How Do People Save Large Percentages of Their Income?
Traditional financial advice has always suggested that people should save 10% to 15% of their income for retirement purposes. However, financial planners now consider this as outdated advice. This is because of the fact that people no longer have the security of 40 year long stable careers. The hire and fire culture as well as the gig economy which has become part of the new economy are making career stability a thing of the past. This is why movements like Financial Independence Retire Early (FIRE) have become an important part of the modern culture. Many millennials are afraid that they might not have high paying jobs in their fifties and sixties. Hence, they want to generate enough wealth in the first few years of their career.
Now, since the careers have become shorter, the most obvious solution is to increase the amount of money which is saved for retirement so that there is enough money accumulated in the few years that they have until retirement. Many people who follow FIRE state that they save anywhere between 50% to 70% of their income. This seems odd to a lot of people given the fact that they are one pay-check away from bankruptcy. The question really arises as to why can some people save such a large chunk of their salary whereas others can barely get by.
The details about the frugality mindset have been mentioned in this article.
- Manage the Housing Expense: The FIRE movement is easy to understand mathematically. However, it can be difficult to follow in real life. This is because the FIRE methodology relies on extreme savings. This means that people have to make a lot of sacrifices. One such sacrifice is in the housing department.
The mortgage or rent is hands down the biggest expense in an average persons budget. Hence, if a person has a lower mortgage or rent, they can save a lot of money. They would have to cut several other expenses in other areas if they decide to spend lavishly on a mortgage. It is important to understand that banks are in the business of making you indebted. This is the reason why they lend excessive amounts of money to people looking to buy a house. However, just because the bank is willing to lend it does not mean that a person should borrow the money.
It is important to ensure that the house being purchased or rented is of the optimal size. It does not need to have too many spare bedrooms which unnecessarily drains the investors budget. It is also important to practice geo arbitrage. This means that a person should relocate to lower-cost areas. This allows them to cut down on costs without cutting down on space. Sometimes renting a spare bedroom or sharing a bedroom can help increase the cash flow. People who follow the FIRE model do not spend more than 15% of their income on a house.
- Manage Vehicle-Related Expense: After housing, vehicles are the next big expense in any household. This is because people tend to have multiple new cars in their households. The reality is that cars are a diminishing asset. Hence, if an investor purchases too many new or expensive cars, their net worth tends to decline quickly. People whose objective is to retire early tend to use cheaper cars. If they stay in parts of the world where the public transport system is well connected, they may not buy cars at all. Some people following FIRE bicycle to work. This helps them save money while simultaneously keeping them in good shape. It is not advisable to spend more than five months of your income on buying an automobile.
- Manage Entertainment Expenses: People who follow the FIRE philosophy tend to optimize their eating out and other entertainment expenses as well. Although these expenses are not huge in magnitude, they do add up over time. People following FIRE do not have to skip on all of lifes pleasures. They just tend to enjoy and entertain themselves in a frugal manner. This could mean choosing cheaper restaurants and/or going to restaurants less often.
- Save Your Raises: The most important lesson is to ensure that if the income of a person increases, their expenses should not increase proportionally. People who follow the FIRE philosophy know that any increase in the income should go to the savings account or should be invested. By consistently living below their means for a period of six to seven years, most people can save enough money that it enables them to live without worry later on. People who are following the FIRE philosophy tend to work side jobs in order to increase their incomes and their savings rate.
- Calculating the Cost in Terms of Hours: People who follow the FIRE philosophy tend to understand that if they consume more, they will have to work longer to earn their goals. Hence, they often know the hourly rate of their work. While making big decisions, they often compare the hourly rate to decide whether the additional expense is worth it. They also take other measures such as restricting the number of credit cards that they use or eliminating them altogether.
The bottom line is that it is possible to save 50% of a persons income or even more. However, it would entail making some sacrifices. However, if the larger purpose is considered and kept in mind, the sacrifices may be well worth it.
|❮❮ Previous||Next ❯❯|
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Importance of Personal Finance
- Process of Financial Planning
- The Financial Life Cycle
- Three Types of Income
- Misconceptions about Personal Finance
- Macro-Economic Factors and their Effect on Personal Finance
- Going From Financial Goals to a Financial Plan
- Components of a Financial Plan
- Personal Financial Statements
- Advantages and Limitations of a Budget
- Ratio Analysis in Personal Finance
- Dollar-Cost Averaging
- Pitfalls of Dollar-Cost Averaging
- Value Averaging Method of Investment
- The Rent vs. Buy Decision
- Financing Your Home
- Fixed-Rate Mortgage vs. Adjustable Rate Mortgage
- The Phenomenon of House Poverty
- 5 Step Retirement Planning
- Retirement Basics: 401K Plan
- Retirement Basics: Roth IRA
- Auto Loans and Personal Finance
- Earnings Power in Personal Finance
- Personal Financial Planning For Small Businesses
- Common Pitfalls of Tax Planning
- Zero Based Budgeting System Using Envelopes
- The Concept of Financial Freedom
- The Financial Independence Retire Early (FIRE) Movement
- How Do People Save Large Percentages of Their Income?
- Rich Dad Poor Dad Philosophy
- The Pay Yourself First Principle
- Personal Finance Lessons from Rich Dad Poor Dad
- Estate Planning in Personal Finance
- 7 Personal Finance Mistakes to Avoid