Why panicking is the worst thing to do in a financial downturn
During a period of decline in the market, many individuals feel like they are losing their shirts (and possibly much more).
Remember, corrections happen often. Technically, so do recessions. We typically have a correction once every couple of years and a recession every 5 years or so. That said, the overall equity market still returns just under 10% over the last 200 plus years.
So what might one do amidst a significant financial downturn? Suggestion: hold on tight!
How often do these "market crashes" happen exactly?
According to USnews, corrections happen at least once every 2 years. Sometimes they happen annually. When corrections do occur, they typically only last a couple of months and drop less than 20%.
Bear markets (recessions) occur every 4-5 years. They typically drop 20% or greater and last for a duration of one year, give or take a few months.
The worst meltdowns or recessions in recent memory was "The Great Recession". That sucker lasted 18 months and was the worst meltdown since World War II. During that period, the S&P 500 lost approximately 50% of it's total value. Now that's scary stuff!
How long does it take to recover from a typical market dip?
The single most significant factor of a recovery whether or not you stayed invested throughout the entire downturn.
As history has shown repeatedly, if you choose to try and time the market and you get out while it's on the way down, you technically have to time the market correctly twice- once on the way down, and then once on the way back up when you "re-enter" the market. Market timing is a fool's errand.
There are professional money managers who spend their whole entire life's work trying to time the market and, guess what... 92% of actively managed funds fail to match the returns of the market (i.e. S&P 500 index) over a 15 year period.
That means if they cannot do it, why would you even try? You don't have the time to sit around and read financials all day like these guys do.
As for how long the typical recovery takes.
In a correction, you should be back to even within a couple of months. For recessions, you usually get back to square within 18 months, give or take. Regardless, the markets have always climbed back and resumed breaking records. This is no guarantee but it seems highly likely given that we have two centuries of market data to rely on.
What to do when things get scary
My personal philosophy, as well as the philosophy of many seasoned investors, is to sit tight. Selling when the market is falling is one way to guarantee a financial loss and give yourself a lasting bad experience with investing in the market.
For the bravest of the brave, you could take this one step further and actually invest during a downturn. This is what I personally do. I take advantage of funds going "on sale" and purchase shares of the index funds that I already usually invest in at a drastically lower price than I would have gotten if the market continued to climb. See my thoughts on low cost index funds if you are unsure what these are.
It was the infamous Warren Buffet who said when the sky is raining gold do not go outside with anything less than a washtub. This is the very basis of the saying "buy low".
If you happen to be an individual stock picker, and not a typical index fund investor, then I suggest you go elsewhere for information because this is not a game I like to play.
When you invest in index funds like the S&P 500, you are betting on the entire US economy. Realistically, in order to lose ALL of your money, the entire country would nearly have to "go out of business" and I just would not bet on that happening anytime soon. Beside, even if the U.S. economy completely tanked and all businesses closed up shop, there will be much bigger problems going on in society that will quickly overshadow your worries about how much money is in your account.
If you are invested in broad based, low-cost index funds, then I would plan to stay the course and avoid selling in a downturn. You lose money when you sell or when a company goes out of business. If you stay invested, particularly in these broad index funds, the likelihood of never returning to baseline is slim to none.
If you had a crystal ball and could see things coming, perhaps you could adjust your asset allocation (i.e. more bonds and less stocks) prior to or immediately after the beginning of a downturn. The problem is, nobody is able to time this. Most of the corrections and recessions have no consistent way to assess when another one is coming. The best you can do is decide whether you think major market fluctuations are ahead based on national news - think politics and pandemics.
For example, take the onset of the coronavirus (COVID-19). If you had first heard of the potential outbreak on the news January of 2020, perhaps you could have adjusted your allocation more towards less-volatile bonds to soften the blow. Nevertheless, things were able to return despite the fact it seemed the downward spiral would never end. If you are considering yourself a long-term investor (which I hope you are), perhaps ignoring these events altogether is your best bet. Ask your financial pro if you don't believe me and if he disagrees, find out why (it usually revolves around him or her making an extra commission to manage your funds).
In the end, no results are guaranteed. Past history does not indicate future returns. Besides, none of this is investment advice and I am not a financial professional. You have to take the good with the bad. The overall average returns of the market of just under 10% per year include years where the market dips greater than 50%-such as what happened in 2008. You truly do have to take the good with the bad when it comes to investing.
In closing, corrections happen all the time. Further, we are never that far away from a full recession. They are coming. They will continue to come. Be prepared. Be ready to see your accounts lose massive value. This are the harsh realities. If you cannot handle it, maybe you should go bury that money under the shed and let the worms get it.
Understanding life insurance policies
Insurance is often a very important component of a sound financial portfolio. However, the needs of each person is unique, especially when it comes to life insurance.
When deciding on life insurance policies, there are several important things to consider.
First, you need to consider your current debt to income ratio. If you are the high earner in the household, and carry a lot of debt, taking out a larger policy on yourself is probably justified. Even if you are a low earner, but carry a large amount of debt, considering a medium to large policy is definitely warranted.
It is also important to consider where you estimate you will be in the future regarding your financial situation. If you are a habitual saver, perhaps taking out a larger policy now and shifting to a smaller, more affordable policy later would be justified.
If you are already financially independent, saved 5 or more years worth of expenses, and carry no significant debt, life insurance may not be needed at all. It is definitely a conversation worth having with your financial professional.
What is Life Insurance?
Basically, it is a contract. The payer (insured) is in contract with the insurance company. The exchange is a monthly premium for a "potential" lump-sum payout. To remain under contract, the insured pays a monthly premium to remain eligible for a "death benefit", which is often the lump-sum payout.
If you ever wanted to discontinue your policy, you could just simply stop paying the premiums and your coverage would cease. I would check with your provider first however.
Common Types of Life Insurance
Basically, there are two types of life insurance. There are fixed term policies and there are lifetime policies.
