Keys to the FI Kingdom Part 2
Second Key to the FI Kingdom: Develop a spending plan that works for you
So you decided that the prospect of living life in the rat race under soul-sucking fluorescent lights for the next 40 years doesn’t actually sound appealing and you want to enter the FI Kingdom–great! But how?
Well, you’ve already read my introduction on the FI (Financial Independence) Kingdom and you know just how important developing a spending plan is for our success, now comes the fun part–putting together your spending plan that will act as your primary key for escaping the rate race and achieving your freedom! Above any other tool in your arsenal, your spending plan is the primary tool that affects all other aspects of your FI journey.
For example, how do you know when you hit FI? Your spending plan is the key to understanding when you hit your FI number and subsequently it’ll give you the answer for when you’ll achieve FI. So in this respects, once you have your spending plan/budget, you’ll know roughly (1) HOW MUCH you’ll need for FI–also known as your target number–and, (2) WHEN you can reasonably expect to achieve FI based on historical average returns of the market.
First, recognize this is a psychological and emotional game; Money represents your life spent at work for a good called money. Because you’re trading your life for it, by its very nature it is wrapped up in emotional and psychological realities for you. When we talk about money, we’re really talking about hours of your life traded away; it’s a personal game we’re playing when we talk about investing, financial independence, and developing a spending plan. Because it’s a psychological/emotional game, we can’t treat it like a mere mathematical equation. People don’t overspend because they think it’s fun to owe their credit card 18% interest each month! Nor do people buy bigger houses/cars because they think “well that was the logical thing to do because I know I have X percentage rate and this only represents X of my housing expense per my overall net income”. No, we humans are emotional psychological creatures that compare and contrast and “covit our neighbors things,” and we want to be on-top, the very best within our social ladder. This is why it’s important to evaluate and re-evaluate your spending plan and negotiate what you’re willing to invest now and what you’re willing to live off of so that you feel like you’re actually living life. Dave Ramsey’s saying here is helpful–live like no one else now, so later you can live life like no one else.
Second, it’s necessary to take a few deep breaths and begin to be honest with yourself regarding your WANTS and your NEEDS, recognizing that this is a psychological/emotional negotiation. The FI process requires being honest with yourself about WHY you do what you do, and WHY you spend your money on this instead of that. Become aware of the emotional triggers for your spending, and what’s behind the desire for X. You need to be able to untangle the wants from the needs. The process of NAMING is the process of becoming self-aware, which in turn reduces anxiety and the need for said object/status/security-blanket.
For example, what is the emotional satisfaction that I receive for purchasing this item off of Amazon? What’s the real value that it adds to my life? Is it worth trading X amount of hours it takes me to work to earn that money to spend it on this item? How might I use some other means to get the same satisfaction without needing to purchase the item? For me, I oftentime am tempted to purchase a book–a book that I’ll most likely only read once–instead of going to my local library to read the item. I can dissect the book, take copious amounts of notes with page references and quotes, and then return the book free of charge. Why do I want to buy it? Does it make me feel smarter/wealthier/more prestigious to have an extra book on the shelf? Do I want all my friends to know that I’m smart/sophisticated for having that book on my shelf? Am I hoarding knowledge/ or some other item? Does that item make me feel safe/in control/or loved? Well the reality is a book or item cannot provide the safety/control/or love and social status that you would like for it to. Naming that reality and trying to address the real emotional need or trigger will provide longer lasting happiness and contentment than the quick fix of purchasing it.
Third, you will need to face your finances–literally get out your financial statements (the bills) and start to count up where each dollar went over the last 3-6 months. You will begin to see a pattern on what you value and what your dollars are going towards. But again, when we talk about dollars, we’re really talking about your life traded for those dollars. You’ll need to come to the emotional reality of whether a good or service is really worth that much of your life spent at work. And, please remember, you can either spend your money once and for all (a realized life-traded transaction) or you can invest that money so that it grows into more money (an investment of life-traded money for more money which will reduce the amount of life you need to give towards your work-for-money stage of life). If you follow the FI Kingdom path, one day it will not make financial CENTS to trade your life for money–your investments will make enough for you to live life to the fullest without the need to trade any more of your life for money. Said another way, there is a said amount of hours you will trade for money in life, it can be 40 years or it could be as little as 7…which will you choose?
