Declaring Your Financial Independence
On July 4th, I appeared on The Willis Report on Fox Business News. I weighed in on the topic of declaring your financial independence, something near and dear to my heart. (Sorry I don’t have video, here’s a transcript and a related story on the topic.) The advice below may strike you as pretty common sense, but I follow it religiously, and it helps me live a value-driven life, without stressing a lot about money:
1) Thou shalt not live beyond thy means: Get a budgeting tool that works for you so you know exactly what’s coming in, exactly what’s going out — and then make choices and set goals for the money based on what you value most. Be creative; fun is often free (see my previous post regarding Bananagrams and country club fireworks, and #2 below.)
2) Thou shalt set aside 3-6 months of funds for emergencies. Once you have a handle on step number 1, it is easier than you think to get to step number 2. Be frugal in things that don’t make much of a difference in your lifestyle (stick with generic household brands, call your insurer once a year and try to get your auto and homeowners premiums reduced).
And make the most of freebies! My friend Julia Scott over at the BargainBabe has some terrific stuff on tap today…free ice cream, free bowling, even a free bra. Lots of coupons too. Use your savings to build a rainy day fund that will give you peace of mind.
3) Thou shalt pay off any balance on thy credit cards in full and on time each month. Just do it.
4) Get the best deal on major financial products. Don’t spend your precious time saving 25 cents on a can of tuna. Worry about getting competitive bids from at least three lenders when you take out a mortgage or a car loan. Learn how to take care of your credit score, which will get you the lowest interest rates on loans and save you tens of thousands of dollars over time. Get the big purchases right. They matter.
5) Save early and often for retirement and the cost of college for your kids. Try to do it in a tax-advantaged vehicle, such as a 401(k) and IRA for retirement, and a 529 savings plan for college. It is enormously hard to catch up if you don’t get in the habit early on, and the earlier you start the more compounding works to your advantage.
Let’s say that starting at age 22, you set aside $5.50 a day ($2,000 a year) in a Roth IRA, and stop at age 30. Assume your savings grow at an average of 9 percent a year and you don’t touch the money until you’re 65. You’ll have more than $500,000 for retirement — and you’ll have a bigger nest egg than someone who starts at age 31 and contributes for 35 years! That is the power, the beauty, the majesty of compounding at work! (Yes, I was one of those dorky 22-year-olds who embraced retirement planning.)
Don’t understand investing? Spend an hour with a fee-only investment planner who can help you choose appropriate funds for your age and risk appetite. Tell this planner you want to use index funds and other investments that have very low fees. Do not choose a planner who earns a commission for getting you to invest in specific products.
Okay, lecture is over, class dismissed. Have a great weekend.
What rules have proven invaluable to you in achieving financial independence and peace of mind? Comment here or email me at laura at laurarowley dot com.
Related Posts
July 15th, 2011 at 4:48 pm
I’ve been following your column for a long time and I love it, but I have to take issue with your statement on compounding interest. Maybe there once was a time when you could get 9% interest on your investment, but that’s not today… at least I sure don’t know how. I’ve been working since college for 12 years and any money I’ve put in the market over the course of those 12 years has DECREASED or stayed the same. Only stuff like my super low risk PIMCO Total Return fund has consistently earned me money in my retirement fund… and that’s only been about 4-5%. Overall, my portfolio over 12 years is almost exactly flat. It’s up a little this year (yippee), but not by much.
Taking a more reasonable growth rate changes the value proposition. Assuming a super simple lump sum savings of $25k for 43 years (simpler, but similar to your above example) grows to only $135,000 at 4%, $203,000 at 5%. Sure, the impossible 9% rate gets you to $1,000,000, but are you earning 9% today? I love what you say, but I’m tired of hearing financial people tell me that compounding interest will give me a secure retirement using impossible interest rates. Unless the market changes drastically or I learn how to invest better, compounding interest isn’t the place to find retirement. It’s the rest of the tips you share like paying off debts like your home, car, living within your means, etc.
July 16th, 2011 at 6:55 am
Hey Rob — Thanks for your comment. You’re right, I punted on that example; using a 9% rate of return can be unrealistic depending on your time frame. For instance, I have a 529 plan for my oldest daughter that I started in 1997 when she was born and invested 100% stocks (because we were more than 15 years away from the goal.) That account was battered by the dot-com bust in 2001 and the 2008 economic meltdown. Starting in 2008 I made future contributions to a money market type fund, which was stupid, because the market rebounded and I should have bought low while I could. Classic investor mistake, but heck, those were scary times. Meanwhile, her little sister’s 529 plan, which I started in 2002, now has more money in it. With my retirement account, I nearly doubled my contributions for several years while I was self-employed because if the market stinks, the only way to compensate is to save more. (Single Ks allow you to contribute as both the employer and employee.) Studies have shown the biggest impact on your nest egg comes not from investment returns or minimizing fees but the level of contributions. An early start is also really helpful: Studies based on the past performance of the S&P 500 have found that since 1925, the chance of losing money over a year is 28 percent; over 5 years, 10 percent; over 10 years, 3 percent; and over 20 years, 0 percent. Good luck reaching your goals!