Fixed term policies are often referred to as term policies, or term life insurance. This type of policy provides coverage for a fixed period of time, most often 25-30 years. Term insurance is the most popular type of insurance chosen by followers of the financial independence and financial freedom movements as it is typically the more cost effective form of life insurance.
Lifetime policies typically come in the form of whole and universal life insurance. These policies typically carry a much higher premium, however they are payable for the lifetime of the insured instead of expiring after a pre-determined period like a term insurance policy.
Essentially, for a higher monthly premium you stay eligible for a "death benefit" payout under a lifetime policy. In a term policy, if you are not deceased prior to the policy expiration date, there is no "death benefit".
Why I Chose Term Life Insurance
My thought process, like many F.I. followers, is that I chose the policy with the greatest amount of value.
Term insurance affords a much lower monthly premium than a lifetime policy. This allows me to instead invest the difference in cost between the two policies, month after month, compounded over time.
By investing the amount I am saving with a term policy, compared to a lifetime policy, I will take advantage of the effects of compound interest. While taking advantage of this investing strategy, I do not leave myself "exposed" to significant losses of income that my family would incur should I meet an untimely demise. This is because I still have a substantial "death benefit" payout with my term life insurance policy.
I chose to avoid a lifetime (universal or whole life insurance) policy because I anticipate reaching a significant amount of net worth and savings by the time my term life insurance expires.
In other words, if you anticipate saving and investing for the next 30 years, you will likely have a significant amount of money at the end of that term. The need for continued coverage beyond this point, like you would receive with a whole or universal life insurance policy, is unnecessary and very expensive.
Overall, everybody is different
Assess your needs on an individual basis. Consult with a financial professional.
Not everyone will benefit from a term policy over a lifetime policy. Your circumstance may be unique. Consider your overall picture (time horizon, investing strategies, savings rate, anticipated expenses, etc.) when determining what type of life insurance policy will best meet your needs.
In the end, whichever policy you choose, I do feel that life insurance in general is an excellent thing to consider for anyone with a spouse or dependents that will be deeply impacted by your loss of earnings upon the event of your death.
Getting "smarter" about money is a proven road to riches
I am not referring specifically to college education either. I am referring to "getting to know money".
You see, most wealthy people (people with a high net worth) seem to know money pretty well. They know where and how to save it. They certainly know how to make more of it. Perhaps most importantly, they know how to invest it. There are very few millionaires who do not have an excellent education on "how money works" as a medium of exchange.
There are some popular exceptions to this rule such as professional athletes, divorcees, trust-fund babies, and celebrities. Consider how many stories of celebrities and athletes going bankrupt or having significant amounts of debt that we are aware of. It seems that the only difference between those who have received a windfall due to celebrity status or otherwise, and those who remain millionaires for decades, is the level of education they have about their money.
Most of the wealthy got their status because of their desire to study riches. Take some of the wealthiest investors in America as an example:
What all these men have in common is they have dedicated their lives to learning about money!
Buffet is said to read some 500 pages of financial statements per day. This is taking learning about money to a new extreme. Any coincidence that his passion and desire for learning about money and value has led him to be one of the richest men in America? I think not.
Icahn is a ruthless investor and seeks undervalued assets to turn a profit. He has developed an incredible ability to remain patient and concentrate his bets and investments in definitive assets. He has consistently beaten the returns on Buffet by nearly 10% over the last 30 years. How could he possibly have developed these skills? He learned about money and value investing by educating himself on how to read and interpret financial statements.
For Dalio, it has long been said that he had an innate ability to find a way to learn from anyone who had something to teach. He is reported to have even listed to his barber or somebody that he caddied for to pick up valuable long-term investing tips. This should all come as no surprise that he made his money by learning about money.
These are some extreme examples of how learning about money typically leads to generation of assets and accumulation of net worth. However, it can be true for all of us as well.
How can "everyday folks" become wealthy?
Same answer as before: improving your education and understanding of money.
For example, try to predict whether learning about any of the following would increase or decrease your net worth"
My guess would be that your net worth would increase if you learned any, or all, of the above! What do you think?
Where You Can Start Learning About Money
Picking one of the items listed above and searching the library or the internet for reputable sources would be a great place to start. Your goal should be to learn slowly and consistently over time. This information and knowledge will not be an overnight success, but I think you will be surprised at how quickly you see measurable differences when you start teaching yourself about money management.
I have a resource page on this site that lists my favorite and most highly recommended books that I have read which have made profound improvements on my understanding of money management and contributed to substantial improvements in my net worth.
Over time, you will develop the skills necessary to be a dependable money manager which is the most reliable method to increasing your wealth.
Please comment below which area of money you plan to learn about first.
Increasing Your Net Worth Is Simpler Than You Think
How to Increase Overall Net Worth
These steps are for anyone interested in increasing net worth and savings.
Whether helping you get started with saving your first dollar, or guiding you to remain motivated as you cross another financial milestone, these 3 steps are the building blocks of increasing your overall net worth.
My advice: revisit these 3 step early and often.
Saving money does NOT have to be difficult
Saving money does not have to be a difficult endeavor. Yet for many of us, we find it nearly impossible. Most of us suffer from "too much month at the end of the money" which essentially means the average American is living paycheck-to-paycheck.
In the United States, it is a sad state of affairs when examining our average net worth by age.
The chart below highlights, by age, the average net worth inclusive vs. exclusive of the equity in their own home:
Summary of Average U.S. Household Net Worth by Age
Average Net Worth in the United States by Age:
Summary of Average U.S. Household Net Worth by Age less Home Equity
Average Net Worth in the United States by Age minus Personal Home Equity:
The Average U.S. Household Net Worth
As you can see, the average American under the age of 35 is only worth less than $7,000. You would hope that by the age of 50, that number would go up dramatically.