If facing your finances seems to be too daunting, start off with drawing up some estimates and then spend the next four weeks tracking your spending: “I think we spend $600 on entertainment each month, and $1,200 on the mortgage, and $100 on insurance, and $100 on transportation costs…etc.” Now look at the past month to see how close you were at your estimates. When we went through this process, Mrs. Financial Bishop and I just opened up a spreadsheet on our computer and on the very top typed in our net income (the income after you pay taxes) and started line by line thinking about all of our monthly expenses for each month. We built in the Envelope system so that it just says “Envelope $ to Spend” on one of the lines which we knew would include groceries, entertainment, gas, etc. We also wanted to capture what we were going to invest and what money we were going to put back in a separate online bank (e.g. Ally, Synchrony, etc.). We moved the numbers around until we spent on our spreadsheet our entire monthly income. Thus we “spent” the money on paper/digital screen before we actually got the money–we gave every dollar a home.
CENTSability note: The process of budgeting is seasonal as life–it can change, and it will change, but that doesn’t mean you can afford not to develop a spending plan or budget. Rather, the spending plan/budget allows you the knowledge and flexibility to live the life you want rather than becoming a victim of a life lived without intention. If you attempt to live without a spending plan/budget you will almost certainly become a castuality of lifestyle inflation whereby you overspend and (1) increase your target number while at the same time (2) decrease your monthly/annual investment amount. This equates to more years you’re required to work for money. Though I haven’t experienced this yet, I hear that working for the pure pleasure of it is far superior to working because you need the money–I can’t wait for that day! Until we no longer need to work for money, we’ll always have a second driving force that taints our decisions–where we live, what we do, how much time we get to spend with our family, etc. This is tantamount to freedom; freedom to having a real untainted choice in the matters that mean the most for our day-to-day lives.
The Spending Plan Example
Though I really want you to build your own spending plan spreadsheet–building your own spreadsheet is a FI Padawan’s right of passage!–here’s an example to get the creativity mojo flowing:
(Please note: Investing % is based off of actual net income and includes the company matches, which is why the percentage is higher than one would expect–it’s a bonus. Some people might not like calculating it this way, but for me I see it as money I cannot actually spend and it’s money that I only get by obtaining it through the company match–i.e. Investing. So I don’t count the company match as net income because I don’t have access to that money in the same way I have access to my net income. What really matters to me is how much money is going into investments compared to my net income. The bonus also allows for an extra psychological boost.)
Don’t get discouraged if your total monthly income isn’t this much. This is just an example–don’t give up before you start! The numbers are just there for illustration purposes. And, if you make a lot more than this number, it’ll be up to you to find the right percentage to invest to sustain your lifestyle in just a few short years. It means nothing if a Doctor makes $500,000 a year only to turn around and spend $495,000 a year–the Plumber who makes $60,000 a year and saves 50% of that is “richer” than the doctor!
You’ll notice that we have two categories in the spreadsheet, money that is leaving the bank, which includes our investments, and money that is going to our savings account. Then, at the very bottom we have the breakdown of our total expenses, total investing, total investing and savings, and lastly and most importantly the percentage of our investment and our expenses based off our income. The Company match here really helps to bolster this percentage. But in our example, with a couple who combined makes a mere $66,000 per year can have an investment rate of 70% of their income. At that high savings rate you’re looking at FI Kingdom Come (=FREEDOM) as early as ~10-11 years (assuming 4% withdrawal rate, 7.5% average real rate of return, ~2% inflation, and $0.00 starting out). And if you really wanted a “sure thing,” you could shoot for a 3% withdrawal rate and it would only take you 13 years (assuming 3% withdrawal rate, 7.5% average real rate of return, ~2% inflation, and $0.00 starting out). How’d I get there? Take your annual expenses and multiply it by 25 times (=4%) to get the number you’d need. Then use this calculator and plug in the numbers to see how long it’ll take (“Investment Length”) to reach that number.
For example, in the example spreadsheet the monthly expense is $2,545, so we multiply that by 12 months to get $30,540. Now we want to know what a 4% withdrawal rate would need to look like. So we take 25 x $30,540 = $763,500. We use the Investment Length calculator to find out it would take 10.9 years to reach that number if we assume a 7.5% real return (a return that addresses inflation). The beauty about building your own spreadsheet is that if you use formulas, if one number changes all of them change so you won’t need to continue to calculate this by hand.
The higher the percentage of savings, and the lower your annual expenses, the quicker you’ll reach the FI Kingdom. This has a double effect: by reducing your annual expenses you also automatically increase the amount of money you can invest. It takes less time to reach your goal because you’re at the same time increasing your investments while decreasing your target number. At 70% annual savings you could expect to reach FI in about 8-10 years (depending on whether you use a 3% or 4% withdrawal rate).
