#007: Know Your Savings Rate or You’ll Regret It
How much free time are you earning per month?
Today, I am going to show you why you should understand your monthly savings rate.
While everyone knows what “saving“ means only few people think about its impact on their future 10 to 20 years ahead.
By actively thinking about your savings rate today, you can develop a mindset that can reward you massively with free time a decade later.
The problem is that most people believe they need to chase a higher salary instead of first understanding and controlling their savings rate.
Common misconception: the more you earn the wealthier you are
It is tempting to believe that people with a higher income must be wealthier than you.
Then, we wrongly conclude that the only way to become wealthy is to earn more.
But there’s a trap: If once you earn more you also spend more you don’t get to save much.
However, if you earn less but manage to save more relative to your income you will be closer to financial freedom than somebody with a higher income.
I call this the money trap: Get a higher salary, increase your living costs, run faster in the hamster wheel.
On the contrary, young people with no responsibility yet no salary don’t know the hamster wheel. — How come?
Because they don’t trade their time for money so easily!
Understand that your most precious good is the time you own
As I already have written in this post, your savings rate tells you how much free time you own.
Why?
Because your savings rate and the amount of free time you own are equivalent:
If your monthly income is $5,000 and you only spend $2,500, your savings rate is 50%.
This means you can live 1 full month off those savings.
Once you become sensitive to thinking about your savings rate you might ask yourself:
How much do I need to save to be able to completely live off my savings?
The 4%-rule: If your annual expenses don’t exceed 4% of your net worth you can stop selling your time for money.
Let’s break this down:
If your total expenses per year are $40,000, then you can stop generating active income once you reached $1 million in net worth.
The 4%-rule was originally established to estimate retirement withdrawals adjusted for inflation and taking into account average life expectations of retirees.
It should serve as an indication for when a retiree’s savings will go to zero.
Personally, I like to interpret and apply the 4%-rule for myself in a much different way:
If you are a long-term investor (like me) and you aim for 6% — 8% return per year on average then your net worth won’t decrease once you start applying the 4%-rule (even if you factor in modest realistic inflation of 2% per year).
That’s because you have invested your net worth smartly to get those returns that compensate your expenses.
Make a rough projection to understand where you are on your financial life trajectory.
You own this to your future self.
Follow these 4 steps to make your financial projection:
- Calculate your savings rate and net worth. You can follow the guidlines and template here.
- Calculate your yearly expenses. Also, consider yearly 1-time expenses such as potential electricity bills, holidays, etc.
- Multiply your yearly expenses by 100/4 and you get the magic number you need to hit to stop selling your time for money.
- Calculate how many years you would need to save and invest to hit that number regarding your current savings rate.
Now I understand I will “never“ be able to retire
That’s absolutely not true.
So far, you’ve done the right thing since you have become aware of your goal and challenge.
Understanding the challenge means understanding your savings rate.
Now track it, think about it and develop your mindset.
Then adapt your lifestyle, career planning, spending or investing habits accordingly.
Remember, we are thinking long-term here.
A change of mindset today, might reward you a whole year of free time in 15 years. But if you don’t start today, you won’t get that whole year later. Minimize your regrets.
And since you are already thinking about life-changing opportunities, you might want to have a look at this post as well: click here.
Key takeaways
- Understand your savings rate to start building wealth.
- Establish your own financial projection with a time horizon of 10 to 20 years.
- Develop a mindset leading to an intentional lifestyle while earning free time month by month.
Don’t miss the next post, where I will explain how I take decisions to maximize satisfaction over a lifetime.