Well, guess what, it doesn't. According to the chart, by 50 years old, you can expect a net worth of less than $90,000. By the age of 65, Americans are only worth about $170,000.
That means that after 30 plus years, the average American only increases their net worth by $160,000.
Sound like a lot? It isn't! So how can we kick these savings into overdrive and take advantage of the power of compound interest?
Easy ways to increase your overall net worth
1. Learn about money
Seems simple right? This one seems straightforward but many readers ask why this is important.
Think about it this way: you would not perform heart surgery without going through undergraduate studies, med school, fellowships and residency training first. That's a lot of preparation.
So why would preparing to increase your net worth be any different. You need to learn about it. What is the primary driver of net worth... money!
Here is a list of the most meaningful books that I read when I first started my financial independence journey.
2. Track your money
I don't really care how you do this but it is unavoidable. You do not need a full blown budget but you do need to be aware of where your money is going. If you have no idea where an entire months worth of earnings or paychecks are going, you have very little chance of increasing your overall net worth.
If this intimidates you, take this on incrementally. For example, if last year you had an extra $200 every month in your checking account after expenses, and now you only have $50, investigate where that extra $150 went.
This is a great place to start. This is where you can identify extra savings very quickly.
Some ideas and quick tips for where to look for extra money each month:
3. 'Automate' or 'Normalize' your savings
I purposefully used BOTH automate and normalize for #3. Why? The fear factor associated with "automation".
Some of you are going to be scared off by the "automate" verbiage. You do not like the rules of needing to link accounts and automate savings in regular intervals directly to your 401k, 403(b), 457 (b), etc. I am certainly aware that this is very common advice in the common wisdom of pay yourself first.
The problem with automation is that it becomes another point of friction, or sticking point. Many of us do not like the rigidity of automatic deposits.
For others, automation is great advice. If your company gives you a "match" into your retirement account, you need to take advantage of this up to the maximum amount they will match. Otherwise, this is free money being left on the table each month.
To get started with automation, simply set up an automatic deposit on a weekly, bi-weekly, or monthly basis. Direct it to your 401k, 403(b), 457 (b), IRA, brokerage, etc.
I personally prefer sending it to a taxable brokerage account or IRA which gives me access to low cost index funds (although volatile, over a 210 year history they typically yield an 8% return, give or take). Please consider the fees of your retirement accounts. Make sure to ask for all types of fees. Be sure to ask about:
If you need a little extra motivation, consider that Tony Robbins - in his book Unshakeable - tells a story of what happens if the government imposes a tax on you.
To paraphrase Tony: if you had a tax imposed on you suddenly, you would initially complain and kick dirt, but you would still eventually pay it. Think of your automated savings like a self-imposed tax. You might complain about saving a pre-determined percentage of your pay initially, but eventually you would find a way to "pay it". Consider the added benefit, in this case, that this self-imposed tax is actually just you "paying" yourself.
If you still cannot get over the idea and rigidity behind automation, do not give up. I believe there is an alternative option.
It is something that I personally do. It typically is not as consistent and it does require some discipline.
I call it normalization of savings.
What I mean by normalization of savings is find a way to make savings a normal part of your life and money management.
How would you do this? With repetition and practice.
For example, if you never saved before and you anticipated finally starting to save, that first $100 deposit is going to seem monumental. While it certainly is monumental, it only is so because you have never done it before.
Over time, as you continue to deposit $100, month after month, year after year, each individual deposit will not have the same psychological impact as the very first $100.
This habituation effect is actually what we are looking for! It is the normalization of savings.
If a deposit into your accounts seems like a big deal, it is probably because you have never done it before (or at least not in that amount). This psychological "wow factor" adds yet another layer of friction which will prevent you from saving it in the first place.
Put your money where your mouth is.
Write these 3 steps on a whiteboard, paint them on the wall, whatever. I do not care how you do it, just remember to revisit these 3 steps no matter where you are on your path to financial independence.
They can serve as a great motivator for beginners or a "back to basics" course for those well seasoned pros already along the journey.
Be sure to leave us a comment below on how these strategies gave you a kick in the ass to get started or helped orient you somewhere down the road...
How I eliminated a significant amount of college debt
Debt payoff typically isn't easy. Many times, the first step is to take a cold hard look at your financial situation which is more than most can tolerate. In the end, however, you will be glad that you did.
Debt payoff is often a thankless endeavor because it mostly revolves around undoing a mistake. Being in debt means that the money was already spent. The bad decision was already made.
Conventional 21st century American culture informs us that we all should strive for the "American Dream". Yet most of our understanding of the American dream is violated by the pervasive images of cars, clothes, and material possessions from films and TV shows. Folks, this is not reality.
America is about freedom. Freedom cannot possibly be pursued to its' fullest if you are under a mountain of debt and financial obligations. Debt keeps you in jobs you hate. Debt is one of the leading causes of stress. Debt breaks up families and creates marital divide.
For Millennials, student loans are the spearhead of our credit crisis. Unaffordable rates for college tuition is readily subsidized by eager lenders preying on the young and innocent. Millennials were led to believe that the only way to "succeed" was by going to school. How well is that paying off for us?
We are left to watch those who have elected to go into trades and forego college beginning their lives with significantly higher levels of financial strength. They start families much earlier than college-goers. With a smart first time home purchase, they are able to avoid debt to an extent most academically-inclined students will never know. Those who avoid student loan debt have essentially given themselves many advantages that otherwise are unattainable for those who have received higher education.
Don't get me wrong, college education typically equates to higher salary and lifetime earnings (provided you find a job). But it is about what you trade in your 20's and 30's that is not easy to recover. If you spend most of your 20's and 30's paying off student loan debt-which is what most people are doing-you will have little energy and capital to allocate elsewhere.
Student loans are a difficult situation that is wreaking havoc on Millennials, as well as younger generations. This crisis can be averted however, even if you already have accrued a significant amount of debt. I must admit, it will take tremendous discipline and consistency to get yourself out from under your student loans.