The reason I give a range between 3-4% is that there is some debate as to whether or not the 4% withdrawal rate is “Safe”. As I’ve mentioned before, I’m in the camp that would like to see my capital actually grow while I’m living in the FI Kingdom–costs change and I want to be able to address additional expenses later on in life. So for me and my house, I like to shoot for a 3% withdrawal rate. With any projections, there are a number of assumptions that are involved. But suffice it to say there are very smart people that argue for 4% and some who argue for ~3%, and since we’re talking about a difference of a year or two in additional savings, I would go with the safer bet since you’re already at your top-level earnings in your career–it really beats having to go part time or cut your budget later on in life. If the 4% crowd are right, then you’ll have a little more money to give away to charity, but if the ~3% crowd are right you’ve just saved yourself some headache of having to go back to work while in your golden years! The choice isn’t really a choice in my mind.
Above in the Primary Points section I’ve provided you with a range of possible withdrawal rates–what I like to call the range of FI, from the minimum to the diamond level. At each level you become more and more secure in your financial freedom. At 25 x your annual expenses, you have a lot of freedom. But at 50 x your annual expenses you’re looking at possibly starting a foundation or having a building named after you by the time you die! It all depends on how much money you feel like is “enough” for your long term goals. It’s also important to realize that your financial needs will change over time. When you’re a young FI, you’ll most likely trade your mortgage payment for your healthcare costs until you reach Medicare age eligibility–currently 65. But eligibility ages could change as people live longer. You just need to be aware of these kinds of things as you start planning. For me and my house, we just expect that our mortgage will be traded in for healthcare costs when we decide to move away from full-time employment. Healthcare costs should be factored into your equation when you’re looking at your target number. More specifically, I follow BIG ERN’s advise and I plan for the costs of a high deductible healthcare family plan plus the annual out of pocket maximum for that family plan–it’s not a little number but it provides peace of mind. It’s also a good idea to recognize that your expenses will change and that having a lower percentage withdrawal rate only provides you with more flexibility.
Also, because sequence of return risk, your first 10 years of FI is the most dangerous for your long term success. Once you can get past those years successfully with your capital intact and having grown a little, you have about as good of a chance of long term success as anyone ever has. But that said, you should plan for a little more than what a 4% withdrawal will give you just in case we hit yet another dot-com bubble or experience a lost decade.
Now let’s look at some things you can do to decrease expenses so you can increase your investment rate and get those keys to the FI Kingdom even earlier.
Life Hacks & Frugal Virtues
- Relocate close to your employment. This reduces the cost of travel and time spent behind the windshield in a stress-filled living nightmare.
- While you’re at the whole relocating thing, downsize to a smaller home or apartment. This lifestyle design allows you limited space and encourages you to be a more thoughtful person when purchasing clothes, furniture, hobby items, etc.
- While you’re at that whole relocating thing and downsizing thing, go ahead and get rid of as much stuff as possible—the psychological and physical toll of having a cluttered home is legitimate.
- Walk/Bicycle/Train/or share a ride as your means of travel to your place of employment.
- Downsize to a one-car family with a fuel efficient car (30 mpg +). If you own two cars, try just using one car for a month to see if you could get by without two. In graduate school we found that one of our cars sat unused most of the time, so we gave it to my parents and went to a one car family. It saves us a LOT of money each year on insurance, gas, maintenance, registration fees, etc. The extra money we save we invest.
- Extra CENTSability bonus tip: Actively save up for only 1 car in your life. After paying off our car we started making “fake car payments” to ourselves in the form of a 50/50 stock/municipal bond allocation right to our brokerage account so that in 10 years when we need another car, we’ll have it. The extra money that we don’t use for the car will remain to grow for the next 10 years to purchase our next car. In this model, we project that we’ll only need to actively save up for a car for one 10-year period.
- Until you’re disciplined, pay for everything in cash, and never use your credit card unless you can pay it off in full at the end of the month.
- Shop around for the cheapest insurance / Mortgage Rate / etc. It’s always a good idea to shop around and get multiple quotes. For example, when we were looking for a home mortgage loan we got 4-5 quotes and landed with a well known credit union for a 2.75% fixed 15 year loan.
- Extra CENTSability bonus tip: when selecting your payment method, choose to pay every two weeks and you’ll end up making a few extra payments a year, which will pay off your loan faster than the monthly payment plan option.
- We joined a family wireless cell phone plan to reduce costs. You can check out other options like Google’s Project FI or Republic Wireless too.
- Plan out your meals: Plan out weekly meals and go to the store once a week. We plan out our weekly meals on Thursday for that following week. Normally we just plan out dinners (lunch is leftovers from the night before, and for breakfast we have toast or cereal). We go to the grocery store once per week to reduce excessive traveling (e.g. ~$0.60 per mile). We rarely go out to eat for our weekday meals.
- Bring your lunch to work. Since you’re now planning out your meals, your lunch can be last night’s delicious homemade dinner from scratch! YUM!
