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When you get right down to it, the pattern we all follow to reach retirement escape velocity is very much the same.
Our nest eggs are all governed by the same two simple equations.
Universal Retirement Equations
1) Income – Spending = Savings
2) Savings x Growth X Effective After Tax Rate = Nest Egg
I call these the savings equation and the nest egg equation. As you can see, there are four universal levers we can use to ultimately grow our nest egg, and mastering them in the right order can send you hurtling at light speed toward retirement. In typical order, here are four skills you will find you need to master to retire quickly.
- Master spending control
- Expand your income potential
- Deploy your money for optimum growth
- Minimize your tax exposure
This is part one in a two part series, where we will on the first two steps to retirement: spending and income. For the second half of the series, click here.
Step 1: Master Spending Control
Your first step into the adult world will almost always be focused on spending.
Unless you are fortunate enough to grow up with a trust fund, you graduate with little to nothing attached to your name. Perhaps, as is quite common, you actually come to the working world with a certain amount of student debt. Welcome, Skippy, to the American Dream.
Stage I of retirement building is straightforward. When you are first starting out, you have no capital to work with, so you are focused on Equation 1: Income-Spending=Savings.
Furthermore, right out of college you have very few entry level jobs to select from, so the band on expanding your income is fairly narrow and will improve quickly if you just give it time to play out. Your control of spending, by contrast, is completely within your grasp. Thus, it makes the obvious first choice.
A lot of people dread this step. Deprivation! Let’s all just lay down in the street and die right now. Relax, bud. Keep in mind that the spending control does not mean you have to be a tightwad about every category, every dayl.
As an example, I was born a foodie and still put away a lot of money while satisfying my food cravings; I did this simply by making sure the frugal decisions I did make in other areas really packed a punch.
My first job was in New York City, one of the most expensive areas in the world. I wanted to live in a safe area with a reasonable commute from work, so that meant I took a roommate to keep costs reasonable. And while we picked a safe neighborhood (Upper East Side), we picked a shitty little apartment that was a multi-flight walk-up, with bars on the one set of windows in the entire space and no natural light in the living room. Safe, warm, and clean, but my mother admitted years later to me that she cried after she saw my apartment for the first time.
Luckily, I was too young and too used to living in crappy dorm rooms for it to bother me; in fact, I considered it a step up since the room I slept in during college was so small and cramped it was zoned as a closet by the school. That one decision probably helped me put away $15k more a year than my peers. I also didn’t think I was going to live in the city for very long, so I eschewed a $700 bed frame and slept on a mattress on the floor. Cha-ching!
The original Money Habit pad. Being a newly-minted adult meant that I made my bed exactly never.
These were places that packed a big punch but didn’t make me feel particularly deprived. Because I made these big-ticket savings decisions, I was able to over-index on warm croissants, artisanal baked goods, and brunch – my true loves – and still maintain a 70% savings rate.
The important thing to remember is that you can have anything but not everything.
Controlling spending is about deciding what really matters to you and then figuring out how the “things that don’t matter” can cost you less. Depending on the person, that means it’s about cheap accommodations, low food bills, mostly free entertainment where possible, and cheap or limited travel. I will warn you that it is tough to impress members of the opposite sex when your bedroom has a mattress on the floor, but it worked for me.
Step 2: Expand Your Income Potential
A few years into the journey, perhaps you have some ability to affect the other half of equation 1 through finding a higher-paying job, or developing a side hustle.
It is a good time to focus on this section when you have at least 3 years of work under your belt. With 3 years of work behind you, you have real work experience you can parlay into a higher paying job and/or you are probably stable enough in your life to make for side hustles.
Depending on what field you’re in, you will probably wisen up to the fact that switching jobs or at least quietly interviewing every 2-3 years is ideal, because in-house raises tend not to keep up with market rates.
You may start blogging on the side or picking up side construction projects. Picking income-generating project is a longer discussion, but you will generally be thinking about side hustles on two axes: upfront resource commitment (time and money) and length of commitment.
AirBnB and Uber are two surprisingly lucrative, low-commitment and short-time frame commitment roles. On the other side of the spectrum is building an e-commerce business or producing a niche product. I guarantee you that everyone has a skill or other resource they can monetize on the side for at least $5-10k a year. And I am not going to suggest you create crafts on Etsy, because that is often bad money sense for a ton of time.
Income and Expenses: Typical Complaints
These two factors – income and spending – determine how much you are able to save each year. Since these are the only two levers that contribute to savings, you must get good at one or the other of these. If you get good at both, you are stacking acceleration upon acceleration.
This is where most people fall off the bandwagon. Making more income is hard, and the area with the most immediate control is spending. But the average dude looks at the prospect of cutting drinks out with friends, driving a beat up car, and sleeping on ikea furniture and thinks, “this isn’t really living. It’s not worth it.” Average Dude is mistaken. Average Dude has made two mistakes which make the prospect of building his retirement nest egg seem much harder than it really is.
The first mistake is that he does what we all do, which is to take the present set of circumstances and extrapolate it far into the future and across his whole life. He will live this way forever, and because he made a few frugal decisions that makes him a miser across all aspects of his life. This is actually one of the top 10 cognitive distortions we are all guilty of, and it is called overgeneralization.
The efforts you make to cut spending can be temporary rather than forever.
Average Dude, you do not have to live without XYZ luxury forever. If you live without XYZ luxury for two years, you will save up a nice chunk of change that will then work for you forever, giving you little forever employees that will fund your XYZ luxury for the rest of your life.
The second mistake Average Dude makes is to overestimate how necessary XYZ luxury is and underestimate how much joy there is already in his life from his current purchases. Did XYZ luxury exist five years ago (I’m looking at you, Amazon Echo and Iphone 7 buyers)? Are you convinced you couldn’t have a meaningful life without these things, and what does that say of 5-years-ago past Average Dude? Was he doomed to a meaningless life before XYZ thing came along?
Don’t overestimate how much a single expensive purchase adds to your life.
The truth is that you are surrounded by an overflow of stuff and you are under-optimizing your joy from each individual purchase already. By working on optimizing your enjoyment, you can sock away a TON without feeling deprived.
If you can master at least one of the two levers for the savings equation, you will be well on your way to retirement. And remember, you cannot advance to the other stages without having saved some amount of capital to work with. So keep plugging away.
Ready to talk about what’s next? Let’s address the remaining two steps in the final part of the series.