Why Did I Have Nearly Six Figures In College Expenses?
The sad truth is that the $96,000 I mentioned is for graduate tuition only. If I added in my undergraduate student loans it was well over six figures!
I got to this amount because I pursued a terminal degree in my field (doctor of physical therapy). As a DPT, we go to 3 years of schooling, during which you are not supposed to work. Regardless of this policy, I chose to continue working full-time as a personal trainer. Being a personal trainer is actually quite a lucrative gig, but the hours are typically not that attractive. For 3 straight years, I had a highly irregular and demanding schedule. It was as follows:
Sound like fun? It was, but only because I knew what I was working for. To eliminate the need for carrying debt throughout my early adult life.
The truth about debt payoff
I am very competitive person. I turned debt payoff into a game. If you have a significant amount of debt, especially student loan debt, I suggest you do the same.
You have to game it out. You need to be aggressive. You need to be a machine. Become an "animal" in the process and set your sights on what needs to be done - debt payoff!
Debt payoff is literally the goal. Debt is the enemy.
During debt payoff, there should be little else on your mind. You need to get focused. Do the math. Find out where your money is going. Calculate your life energy and where it all goes.
If you want a very detailed, impossible to beat formula for how to calculate your real hourly wage, you need to read Your Money or Your Life immediately! This will help put your hours and dollars into perspective.
My success in paying off debt is actually due to Dave Ramsey's Total Money Makeover book.
After reading this book I understood how to become focused on the objective. The only thing that mattered was freeing up as much money as possible so that it could all be used to aggressively pay down this student loan debt.
Every extra dollar, whether it be cost cutting or selling shoes on Craigslist, needs to be contributed to getting this toxic debt out of your life once and for all.
How exactly did I pay off $96,000 of graduate school
Truth be told, I did pay for some of it along the way. I only had to take out less than half in the form of student loans.
For the exercise-minded folks out there, personal training can be a lucrative gig. In 2012 I was actually averaging a little of $30/hr as a wage. The lowest wage I got was from a health club making $12/hr, however having this experience on my resume allowed me to land some gigs as a personal trainer in a private studio paying up to $60/hour.
The cost of school was about $30,000 per year and I was making a bit over that.
However, at the time, I also had other expenses including but not limited to: insurance, utilities, groceries, cable/internet, phone, fuel, maintenance, and some miscellaneous expenses such as laundry, travel, occasional entertainment, and a few other odds and ends.
Notice what I did not have: car payments or housing payments. I did this on purpose to free up as much money as possible.
The way I was able to avoid housing payments is I stayed with my parents for 2 of the 3 years in graduate school. In the third year of PT school, I moved into an apartment where I negotiated an agreement to trade labor/maintenance on the building itself as a rent payment.
Move back home. Get a roommate. Negotiate a bartering agreement. Airbnb.
The way I avoided toxic car debt was I drove a '96 Toyota Camry with 200,000 miles that I paid for in cash. Get a grip. Unless you have extreme concerns about safety ratings for a family of 5, swallow your pride and drive a cheap used car. Period.
If you already have a new car or car payments, call the dealer immediately and see what you can get for it. Decide if the amount you get offered is worth cutting bait and getting out of that monthly payment to free up that extra 200, 300, or even $400 plus per month to hurl into that debt.
My final year of PT school I needed to take out loans because I was on my clinical rotations to finish my doctorate.
I borrowed $34,620 the final three semesters. I did not need to look this figure up. I remember it because it was a focus of mine everyday. It was part of my game. It was part of my life.
When I made that final payment I realized that I had the option to do whatever I wanted with the extra money that I was using to pay the debt. Of course, I also saw a dramatic increase my annual salary because I was a doctor of physical therapy at the end of graduate school.
What happens after the debt is gone?!
The choice is yours. Many people celebrate at this point. I didn't.
I chose to invest my monthly payments- that I was previously making to the school or federal lenders- into low cost index funds. Only 4 years later, I have a net worth (with my wife), of over $300,000 even with a massive correction in the recent financial markets (at the time of this writing, in 2020, the COVID-19 virus and shutdown is in full-effect and the markets are in a tumultuous downfall).
I am not special. My circumstance is not extraordinary.
We paid for our own wedding, in full. I paid for my entire undergraduate, in full. My wife paid for her schooling, in full. My wife even paid off a brand new SUV approximately 4 years ago.
We paid for a lot, by ourselves.
I remember my best friend telling me how much money I would "make" by having a wedding. What I did not realize at the time is that he did not pay for his wedding.
Remember, focus on yourself. Eliminate the outside stories that other people tell you because you have no idea what their circumstance is. You have no idea if they had houses paid for. Weddings paid for. Travel paid for. Honeymoons paid for. Cars paid for. We had none of those. We paid for all of those ourselves.
Why would I tell you this? To brag obviously. No, that's not actually why I told you this. I told you about my story because I want you to write your own, equally extraordinary and unique story for yourself. It can be done. Find a way.
Make extra. Save extra. Cut costs. Get creative with housing and cars. Take on a second, third, or fourth job the way we did. Remember, it only has to suck for a little while until you get this debt paid off.
Share your story in the comments below. Let us know if this motivated and lit a fire under your ass to do better and get more aggressive. I write for you guys. I am telling my story to motivate you.
This is certainly not professional financial advice nor do I know what the hell I am talking about. That said, look at my results. They speak for themselves.
Until next time...
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.” - Albert Einstein
How dramatic is the effect of compounding?
For finances, and most other objective measured, the value of compounding grows in logarithmic fashion. This means that as you move along the horizontal (x) axis, the growth on the vertical (y) axis grows exponentially. More simply put, the line curves upwards (or downwards if in debt) instead of increasing in a straight line -see below.
