Which feels easier: Cutting $100 from your monthly budget, or saving $30,000?
If you want to get to a point where making a living is no longer a #1 concern (or even #2 or #3), your most direct way is by increasing your savings rate. I used to be the kind of person that thought: “Hey, I’m earning a great income. Why can’t I drop a few hundred dollars on a nice dinner out?”
But once I understood the equation for financial freedom, it was clear that the fastest to way to get off the hamster wheel was to amp up our savings rate. Over the following six years, we put away 2-3x of our living expenses each year and built our savings to the point where I felt secure enough to leave the corporate track. We did this while adding two kids to our family, taking 10 months off after the birth of each kid, and losing one income when my spouse left her job to be a full-time parent.
What’s the trick we used to aggressively without giving up on all luxury and living on beans and rice (although my kids do truly love beans and rice)?
One mindset trick helped us stay motivated to keep managing our costs, even as our family grew. In this post, I’ll explain what we did to build our savings to the point where we could make a jump towards our ideal life.
Understanding how much you need to save
But before I get to that, let me first explain how to figure out how much you need to save. The idea is that you save a chunk of the money you earn, invest it into an asset-producing asset (e.g. investment portfolio, real estate, business ownership), and those assets produce an income that can fund your living expenses.
Use the 4% safe withdrawal rate to calculate how much savings you need to support your expenses:
- The 4% rule is the amount you can safely withdraw from your savings without ever running out of money. It is based on historical market returns net of inflation.
- If you spend $100K, you need $100K/4% = $2.5M.
- Note that the 4% rule provides a useful guidepost for how much savings you need to support your lifestyle. However, it is a guidepost only. The accuracy of the 4% rule (and any retirement calculator) rests primarily upon your ability to accurately forecast the expenses required to maintain your lifestyle. In real life, your expenses are never linear.
But before you get overwhelmed by that number, here’s an important distinction that rarely gets made in the conversation about financial freedom: You don’t need to accumulate the entire amount before feeling free to make a significant life change. I didn’t.
Financial freedom isn’t about retiring and never earning another dime again. Vicki Robin, godmother of the Financial Independence Retire Early movement and author of “Your Money or Your Life” says this:
If your goal is to switch to a more fulfilling career, downshift to work less, take a career break, or work for yourself, you will still have earned income coming in at some point. Instead of using the 4% rule as a number you must reach before you’re allowed to make a jump, use it to understand how much of your expenses could be covered by your assets. This gives you the peace of mind of knowing that you can support a minimum level of spending even if things go haywire.
What proportion of expenses you need to cover before you take the leap will depend on how risk-tolerant you are. I’m pretty risk averse, so I needed my savings to be big enough to cover the vast majority of our spending needs (we settled at 80%). At this level, we feel free to design our work and lifestyle based on our values without having to prioritize making a living.
Another way to think about it is to separate your spending for basic needs vs. discretionary wants. If you aim to save enough to cover your basic needs, you can make a jump towards your ideal life knowing that you have a safety net.
The double benefit of managing your expenses
Your ability to achieve the amount you need (whatever your version of financial freedom) hinges upon increasing your savings rate. The thing about keeping your expenses low is that you get a double benefit:
(1) As you spend less, you save more and get closer to the goal.
(2) As you save more, you spend less and make the goal easier by decreasing the amount of money you need.
This second piece is the bit that I want to drive home. When you choose to cut out, say $100 of dining out expenses per month (which in SF is easily the cost of one meal out for the family), you are reducing the amount you need to save to reach your goal by $30,000 (which is ($100 x 12)/4%).
I don’t know about you, but cutting out $100 from our monthly budget feels a lot easier than saving up $30,000. Every time we make that choice, we are getting $30,000 closer to our goal. You’re shifting your goal and making it easier on yourself. This was the trick that enabled us to accelerate our savings radically.
How much do you need to save to pay for that?
|Cost (per month)||How much money you’d need to save||How you might reduce the cost:|
|$100||$30,000||Cut subscriptions, Pack your lunch|
|$200||$60,000||Review your grocery bill, Reduce eating out|
|$500||$150,000||Review big irregular costs (e.g. vacation, house improvement)|
|$1,000||$300,000||Reduce childcare, Get rid of a car, Move to a smaller home|
The problem, of course, is that you are constantly assailed by the temptation to spend more. To keep this at the forefront of our mind, I created this sign and taped it up on our fridge. Print this out and put it on yours. You’ll be amazed at its power to help you spend consciously.
Every time we wanted to make a purchase, we asked ourselves how we felt about moving our goal $X farther away. Would I enjoy this Michelin star dinner more than waking up on Monday in charge of my own schedule and excited about what I get to do? Is the hassle of forgoing a second car worth getting rid of the anxiety around workplace politics and climbing that damn ladder? Does this shopping trip make me feel better than having the leisure to enjoy a slow breakfast with my kids every morning?
The point isn’t to spend nothing and live like monks. Sometimes we do choose to buy the pair of shoes or splurge on a vacation at the luxury resort. The point is to make ourselves aware of the trade-off we are making each time we spend so that we spend consciously.
Where this savings mindset got us
10 years ago, our savings could cover only 5% of our spending needs. Here’s how far we’ve come since adopting this new mindset.
Once we understood that each dollar we didn’t spend would get us that much closer to living our ideal life, we combed through our budget and started cutting out the stuff that didn’t actually bring much value. For us, there weren’t any silver bullets. Instead, it was about cutting out a little bit in a lot of different areas where we were spending mindlessly.
Here are some of the things we cut that made a difference to our bottom line, but not to our happiness:
- Going down to one car, and then to no car for several years (until baby #2 made hassle>savings)
- Living in neighborhoods on the farther edges of the city, instead of the prime areas
- Minimizing going out to eat when it’s just for convenience sake
- Buying used instead of new on bigger ticket items like furniture and kids gear
- Scrutinizing all ongoing payments and subscriptions
Perhaps more important than the cost-cutting was keeping our standard of living as flat as possible even as our incomes rose significantly.
Where spending money does bring us a lot of joy, we keep spending. Traveling is a huge part of our family life, and we consciously choose to allocate a big chunk of money to our travel budget. My spouse and I spent a year traveling around the world before we got married, and our daughter has already been to 15 countries before the age of 3. In fact, we’re currently on a trip to Greece, and I’m writing this from the balcony of a room overlooking the Aegean Sea.
Managing your spending doesn’t mean you have to suffer. It just requires that you get super clear about where spending money brings you value and where it doesn’t.
The big secret when you spend consciously
And here’s the big secret. Not only did saving get easier as we made conscious spending a habit, but we also experienced the unexpected side effect of feeling lighter.
I’m not a minimalist, and I get as much pleasure from a shopping splurge as the next person. In the past, I could easily lose big chunks of time browsing for luxury watches or comparing electronic gadgets. But by putting constraints around our spending and getting clear about the things and experiences that bring us joy, I free up the 5-10% mental space in my head that used to be occupied by thinking about buying this or that.
Once you can fully internalize what you’re saving for (your version of financial freedom), understand how much you need (using the 4% rule as a guidepost), and harness the power of saving by understanding the true opportunity cost every time you take out your wallet (tape that sign up to remind you!), you will be well on your way to affording your ideal life.
Sign up below to get the next post sent to your mailbox:
Hi, I’m Jen. I’m a breadwinner mom raising my modern family in the most expensive city in the US. This year, I’m leaving my corporate career for a life of greater intention.
I write about how to achieve financial freedom for your family so that you can live your best life while providing for theirs.
Read my story here.