- Buy dried Beans, Chickpeas, and other legumes: Instead of buying canned beans, we buy dried beans and cook them ourselves which allows (1) more bang for your buck and (2) control over the sodium levels and spices. Consider getting an Instant Pot to reduce wait-time for cooking your dried beans, chickpeas, and other dried legumes. When we got our Instant Pot we got rid of our Rice Cooker–we replace or reduce, rarely ever do we add to our appliances or other home items. Bonus Benefit (BB) of living in a small home is this provides “a good self-sabotage” preventing us from accumulating too much “stuff.”
- Make your own deodorant–it’ll probably be healthier than the chemicals you’re putting on your body with the store-bought brands. Check out Pinterest for many different options.
- Make your own cleaner: Clean your house with a homemade vinegar + rubbing Alcohol solution (I use a 1 cup vinegar, 1 cup rubbing alcohol, and finally 1 cup of water–mix it all up in a spray bottle and voilá).
- Make your own laundry soap. Again, pinterest is your friend here.
- Use dish soap conservatively. We have a spray bottle at the sink that we use; just fill it up with water and put the concentrated dish soap in and voilá.
- Start a compost pile and a garden. At the very least, a basil and mint plant are worth the investment! For the importance of gardening and thinking more wisely about resources and being and overall good human being, see Wendell Berry’s The Art of the Common Place–his concept of farming by proxy has made me deeply appreciative and more thoughtful about how I treat the earth.
- Utilize less expensive fitness options. We run, walk, and use free workout apps for our exercise habits. I also bicycle into work each day so I get a bonus benefit (BB) for that one life-hack!
- Hang your clothes out to dry instead of using the dryer. This can actually become very therapeutic, as I find placing clothes out to dry have become a calming ritual.
- Make your own Beer! If you drink alcohol, consider making your own beer–it’s fun and very tasty! A $100 investment easily pays off in a year when you make 5 gallons of homebrew at a time. Bonus benefit, I can turn that into a social event and have great excuse to hang out with friends.
- Consider eating less meat and dairy–better yet, cut it out all together. The most expensive items in the store oftentimes are meat and dairy products. Our grocery budget for years was a mere $25 per week. Now, we’ve relaxed a bit because we’re not in debt and we’re not making peanuts so it’s jumped to $50 per week.
- Extra CENTSability bonus tip: Try and find odd little stores with great deals. For example, we buy a lot of our spices at BIG LOTS because they have $1.00 spices on items that would be $2-3 at our local grocery store. Just check the ounces to confirm they’re actually cheaper by the ounce.
- Stop buying napkins, paper towels, and laundry softener. You can use actual cloth napkins and towels instead of the disposable ones–how did that even become a thing? It’s incredibly wasteful. Laundry softener–sure it smells nice, but it’s another pollutant and your clothes are going to smell more like your perfume/cologne than anything else, so why even bother?
- Use reusable tupperware instead of disposable plastic bags. Again, how did this even become a thing!?! While we’re at it, try to move away from all single use plastics to the extent and degree that you can.
- Reduce the number of items of clothing in your closet. The Bonus Benefit of living in a small home is there is a limited amount of space in our closets and it (re)enforces good spending habits and creativity. Clothing can be an excessive expense, but it doesn’t have to be. We save $40 per month and put it in a high yield savings account, and when there are big sales we buy for the next season. When we buy new clothes, we try to buy items that have multiuse or can be mixed-and-matched with a variety of outfits.
- Mow your own lawn, and use a REEL mower while you’re at it for the bonus benefit of the exercise you’ll receive.
- And, if you have a problem with people breaking into your shed and stealing your gas powered mower, I’ve found out from personal experience, they will normally leave your REEL mower alone–because let’s be honest, what pawn shop is going to buy that! #Theftprotection.
- Another Bonus Benefit of owning a REEL mower: no oil changes, no engine repairs, no gas smell, reduced noise, and you can mow right at the break of dawn (the coolest part of the day!) without waking up your neighbors!
- Instead of going out to eat with friends, go old-school and invite them over for a home-cooked meal and game night! Bonus points if you all agree to put away your cell phones for the whole evening! In a world that’s constantly connected to social media, it’s refreshing to connect to other human beings without noise and distractions. It’s sad to me when someone pulls out their phone to check out Facebook or Instagram while they’re surrounded by human beings that love and care for them. Being present means embracing the silence and awkwardness sometimes–if you can get past that, you might find real connection and belonging.
These are just a few ideas that have helped me along my journey. What other items did I miss? What life-hacks have you found most helpful?
Summary of the four keys to the FI Kingdom thus far:
- 1st Key to the FI Kingdom: Believe that you can change your narrative and decide what you want to achieve
- 2nd Key to the FI Kingdom: Develop a spending plan that works for you