s a relationship between savings rate and the number of years towards financial independence.
And again, we show you that same concept in a spreadsheet that you could get again if you want. By simply sending an email to Mike@TrueWealth.show with the subject of years, where you can plug in your numbers. Hope this helps you on your financial journey. If you have any questions or comments, you can leave them below or send an email to Mike@TrueWealth.show and until next time, hope you have a great day.
