Where It All Comes Together
Two major steps are out of the way at this point. To review, they are:
When you finally cross the threshold of owning more than you owe, you will have a positive net worth. This is where the long-term journey truly begins.
From my point of view, for anyone under a net worth of $10 million, all debt is bad debt. Focus hard on paying everything off. Some of you may want to keep your mortgage, but please realize that the interest on the loan (even if it is only 3%) can dramatically reduce the amount of money you are putting toward investing over the course of 30 years (average mortgage duration).
Remember, over the course of a 30 year mortgage, the average homeowner pays 2.5 times the original purchase price due to interest.
Once You Cross Over "Into the Black", the Fun Begins...
The first two steps of this journey were highlighted in Part 1 and Part 2. If necessary, go back and review those. The sole purpose of putting those two steps together is to get to the point of attaining a positive net worth, even if it's only $1.
Now you can begin to focus on savings, or what is commonly referred to as a "savings rate". I define this as the percentage of your take home pay you put towards savings.
A) To help start to figuring out your savings rate, consider the following:
B) After you have determined how much you are contributing to the above areas, find out how much you are adding to the following accounts on a weekly, biweekly, or monthly basis:
To calculate your savings rate, find out how much of your take-home pay goes to accounts listed in section B) from above. Section A) is still useful in adding up to determine "how much your job is truly worth" as many of these items listed in section A) are significantly cheaper for you as an employee compared to if you purchased them on your own.
Once You Know How Much Your Saving, Find Out How To Increase It!
Now that you have determined how much you are contributing to saving, look at this figure at least twice per year to see if you can increase it.
Never stop doing this step. Ever. You want to see throughout the "seasons of life" if you can be more and more aggressive with your savings efforts. Only you will be able to determine for how long and how much money needs to be accrued before you relax this plan.
Many have used The Shockingly Simple Math Behind Early Retirement article as a means for figuring out their "FI number". Perhaps this will be your next step as well.
To increase your savings rate, you can focus on income and expenses. Ideally, focus on both for the biggest impact.
The goal: Increase income and decrease expenses simultaneously
Ways to increase income:
Ways to decrease expenses:
The wider the gap between income and expenses, the greater potential your savings and thereby investments will have.
If you only have $100 saved, who the hell cares if you invest in something that generates a 25x return... you'd still only have $2,500 dollars---hardly enough to make you rich. This is a 2,500% return on your initial investment of $100. Guess what, "the market" typically returns 8-10% over time, not 2,500%.
Remember, your most powerful weapon at your disposal is compound interest. The way you make compound interest even more powerful is by saving, early and often!
Step 1 - Calculate Your Net Worth or Figure Out Your Lifetime Earnings vs. Savings
Step 2 - Attain a Positive Net Worth (most often by eliminating debt) and create some breathing room with a fund of at least 3 months worth of expenses
Step 3 - Determine your savings rate and find ways to increase it
Dr. Jon is a physical therapist by day, and a dedicated frugalist by night, deeply enthralled in the thrill of "pinching pennies" and investing the margin.