Frequently, in the personal finance community, we use money on the horizontal (x) axis, and net worth on the vertical (y) axis as follows:
Examples of the effects of compound interest using $10,000 initially and never adding another dime!
After 10 years, your initial $10,000 (assuming you added nothing else), grows to only $19,990. Not bad, but this will not get you rich.
After 20 years, your initial $10,000 (again assuming you add nothing), grows to $43, 157. Again, not too bad considering you never added another dime - which is typically very unrealistic for those interested in saving and investing.
Fast forward to the 50 years mark, your initial $10,000 investment turned into a whopping $434,274. Again, this does not adjust for inflation and just shows you what your initial dollar amount will potentially turn into after 50 years of passive index fund investing.
Initial investment of $10,000 plus adding another $500/yr to your investment
You may feel somewhat underwhelmed after that first example. That is fine. The power of compounding is quite dramatic, however some folks argue and become upset when they hear about 50 plus years of investing. It might just be too far out for most people to imagine and remain motivated on the path to F.I.
This is where demonstrating the power of saving plus compound interest comes into play.
Take our initial investment of $10,000, use the same parameters of hypothetical growth at 8% compounded annually, and add $500 a year.
This time it only takes 43 years to cross the $400,000 mark. At the end of 50 years, your initial investment of $10,000 plus an additional $500/yr, compounded at 8% annually, turns into $720,000.
Initial investment of $10,000 plus an additional $5,000/yr in an IRA
Now what if you simply take your initial investment of $10,000, and add $5,000 per year to an IRA, compounded annually at 8%. Essentially this would be nearly maxing out an IRA every year ($6,000 contribution limit as of 2020).
Following this process of $10,000 initial investment, plus $5,000 contribution annually to an IRA, compounded at a hypothetical rate of 8% annually - you would be a millionaire in 36 years with your investments growing to $1,078,364.
At the 50 year mark, you'd have potentially $3.3 million in the bank. Not too shabby.
There is significant potential waiting for you in the form of "compound interest"
As you can see, compound interest takes time to reveal its' magic. The earlier you start, the longer you have for compound interest to work in dramatic fashion.
When evaluating the role of compound interest most folks refer to the rule of 72. The rule of 72 helps you learn how long it will take to double your initial investment. You discover this by dividing 72 by your expected annual interest rate (8% in our example).
The Rule: 72 / expected annual interest rate = years until initial investment doubles.
In our example: 72/8 = 10.3 years. In other words, every 10 years our money would double.
How do I make compounding more powerful?
As you can see, each of our models demonstrates-after a hypothetical return-a "hockey stick" growth curve. This means your money compounds and grows exponentially upward instead of a straight line.
Of course, this does not happen consistently. Here is a caveat: Actual stock market returns look nothing like a smooth line the way our model shows. It takes many scary nosedives in a few months to high altitude climbs over many years. These fluctuations occur due to many reasons such as investor behavior, consumer sentiment, inflation, pricing, GDP, etc. Many factors determine market returns.
However, according to over 200 years worth of data, the average return of the stock market is in the 8-10% range. Remember, this is just an average. Do not expect these returns on a reliable and consistent basis. Some years will be higher, and some years will be much, much lower. Overall, unless America "goes out of business", you are likely to see a positive return with longer time horizons of 20 years or more.
How To Increase the Power of Compound Interest
There is a very simple, yet often overlooked method of increasing the power of compound interest. How? START WITH A HIGHER INITIAL INVESTMENT.
To illustrate my point, say you start with an initial investment of $100,000, instead of $10,000. Do not add another dime to that $100,000. Ever.
In 50 years, after an 8% return compounded annually, you'd see your initial investment grow to...
This is approximately $1.4 million more than what you would have compared to if you initially invested $10,000 plus $5,000 a year compounded at 8%.
To illustrate this point further, in the model representing a $10,000 initial investment plus $5,000 annually, you will have contributed a total of $260,000 of capital with a final worth of $3.3 million.
By starting with a greater initial investment, not only will you be worth $1.4 million more - at a total of $4.7 million - but you will contribute $160,000 less of your own capital.
The power of compound interest is one of the primary motivators that keeps me steady on the path to F.I.
Consider visiting a compound interest calculator and plugging in your own numbers.
Remember, our models and examples are completely hypothetical and do not represent real returns, nor are they adjusted for inflation. In no way is this a guarantee of returns. Please seek guidance from a financial professional, of which I am not.
Still, the point remains. The dramatic effects of compound interest are on display.
The ideal recipe would be to start with a big lump sum as soon as possible. However, if you are unable to do this, the next best method would simply be to start as soon as possible.
Enjoying our content? Please leave a comment below.
Further, take a look at our favorite resources that built the foundation for our awareness of financial independence, frugality, and investing.
Cutting monetary costs are not the only benefit of these thrifty habits
Some folks need more incentive than simply a lower price tag to practice frugality. Thrifty habits often come with additional benefits, aside from lower cost.
Below you will find some of the dual benefits of common cost cutting techniques. Use this as a means to continue to motivate yourself on why you chose the financial independence lifestyle.
1. Cutting Cable... or just reducing the monthly services
The cost implications of this are obvious. Paying $160 per month just to watch a few games or occasionally flip on the hunting channel? Why not see if you can reduce how much TV you watch by eliminating the channels you barely watch, or even cutting cable altogether.
Some will make an argument that they get great benefit from watching a certain sports team or having access to a certain movie channel. That is entirely your business, not mine.
What I am suggesting is seeing if truly assessing this habit from more than just a monetary cost perspective really yields a positive return on your happiness.
Remember, time is life's most precious commodity. As far as we can tell, it is a fixed commodity for all of us. Consider that, according to the BLS, the average full-time employed American still finds enough time to watch approximately 2 hours of TV per day! Unemployed Americans watch nearly twice that at 3.8 hours per day. This is alarming! Think of all you could be doing if you reduced, or even eliminated, the TV watching habit.
