Focus On What You Control: Your Savings Rate
A successful investor is a successful saver.
When I was running an RIA, one of my business goals was to help my clients achieve investment success. So, what metric do you use to quantify success?
Your metric for investing success should be your savings rate, not your rate of return. You can optimize your portfolio to the best of your ability. But, if the US market goes through a recession, you will still feel it. It is unavoidable.
For that reason, you need to focus on what is in your control—your savings rate.
As firefighters, we don't control when a structure fire occurs, what type of structure it is, or whether there are occupants in it or not. We focus on what we can control—our training. We train mentally and physically to be prepared for any situation.
So, don't let the doom and gloom or razzle-dazzle of the financial pornography networks influence your financial decisions. There is a reason why every investment commercial ends with, "past performance is no guarantee of future results." Investment returns are out of our control. We can't predict this week's weather accurately, never mind something as complex as the global economy.
But, through all the ups and downs of the market, you should focus on maintaining a specific savings rate based on your long term financial goals.
For example, Elena and I save 15% of our gross household income towards retirement.
This is prioritized before almost anything else. If our income doubles next year, using a percentage (instead of a dollar amount) allows our savings to scale with our income. This helps us maintain our commitment to saving and not allow lifestyle creep to take command of our extra earnings.
After our house is paid off, we plan to increase our savings rate significantly to reach financial freedom.
For an ambitious young couple hoping to reach financial freedom by 40, this may mean saving 30-40% of their gross income every year. For someone who enjoys his career and wants to make work optional at age 65, that might mean saving 15% of his income year over year.
Once you have decided upon your target savings rate, you can begin to modulate your expectations of goal accomplishment based on the different rates of return you may get from your investments. As time goes on, you can increase your savings rate up or down as needed.
So, what can you do to increase your savings rate?
You can D.A.B. (Do a Budget…not the dance move)
If you want to prioritize a specific savings rate, your budget is the place to do it.
If your household brings in $5,000 every month and you want to save 20% of it, you should have a line item, such as savings or retirement, with $1,000 beside it. Now you can budget for the rest of life's obligations with the remaining $4,000.
Keep Your Expenses Reasonable
Like it or not, wealth is not a function of how much you earn. Wealth is a function of how much you save. Too many firefighters get on the hamster wheel of:
GO TO WORK…MAKE MONEY….SPEND MONEY…GO TO WORK…MAKE MONEY…SPEND MONEY…REPEAT…REPEAT.
Our lifestyles tend to inflate right alongside our incomes, thus exhausting the hamster (aka firefighter) turning the wheel.
If you want to skip the rat race, you need to:
Avoid Lifestyle Creep
Align your spending with your values
Enjoy free or low-cost activities when possible
What do many firefighters do when they get a raise? They spend it frivolously. Their lifestyle increases right along with the pay raise. Have you ever seen a recently promoted firefighter roll up in a new truck? That's my point. Lifestyle creep is real, and it is hurting you.
Do you value paying $150 a month for Verizon cell phone service? No…not really? Well, go for a low-cost option like MetroPCS and cut your bill in half. Do you value that Dish Network package that you never get to use because your kids are watching Netflix? No? Well, cut the cord as well as the cost. Quit spending money on things that you don't value.
Everyone enjoys a nice family vacation or a nice meal out to eat, but they can be pricey. Instead of spending thousands to take your kids to Disney World, you could tour some local historic landmarks and go camping for a long weekend. Instead of spending $100 a week to go out to eat, you could take the time to teach your kids to cook and turn your out to eat night into kids' cooking night.
I'm not saying don't ever take a vacation or go out to eat. I am suggesting that, often, there are low-cost alternatives that will actually provide more fulfillment to your life.
It is possible to live an abundant life while keeping your expenses reasonable and prioritizing your savings rate. And the great thing is, the hamster wheel turns into a road map, and it looks more like this:
GO TO WORK…MAKE MONEY…SAVE…SPEND WISELY...GO TO WORK…MAKE MONEY…SAVE…SPEND WISELY...GO TO WORK (OPTIONAL)...
Successful savers are successful investors. Don't let market ups and downs deter you from focusing on your savings goal. The more you contribute, the less you have to rely on uncontrollable factors, such as rates of return. Compound interest is a magical thing, and it works. But it takes time. So, be patient, focus on your savings rate, and maintain a long term perspective.
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