15. SAVING RATE – THE TRUE SECRET TO FINANCIAL INDEPENDENCE
“The very first step to building wealth is to spend less than you make." -- Brian Koslow
In today's society, many people believe that in order to achieve financial independence, we need to make more money. The same people also believe that with more money, there is power, authority and status. With more money, it's quite natural for them to move to a bigger house, drive a nicer car, live in a posh.
In this materialistic world, many millennials can't resist the temptations of peer pressure and become slaves to their credit cards. They live a lifestyle that they can’t really afford. They live with the money charged to their credit cards. They often shop for new clothes and shoes, dine out at nice restaurants and cafes, drink Starbucks coffee, drive fancy car, and stay at nice hotels during travel.
That's why most people are still in the rat race, not being able to get out of it. It's not that they don't have enough money to retire early or have financial independence. Rather, they have upgraded their lifestyle over the years with more expensive things and possessions. They continue to spend even more. This means they will have less saving despite receiving a fat monthly pay cheque.
In order to spend less, it’s good to live a simple, minimalist lifestyle. As you live life frugally, you tend to buy and accumulate less things. Even for the things you own, you probably bought them at a very good deal. When you have less things, you have less headache to upkeep them. Probably you are happier too.
You don't need to buy a bigger house to store them. You don't need to clean and maintain them. You don't need to create a store room to keep them out of sight when you no longer need them. It's a chain reaction. You possess less. You spend less. You have more savings. The money you save can also be used elsewhere if need be. The money you save can definitely help you achieve your financial independence earlier.
If you are determined to achieve your financial independence and have an option to retire early, you should focus on savings. Yes indeed. Instead of focusing on making more money, you should focus on spending less. Those who spend less in their daily lives can usually gain their financial independence and time freedom faster than those who earn the same income.
I have covered the topics on how to make the most income from your 9-to-5 job in earlier section. While you maximise your potential earnings from your career, you should focus on savings. Otherwise, no matter how much money you make, you will still be unable to retire early.
"Your time to reach retirement depends on one factor: your saving rate, as a percentage of your take-home pay."
According to popular American blogger Mr Money Moustache, "Your time to reach retirement depends on one factor: your saving rate, as a percentage of your take-home pay."
He further elaborates, "If you want to break it down just a bit further, your saving rate is determined entirely by these two things: 1. How much you take home each year; 2. How much you can live on."
He explained that as soon as you start saving and investing your money, it starts earning money all by itself. Then the earnings on those earnings start earning their own money. It can quickly become a runaway exponential snowball of income.
He further mentioned that as soon as this income is enough to pay for your living expenses, while leaving enough of the gains invested each year to keep up with inflation, you are ready to retire.
I totally agree with his emphasis on the importance of savings. That's the reason why I am an advocate of frugal living through minimalist lifestyle.
In fact, Mr Money Moustache has come up with a simple table that focuses on saving the biggest percentage of take-home pay. It also gives a nice ballpark figure of how many years it will take you to become financially independent.
In his table, he has made 3 assumptions:
- You can earn 5% investment returns after inflation during your saving years
- You will live off the "4% safe withdrawal rate" after retirement
- You will be only touching the gains, not the principals.
I have added one more row to his table with zero saving rate (meaning you spend 100% or more of your take-home pay) so that you can see the worst scenario.
I also added one more column "Age to retire comfortably" into his original table assuming that a person can start making an income after he/she graduates from university at age 23. This column will then give you an indication of your age if you want to retire comfortably with the saving rate as per Mr Money Moustache’s table.
Saving rate (%) | Working years until retirement | Age to retire comfortably |
0 % | work until death | impossible to retire |
5 % | 66 working years | 89 years old |
10% | 51 working years | 74 years old |
15% | 43 working years | 66 years old |
20% | 37 working years | 60 years old |
25% | 32 working years | 55 years old |
30% | 28 working years | 51 years old |
35% | 25 working years | 48 years old |
40% | 22 working years | 45 years old |
45% | 19 working years | 42 years old |
50% | 17 working years | 40 years old |
55% | 14.5 working years | 37.5 years old |
60% | 12.5 working years | 35.5 years old |
65% | 10.5 working years | 33.5 years old |
70% | 8.5 working years | 31.5 years old |
80% | 5.5 working years | 28.5 years old |
85% | 4 working years | 27 years old |
90% | <3 working years | 26 years old |
95% | <2 working years | 25 years old |
100% | 0 working years | 23 years old |
0% saving rate
As you can see from the saving rate table, if you have zero saving rate, meaning you spend 100% (or more) of your take-home pay, you will never be able to retire totally. In fact you will be forced to work until your last breath unless you are living off saving from your wealthy parents, social security, pension fund, etc. I can't imagine myself working until I drop dead! Can you?
5% saving rate
Next, if your saving rate is only 5% of your take-home pay (which means you spend 95% of your take-home pay), you can totally forget about early retirement! In fact, you will never be able to retire until you are 89 years old! I wonder how many of us can live until 89 years old. Even so, can you still work for a living at age 89? Literally, it is no different from working until our last breath.
10% saving rate
Even if your saving rate is 10% of your take-home pay (meaning you spend 90% of your take-home pay), you will not be able to achieve your financial independence until you reach 74 years old. Do you want to work until you are 74 years old? Not me for sure!
15% - 20% saving rate
With a saving rate of 15% to 20% from your take-home pay, you will be able to retire comfortably at age 60 to 66 years old.
To put things in correct perspective, United Kingdom, Canada and America’s retirement age is around 65 years old. Singapore’s retirement age is 62, and Malaysia’s retirement age is 60.