Consider the following additional benefits of cutting/reducing cable, aside from cost savings:
2. Joining a public library
Save money on books and movies. This one actually lends back to our first idea, cutting cable. Stacking these habits would be an excellent idea for maximum benefits of the frugal lifestyle.
There are many free events at the library. Some events at our local library include, but are not limited to:
For those with a family, most public libraries have dedicated areas for children. This can be a great alternative for children to learn and socialize instead of watching TV or playing games on a device.
3. Learn how to DIY
You control the costs because control the inputs.
Aside from controlling costs, think about how DIY might further impact you in the following ways:
Frugality is often about Dual Benefits
Again, as we highlight in "what is frugality", being thrifty is often of great value to those of us leading a life aimed at financial independence.
These dual benefits are an excellent way to continue to properly value our cost saving efforts beyond dollars and cents.
The more you understand about why you have chosen frugality, the easier it will be to stay on track over the long term.
If you have anything further to add to this article, please place it in the comments below.
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Should you believe everything you hear about Financial Independence?
Most of the folks of the FI and FIRE community have very good intentions. As with any group, there are certainly some outliers. In my reading and research over the years, I have found some common myths that often dishearten the community and the people of the financial independence community.
Let us outline 3 common myths I see continuously emerge and break the spirits of our community members.
The 3 Biggest F.I. Myths
1. Financial independence is as easy as increasing your savings rate and investing
This is only partially true for some of us.
However, don't be discouraged if you find yourself saying "maybe for them" or "well that's not for me". Everyone has a different starting point. Even siblings can have different degrees of support. These are just the facts of life.
Your friend who retired at 30 because they hit it big on cryptocurrency or another couple who moved their family to the woods after starting a blog, I guarantee they had a different starting point than you did! If you press them on it, I am sure they will admit it. I wouldn't expect that you guys become friends afterwards however. Finances are one of the greatest fight promoters known to mankind.
Perhaps any one of the following is true about your current situation:
Your situation is unique to you. There are many things that will affect your so called "savings rate" and all you can do is strive to improve your situation relative to you. That's it. This is not a competition unless you want it to be and you enjoy competition, in a healthy manner of course.
Besides, maybe your version of "financial independence" is being debt-free and living paycheck to paycheck. If that's your goal and you are fully aware of the risks of living that close to the edge and are content with it, then who cares about a savings rate!
2. Everyone will understand why you practice frugality and will support you in your goals
Mostly false and very, very rarely true.
Most people do not even have an idea of what frugality even is. You will often be called "cheap", albeit mistakenly. You may even have one of the following condemnations thrown your way:
All of these are aimed at indicating that you should just spend more money. Basically, all of these condemnations are aimed at why you shouldn't be frugal.
This is utter nonsense. Again, frugality - to most of us who practice it- adds tremendous value and meaning to our lives. We actually like being frugal (some of us).
A word of caution: try not to spend too much time, or any at all, explaining frugality and your purpose to somebody who is clearly unwilling or unable to understand this way of life. Just nod, smile, and purchase more shares of your favorite index fund with your savings.
3. Real Estate is the quickest path to F.I.
Depends. I mean really, truly, depends.
Transaction costs are typically very, very high when it comes to real estate. Obtaining financing, costs of upkeep, finding tenants, drafting leases, commissions to realtors. Please be sure that you are able to calculate your real rate of return in real estate. Check out road #9 in Ken Fisher's book The Ten Roads to Riches to find out the hard truth of real estate investing, and learn how to do it right.
Sure you can have investors or use other people's money. Leverage is your friend. Be a friend of borrowing to rapidly increase your wealth. Whatever.
Honestly, most of us are coming from significant financial burden and debt. The last thing most of us want is more debt and more borrowing. Perhaps someday I can be convinced otherwise but real estate is not a great investment.
Consider that according to data collected by Jorda et. al. (2019) from the time period of 1870 to 2015, over a century's worth of data, equities beat real estate returns 8.46 to 6.10% respectively after being adjusted for inflation. Although the figure 6.10% does include home capital appreciation--which lowers the total yield of housing return since capital appreciation is less than 1% annually when adjusted for inflation--residential real estate is not the blow-out winning investment it is often claimed to be.
Be wary about real estate. Costs of home ownership are very variable and it's hard to give a true estimate as to your expected rate of return due to the extreme variability in the cost of ownership.
Leave us a comment below on how you feel about the 3 common myths of financial independence.
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If you find yourself frustrated on your path to F.I., remember the 3 common myths of Financial Independence
Finding motivation on the path to F.I.
Many of the authors and content creators I follow in the financial independence space have transitioned their content to an interesting phase. Often I hear them, at their present net worth, going on and on about how great financial independence is.
Undoubtedly, I am truly happy for them. But how does this affect those of us in pursuit? How does it affect the person who is still 5, 10, or 20 plus years away from financial independence?
For many readers and community members, it can be frustrating. It is hard not to compare yourself to another when it comes to finances. The number one thing that knocks people off track and destroys their motivation is comparison. Comparison to others. Comparison to where you thought you'd be at 30. at 40. at 50, and beyond.
First things first, we should strive to eliminate our comparisons.
1. Eliminate Comparisons
There are two exceptions worth mentioning regarding eliminating comparison behavior:
That said, comparisons are the enemy of happiness in most cases. It can often lead to a path of envy and resentment. Further, it typically only serves negative energy. You will not find a more competitive person on the planet than myself, but even I have had to step away from this one.
This is your path. Not anyone else's.
2. Keep track of your net worth
You can do this on high-end software such as Personal Capital, or use a simple Excel sheet. Totally up to you (I prefer to use an Excel sheet).
This can be a great way to remain focused on your individual situation. It also motivates you to keep track of your income and expenses because your savings rate ultimately helps determine how quickly your net worth can grow. It is often said that the only way to improve something is to measure it.
