Becoming Financially Independent, Part 1: Where to Start - Rodgers & Associates
Blog

Becoming Financially Independent, Part 1: Where to Start

How should young people prepare for retirement? It’s a great question consid­ering the financial challenges to Social Security and the demise of pensions. For many young people, it can be difficult to make retirement planning a priority—after all, retiring is something you do when you’re old!

I believe that financial indepen­dence is a better goal—and the younger you start, the better. Young people should work to reach the point where they no longer rely on their employer’s pay, so that working becomes an option. Of course, many of us would choose to work even if we didn’t need to because we like our jobs. Experts tell us one of the keys to healthy living is having a purpose in life, and many people find their purpose through work.

This newsletter is the first of three dedicated to laying out the eight principles for reaching financial indepen­dence. Memorize them and share them with family and friends. Many people go through life stumbling around finan­cially, hoping one day to win the lottery. Financial indepen­dence does not come by luck. It is within reach for many by learning and applying these principles to their daily life.

Principle 1: Always live below your means.

Many financial advisers say, “Pay yourself first,” which places a priority on savings. The impor­tance of this principle is more profound than just accumu­lating savings—it’s about controlling your spending. It is impos­sible to become finan­cially independent until your spending is under control. The US Government took in $3.464 trillion of income in the fiscal year 2019 but spent $4.448 trillion. Some could say the government doesn’t have an income problem; they have a spending problem.

Savings include contri­bu­tions to an employer-sponsored plan like a 401(k). However, close attention should also be given to after-tax savings. It’s important to build a cash reserve for emergencies and continue to fund tradi­tional IRAs or Roth IRAs. One method to accom­plish this is to invest regularly into mutual funds through automatic deduc­tions from a bank account. Some employers offer payroll deduc­tions to make after-tax investing even more effortless. Automatic investment plans are an efficient way to stick with an investing program because money is invested before becoming available to spend on anything else.

Principle 2: Time is your most important ally.

Start early and save regularly. George Clason’s classic book The Richest Man in Babylon suggests we set out to accumulate savings that will work tirelessly for us. Most everyone starts life working to earn money. Saving early and regularly preserves some of those earnings, allowing them to grow to the point that they support you. Saving early allows time for money to accumulate. The potential gains on investments—and the annual compounding of those earnings—can make a big difference in the timing of financial indepen­dence.

A person who starts saving $275 per month at age 20 will have $1 million at age 65, assuming their savings grow at an average rate of 7% annually. If they wait until age 30 to start saving, it will take $575 per month to have $1 million at age 65, assuming the same return rate. Procras­ti­nating until age 40 will require a monthly savings of $1,250. This illus­trates how important time is to the success of a financial strategy.1

Principle 3: Social Security is a safety net, not a retirement plan.

Social Security will most likely be around for future gener­a­tions. However, it will need to change from the system we know today to remain solvent. When Social Security became law in 1935, the average life expectancy was only 61.8 years. Half of working Americans were never expected to live long enough to collect their benefits. Today, life expectancy is approaching age 80. A healthy 65-year-old couple has a 25% chance that one of them will live to age 95.2 Social Security doesn’t have the resources to cover this longevity. Retirement age could be raised, benefits could be reduced, and the ability to collect benefits could even be means-tested, similar to how Medicare premiums are currently deter­mined.

Politi­cians will need to work out the solution, and that may take some time. Those seeking financial indepen­dence should aim to do so without the aid of Social Security.

Insights

  • Never spend every­thing you make. Your budget should be based on a maximum of 90% of take-home pay.
  • Time is the most important word in our investment vocab­ulary. If financial indepen­dence is the goal, starting today beats waiting until tomorrow.
  • Do not count on Social Security for financial indepen­dence.
Footnotes
  1. Nerdwallet​.com Compound Interest Calcu­lator
  2. How Long Can Retirees Expect to Live Once They Hit 65? By Wade Pfau, Forbes