Hence, by default, you are expected to have minimum saving rate of 15% to 20% from your take home pay. Otherwise, you will definitely suffer once you are out of the workforce after reaching government’s mandatory retirement age.
20% to 30% saving rate
As an employee working a nine-to-five job in Malaysia, you should be grateful for the existence of Employees’ Provident Fund (EPF). EPF forces those who work to cultivate a savings habit for retirement.
Currently, EPF contribution by employees is 11% and EPF contribution by employers is 12%. If you were to add up 11% and 12%, the saving rate is an awesome 23%.
Therefore, logically speaking, with the total saving rate of 23% through EPF, you should still be able to retire comfortably at the age between 55 to 60 years old.
Unfortunately, according to EPF, 70% of members who withdraw their funds at age 55 use up their savings less than 10 years after retiring. This means that 70% of EPF members will no longer have EPF money to depend on after 65 years old.
With a population of 33 million in Malaysia, only 69% is considered “working age” between age 15 and 65 as. Out of which, only 48% of the labour force (14.5 million people) have active EPF accounts. For those 14.5 million people in the workforce, at least there is still EPF contribution. How about the remaining 52% of the labour force? Where will the forced savings come from? Shouldn’t they worry about their retirement?
Even though you shouldn’t depend entirely on EPF for your retirement, EPF contribution does help by forcing you to have a saving rate of 23%.
In my opinion, you should treat your EPF only as a bonus for your retirement. It doesn’t mean that you can spend all your money from your take-home pay after EPF contribution. Seriously, if you do that, you may end up running out of your EPF money within 10 years after your mandatory retirement age at 60.
Malaysia’s current life expectancy is 75.3 years on average. If you live until age 75 or longer, you may end up living on the streets after running out of your EPF money at age 70.
Hence, you should make every effort during your working years to increase your saving rate after EPF and tax deductions from your take-home pay.
30% to 40% saving rate
If your saving rate is between 30% to 40% of your take-home pay (which means you spend only 60% to 70% of your take-home pay), you will be able to retire early between age 45 to age 51.
Isn’t wonderful to achieve financial independence 10 to 15 years earlier than the mandatory retirement age of 60?
Roy Thien, a former senior top executive at Shell Taiwan, left the corporate world at age 45 to start his early retirement life. He is living happily as a full-time traveller, author, public speaker, marathon runner, and a street performer enjoying his life to the max.
Rob Berger, a deputy editor at Forbes and an author, retired from his law job at age 49 after saving an amount equal to 25 times his annual expenses.
I personally also fall into this category, having retired 3 months before I hit my big five zero (50) in 2017.
Based on the saving rate's table, it looks like three of us probably have saved around 35% to 40% of our take-home pay throughout our working years in order for us to retire early.
Literally speaking, for every RM10,000 take-home pay, we managed to save at least RM3,500 (hence we spent only RM6,500). For every RM100,000 take-home pay, we managed to save at least RM35,000 (hence we spent only RM65,000).
You may then ask if it is possible for you to make it happen for your own self too, to achieve financial independence between age 45 to 51. Of course it's possible. It’s very achievable too. And I am a living testimony to that.
As a matter of fact, achieving a saving rate of 35% to 40% during your working years isn't that difficult.
The true secret is frugal living.
Don’t you think it’s better to have extra years on your hands and extra money in your pocket than extra stuff in your closet?
More than 40% saving rate
Of course, you can choose to retire even earlier than age 45. It simply means you need to have even higher saving rate than 40% from your take-home pay.
Mr Money Moustache was able to retire much earlier than me. He retired at the age of 37. Based on the saving rate's table, he probably had a saving rate of 55% throughout his 15 years of working. That's incredible! If you want to live a life like him, you can then aim for saving rate of 55%!
Through the FIRE (financial independence, retire early) movement sweeping across the United States and European countries, many millennials aspire to retire before age 30. This means you need to have a whopping 70% saving rate during your short working years.
Taking about high saving rate! Graham Stephan, a 30-year-old Los Angeles-based millennial, real estate investor and YouTube star who made USD 1.6 million in 2019, saved about 99% of it. He became a millionaire when he was 26. He is aware of his expenses. Despite being such a high-earner, he still saves money on things like coffee. He makes it at home for about RM0.90 a cup. He is very, very conscious of not wasting a single cent. If a millionaire millennial can save so much, to the extent of refusing to drink Starbucks coffee, etc, you can take courage from him to increase your own saving rate through frugal living.
When should you retire early?
There is no definite answer to when you should retire. It's entirely up to you. Whichever is your preferred retirement age, you shall use the table on saving rate as a guide. Then you know for sure how much you really need to save. The higher your saving rate, the sooner you can achieve your financial independence and have the option to retire early.
In my opinion, the most ideal age to retire early will be around age 45 to 51 with 30% to 40% saving rate. Around that age, you should have reached the prime at your career. By then, you will still have plenty of strength and energy in you to explore new things in life, to start the second phase of your life.
I personally don't encourage you to retire any earlier than age 45. You may end up living a not-so-comfortable life thereafter constrained by money with limited savings through your short working years. Besides, you want to give your career enough time to grow so that you can max out your potential income.
In short, no matter when you want to retire, you still need to take the first step to increase your saving rate. As what Brian Koslow said rightly, "The very first step to building wealth is to spend less than you make."
SECTION 3
SAVINGS THROUGH FRUGAL LIVING
“Living a frugal lifestyle gives you the opportunity to invest more money towards your future.” -- John Rampton
F I L L
Financial Independence, Live Life
achieving financial independence from 9-to-5 job before 50
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