3. Evaluate if you need to give yourself a break
This needs to be earned however. Take inventory of where you are by assessing your progress thus far and assess whether you need to allow yourself an increased budget for a few months prior to returning to a more aggressive approach. I would put a definitive end date on this inflated spending, however.
If pursuing financial independence has given you a great deal of stress and you find it difficult to consistently maintain this furious pace, consider having planned periods off from this extreme frugality behavior. Perhaps take two weeks to spend as much money as you want. Try on an inflated lifestyle if you are so brave (just be ready to hate it). See how it feels to let the dollars slip away from you a little more freely. Hey, who knows, you might actually enjoy debt and keeping up with the Joneses. If you do, quit reading now because this is probably not your type of community (you are welcome back anytime however).
If you are worried about FOMO (fear of missing out), try "test-driving" a few atypical spending habits to see if the consumer culture life actually is your calling. If you take this route, I just suggest finding out what the return policy is for whatever you are purchasing.
If you choose to take a break, definitely have an exit plan for when you aim to jump back into frugality or the pursuit of financial independence. This obviously includes not making any purchasing decisions that indefinitely ruin your net worth and personal finances, especially if the cost is high and recurring (think boats, cars, couch payments, etc.).
4. Remind yourself why you joined this community
Don't like your current job? Most people don't and yet do nothing about it. But you are!
Love your job but want more free time? I am happy for you as this is a good problem to have. Your time is more precious than anything. Loving your job and what you do for 40 plus hours per week is a rare bird. If you have it, consider the strategies you learn in this community to negotiate more PTO, remote work, atypical schedules, 4 day work weeks, transitioning to part time, etc.
Do you resent debt and do not like to be a slave to the lender? I can certainly relate to this one. Eliminating debt is often an excellent way to remove your burden to work or at least eliminate your need to be a prisoner to a higher paycheck. Eliminating most debt from your life often allows you to choose work you love and enjoy since the pay rate is less meaningful.
Do you just want to be part of a frugality movement as a sure way to be a millionaire someday? Do not be ashamed. As the late Jim Rohn would say, think of what you will become in the process of becoming a millionaire. Unfortunately, money is one of life's greatest motivators for many of us. Admittedly, most of us are driven by attaining a large net worth (or at least the appearance of high net worth). Saving and investing is one of the most tried and true ways to become a millionaire, as long as you remain invested for the long term and practice a fair bit of industriousness and frugality.
How I, personally, stay motivated for the long-term
I remind myself the importance of stay the course. Being consistent and displaying discipline. I look forward to learning more, saving more, investing more. I have learned to truly value the ultimate commodity in life, time.
I continue to assess my current income streams. This helps keep me motivated to make them bigger or add one or two more along the way. Consider most millionaires have multiple sources of income. When assessing your income streams, I like to try and diversify.
The concept is to save as much money as possible as early as possible, regardless of when and where you start. Remember, your situation is unique and all you are looking to do is improve upon your current situation.
Consider that if you find a way to earn an extra $20 a month every month for 25 years, and invest it in an index fund you could wind up with $17,543 (assuming an 8% annual return).
An extra $50 a month invested over 25 years could be $43,863.
$100 extra a month, could turn into $87,727 after 25 years.
$1,000 extra a month, in 25 years, could be worth $877,271.
Start small, aim high, and be consistent and disciplined along your path. Consider searching along the way for things that can upgrade your present level of happiness. Things to aim for over time that typically are correlated with increased happiness are:
And yes, enjoy the ride. This is not about a life of deprivation. It is about a life packed with value.
Remember to celebrate victories along the way. Celebrate paying off a car or student loan. Hit a certain number for your net worth, do something you enjoy, even if it costs money. Do not be ashamed to celebrate.
Before we begin, this is absolutely not investment advice and I am certainly not a financial professional. Please understand this is entirely for informational purposes only and in no way are we making any claims about this style of investing. Use your head people, this is a blog, not a financial consultation.
How to Begin Investing
How do you actually become an "investor"? This is a common question to which the answer is actually quite a bit simpler than you think.
First and foremost, to be an investor, it takes having a little extra pocket change for which to invest. Remember, it takes money to make money.
What does this mean for you? It means you need to start saving some extra money.
Previously we discussed what it means to have a margin of potential for savings. Your margin of potential is calculated by subtracting your expenses from your income (margin of potential = income - expenses).
Without having a positive margin of potential, you will lack the most sufficient tool required for investing, money. I am not interested in discussing using other people's money or marginal investing because that is not what this community is about.
You can increase your margin of potential two ways:
I do have a basic tenant that I believe all should follow. I believe that you should eliminate your debt first before worrying about becoming an investor. The only debt I believe that you can keep around is a mortgage, provided that you have at least 20 percent equity in your home.
This is a community filled with people searching for financial strength. You do not get to a financially fit position by borrowing. End of story. If you do believe that you can borrow your way to wealth, stop reading right now and find something else to do with your time (like read a personal finance book or two). This community is the type that pays off their credit card bills, in full, every month. That's what brings us security.
Deciding where to save it
Once you've broken free from spending every single dollar you earn, and you have eliminated debt, you have some choices.
Where can you begin investing?
Here are some of the primary investment vehicles where you can save your money and have access to investing in "the market" (not supposed to be an exhaustive list, just the most common):
I just happen to use Fidelity and Vanguard because I have found they offer the lowest account fees and best customer support around. I have tried MANY other investment companies for various accounts without much success. They will remain nameless.
To open an account in order to begin investing, just visit the company site or call the company directly, and seek advisement for how to open any of the following accounts - or even ask about one's I haven't listed such as a 457 plan, etc.
I do not use a financial professional and choose to pick the funds myself. I do this for the lowest possible cost and the greatest potential return. Read the two books below if you think that you cannot do it yourself when it comes to investing.
