Whenever someone finds out that I worked only three years full time after graduating from physical therapy school, and that I’m very close to financial independence at 29 years old, the natural question that follows is, “How is that possible?” The answer to that question lies in the magic of my savings rate.
My Savings Rate
I’ve written about my savings rate on this blog in the past, specifically what my 2017 savings rate was and what I predict it will be in 2018 while taking six months of the year off. Over my three year full time working career, my savings rate averaged about 88% when using the formula below:
- Numerator: Gross 401K Contribution + Gross 401K Match + Total Income after Taxes + Tax Free Reimbursements – Total Expenditures
- Denominator: Gross 401K Contribution + Gross 401K Match + Total Income after Taxes + Tax Free Reimbursements
- Numerator / Denominator x 100 = Savings Rate
To most people without a strong interest in personal finance or financial independence, the concept of savings rate is probably completely foreign. I know that prior to graduation, it was something that I had never heard of or considered, even though I always did my best to save as much of my income as possible for various jobs over the years. This is a shame, as savings rate is the single most important factor in determining how long you need to work before reaching financial independence. Since income and expenses are all already baked into the calculations when arriving at your savings percentage, it takes very little work from that point to figure out exactly how long you have to continue to work your current job before having complete control over your time.
Testing Various Assumptions
Over the last few years I have spent way more time than I’d like to admit using a multitude of online financial calculators and making my own spreadsheets to determine the result of various scenarios.
- What if I am able to earn an extra $5,000/year?
- What if I can reduce my expenses by $100/month?
- What if I cut back to working 20 hours per week when I turn 30?
- What if I decide to only work one travel contract per year and take the other nine months of the year off?
- What if I never earned another dollar of income, how long would my nest egg last?
These are all questions that I’ve explored in depth many times, as well as many others, to the point of possible obsession. Spreadsheets and online calculators definitely make determining the outcome of these scenarios more simple, which can be a good or bad thing depending on your personality.
The Calculator to Rule Them All
There is one financial calculator that I have returned to much more often than others over the years, and I can still remember being baffled by it when I first found it. That calculator is “Networthify” and can be found here. The first time I visited this site, a few things jumped out at me. First, the average savings rate in the US is only 6%. That is a tiny amount and will almost inevitably lead to various financial hardships throughout a lifetime. Second, rapidly growing countries such as China and India are saving a much higher percentage of their pay (28% and 32% respectively) which is very interesting considering their wages are quite a bit lower than much of the rest of the world.
The biggest shock to me after playing around with the calculator using various assumptions was that no matter your income or expenses, your savings rate is really all that matters if you plan to retire in a short period of time. Assuming an equal rate of return on investments, it doesn’t matter if you make $200,000 per year after taxes and spend $100,000 per year, or you make $50,000 per year after taxes and spend $25,000 per year, both scenarios result in a 50% savings rate which means an identical amount of time to reach financial independence. This seems like common sense to me now, but at the time it was mind blowing, and I spent hours changing the savings rate to see how long it would take to reach financial independence at various savings levels. Here are some results assuming a 5% annualized investment return after factoring in inflation (a conservative estimate but not out of the realm of possibility):
- At a 6% savings rate (the average for Americans mentioned above) it will take 62 years to reach FI.
- At a 2% savings rate (the average for those in the UK) it will take almost 85 years! Ouch!
- At a 15% savings rate (the amount generally recommended by financial advisors) it will take about 43 years. Assuming graduating at 18 and working to 61, this is feasible for a normal retirement which makes sense.
- At a 50% savings rate (the target for most of those planning to retire early) it will take a little under 17 years to reach FI. That would mean retiring before 40 assuming beginning work after graduating with a bachelors degree. That’s wonderful!
- At a 75% savings rate (an unreachable amount for many people) FI would be achieved after only 7 years!
But what about me with an average savings rate of 88%? Here’s the secret to my accelerated path to financial independence.
At a 88% savings rate, it would take only 3.2 years to reach FI. This is roughly the trajectory I was on during my full time working career, although my situation is a bit different since I plan to eventually spend more than my current expenses once having kids in the future. As I’ve talked about in prior posts, I’m already past FI in terms of my current expenses, but I want to add at least an additional 40-50% buffer to my current expenses to account for future expense increases, which means it is taking me longer than 3.2 years. I should still be well under five years since graduation when I do hit my goal though, even with taking a lot of time off from now on. To reach financial independence after only a five year full time working career, it would take an average savings rate of 82%.
Is a savings rate of 75% or more achievable for most people? Realistically, no it isn’t. It takes a high income and fairly low expenses to be anywhere near that percentage. Even if it isn’t possible for you to reach FI in five years, if you plan to reach your goal of freedom over your time as quickly as possible, focus primarily on your savings rate and gradually increasing it over time. Even small differences can make a big impact which can be seen using the calculator above. Reduce expenses to as low as possible while still living a comfortable, fulfilling life while on the journey. While doing that, steadily watch for opportunities to increase your income in order to create the largest gap possible between the two numbers and invest the difference. Ultimately this is the only way to improve your savings rate and accelerate your own path to financial independence.
What is your savings rate and how much longer until you reach FI?