The first step toward Financial Independence is to save money. Many of us want to reach that seemingly “unachievable” state of financial freedom or independence, but few of us are willing to do what it takes in order to achieve it. Knowing how important it is to save money is crucial, and the fundamental basis for that Financial Freedom.
Firstly we must get familiar with the phrase “saving rate”. A very simple example of what saving rate is:
You earn $10,000 a month; you save only $2,000 and spend all the rest. Your saving rate is 20%. If you save $4,000, your saving rate is 40%. If you don’t save at all, your saving rate is 0%.
The higher your saving rate, the higher the chances you’ll reach Financial Independence in a few years.
The importance of your saving rate is greater than your absolute income, the return of your portfolio, or any other macro-economic factors.
# How Much Do You Save?
Let’s start with the average American. Did you know that the average American saves only 6.1% of his income?
A widespread recommendation is to keep a little saving worth 3 months of your living expenses as a “safe fund”. This “safe fund” supposed to keep you going with your usual expenses if something unexpected occurs, something as dismissal. Do you have that “safe fund”?
According to a survey of “gobankingrates”, 31% of the Americans don’t have any savings at all!
Think about it for a moment:
Let’s assume you earn $10,000 and spend $5,000 a month. Meaning you live on half of your income (50%), and save the other $5,000. In this situation, for each month you work, you earn one “free-of-work month”; leisure month.
The expenses for this “free-of-work month” ($5,000) will be financed by the saving from the month you worked.
As previously said, according to BEA.gov, the average American saves 6.1% of his income.
Assume the average American earns $10,000 per month (for simplicity).
How much does he save each month?
How much time will it take him to finance one “free-of-work month”?
How much time will it take him to finance a “safe fund”?
Now, what happens to the average American who saves only 6.1% of his income?
For simplicity let’s assume one earns $10,000, saves 6.1% ($610), and spends the rest ($9,390).
In this case, to finance one “free-of-work month” he must work 15 months! (9,390/610=15)
Even Worse, if he wants to finance his “safe fund”, which supposed to cover his expenses for 3 months without an income, he must work 45 months! (15 months * 3).
This is 3.75 years. Absurd.
# Saving can Change your Life
If you save 90% (hypothetically) and spend only 10% of your income, for each year you work, you earn 9 “free-of-work” years! Amazing, isn’t it?
To make it clear:
|Saving Rate||No. of Years to Finance One “Free-of-Work” Year|
|90%||0.1 year (1 month and a week)|
* An important thing to notice here is that we didn’t calculate what happens to your saving if you’re investing the money you’re saving. This is what we get if we simply keep our money safe somewhere (and if there is no inflation).
This is because the main purpose here is to demonstrate the power of saving rate and how it affects the time you must work before you get to Financial Independence.
# What happens if you INVEST your money?
Obviously, we don’t want our money to sit and gather dust. For this to happen, all of our savings must be invested either in the Capital-Markets or in income-yielding-assets. If you put your savings in the S&P500 index for the last 10 years, you have made on average 11% annual return! This way, you ensure that the money you have saved will make more money, and that money will make more money, and so on.
When your savings reach a sufficient amount (worth ~300 months of living), you can start withdrawing money from your saving periodically, and finance your living expenses!
- The saving rate is the amount you save divided by your income.
- It is the most essential tool you can use in order to reach Financial Freedom.
- The average American saves less than 6.1% of his income. You should save much more.
- With basic math, you realize that if you save 20% of your income you get 1 “free-of-work” year for every 5 years of work.
- If you invest your money, and that’s why we are here – You can get much more in much less time.
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