How To Start Investing (once you have eliminated your debt)
The simplest way to break into the investing circles is through low cost index funds.
If you are uncertain about investing and you need more confidence built up before enbtering the stock market, here are two must-read books for you:
How to Start Investing (steps)
Step 1. Choose which type of account you will begin investing in from above (Roth IRA, Traditional IRA, Brokerage Account, 401(k), 403(b), etc.)
Step 2. Choose your Financial Service Provider (Fidelity and Vanguard are my favorites - however your 401(k) and 403(b) plans might not offer these companies)
Note: I primarily use Fidelity and Vanguard due to the low cost nature of their funds and little to no fees associated with their accounts.
Step 3. Link your checking account to whichever account you opened after following steps 1 & 2 above. Start depositing money into this account.
Step 4. Choose your investments (by searching the following "ticker symbols"):
My belief is that the younger you are, the greater the percentage of equity index funds you should have in your overall investing portfolio. My preferred choice is low cost index funds that track the total market or a major index.
Step 5. Keep investing in this account and buying shares of the above for years and years to come to take advantage of compound interest.
That is it. Be advised, there are some limits for the types of accounts listed above for how much you can deposit into your account each year. To find up to date contribution limits, visit the IRS website here.
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The Definition of Frugal
Frugality is a term often used synonymous with being "cheap". However, is that really a fair comparison?
What is frugality really?
1. Frugality arranges itself with value as the central tenant.
So what should we value? Value your time, because there is no amount of money that buys more of it. Value your life energy, it is not an infinitely renewable resource. Value your freedom, the freedom of choice (yes, you always have a choice). Value your relationships, because this is really all that you have in this world. Value your beliefs, because nobody can take them away from you.
I admit, most of the above is more from a philosophical life perspective. Most of you are looking for the secrets to money and wealth. So what should we value from a financial perspective? From a financial perspective you should value:
2. Frugality is also the act of gaining awareness.
Become aware of your daily routines. Assess your spending habits and scrutinize your budget. Do you have a list of things that really make you happy? If not, sit down right now and list the top five things that have the potential to make you smile everyday (do not read another word on this site if you are not willing to sit down and literally write down your five sources of potential happiness).
To become aware you need to become present in life. Become conscious about where you are directing a majority of your time and energy. This is about efficiency, not goal setting. I am not a firm believer on the traditional concepts of goal setting (which you will notice in future posts). Gaining awareness and becoming present, avoiding the torment of merely existing through life, is actually a potent wealth generator throughout life.
3. Frugality is about gaining back your freedom.
We all had it after birth, but lost it shortly thereafter. I am of course referring to our freedom. Freedom to choose and freedom to live your life according to your standards, not others.
Let us be honest, there is very little you can do in life without money. Period. At the end of the day, most people would be much better off in life with more savings and less debt. I suspect quite a bit of mental health issues would be drastically improved if just those two numbers were adjusted, meaning less debt and more savings.
Consider the correlation drawn between mental health status and money problems according to a Money and Mental Health survey:
Remember however, correlation does not equal causation. The survey above could just as easily mean that these folks had mental health problems long before they had money problems. Nevertheless, there is a strong correlation between mental health problems and financial difficulties, regardless of which one happened first.
Using the above findings, I would suggest that most folks who would like to improve there overall well-being take a look at their finances. If you happen to also find yourself in problem debt or financial struggles, perhaps consider if improving your financial health would make life much more tolerable.
Personally, I believe that improving debt to savings ratio- amount of debt relative to your savings- is a forceful method towards gaining back your freedom in life.
Think about what life would be like if you did not have to spend your 40's and 50's sprinting towards retirement savings. Think about how much freedom you would have if, by age 40 (or 50 - if you are older than this my statement likely will not apply), you no longer needed to save another dime for retirement because you were saving aggressively towards retirement when you were younger. You could spend these years traveling with your family, embarking on new experiences, all while likely enjoying some of your best earning years. Your children (if you have any) would like be of the age where they can also benefit from these experiences and memories as well.
So how do I gain back some freedom in my life? By examining your "Margin of Potential" against your income and your expenses. Quite simply, Margin of Potential = Income - Expenses
How to Assess Your "Margin of Potential"
Everyone has a "Margin of Potential" equation. Whether your are on public assistance, or make over six figures, this equation applies to you.
However, I frequently find that most folks just take the difference between their income and expenses, and turn around and spend it anyway. That is why I call it the margin of potential. The difference between income and expenses is not saving unless you do something with it!
After calculating your margin of potential, write down the top three things that you do with that number. If saving and investing are not in the top three, we have a problem.
If you do not have a positive number when assessing your margin of potential you will likely find yourself amidst significant financial troubles. One might ask, "How could I possibly have a negative number?". Answer: credit. You can borrow your way right into misery and allow your expenses to be greater than your income (the "American Dream").
The truth is, frugality is really about making your margin of potential a positive number. Of course, one way to make this number positive is simply make more money. However, for many, increasing income is quite a bit more difficult than decreasing expenses. Decreasing expenses is where frugality truly shines. By lowering your own cost of living and decreasing the inflation of your lifestyle, you will lower your expenses and give yourself the opportunity to have a positive margin of potential.
So what will you do next after establishing a positive margin of potential? My hopes is that you will begin to investigate what using this margin can truly do for your happiness.
I started this blog because friends and family often asked me similar questions regarding personal finance. I was surprised just how much people were interested in improving their financial situation, yet had no idea where to start. It made perfect sense to start a blog and share all the information that I have learned along the way with others. You will find many resources and links referred throughout the blog. I have found all of this information useful and continue to grow my knowledge and understanding in the personal finance space. Admittedly, even I struggled heavily in the beginning with understanding how to improve my financial situation. The power of reading and note taking got me where I am today and will continue to provide a return on investment for years to come. I look forward to sharing with you along the way.