Category Archives: Financial Independence

The Rule of 72

Do you want to know how long it will take to double your money?  Most investors do.  Are you interested in the expediential growth of your money?  Have you ever tried to calculate the rule of 72?

When I first started to read personal finance and investing books, I learned about the math behind what makes investing work.  The big driver behind what causes your money to grow is compound interest. While I was studying, the one theory that I kept coming across was the rule of 72.

The rule of 72 is just a basic mathematical formula.  It is used as a tool to help investors determine when they should expect to double the money they currently have invested.  The rule of 72 allows an investor to know when they should expect to double their money based on a forecasted rate of return.

Start by taking the projected rate that you expect your investment to return every year.  Divide that interest rate by 72. That will give you the number of years that it will take for you to double your money.

Example:

72 / 6% expected rate of return = 12 years to double your principal

72 / 8% expected rate of return = 9 years to double your principal

72 / 10% expected rate of return = 7.2 years to double your principal

The rule of 72 is what makes stocks a more attractive option than bonds or other fixed-income investments.  For example, the Vanguard 500 (VFINX) has returned 10.97% per year between the years 1976 and 2016.  Currently, the average interest rate on an FDIC insured savings account is slightly higher than1.15%. What is the difference between these two investments based on the rule of 72:

Vanguard 500 – 72 / 10.97 = 6.56 years to double your principal

Saving account (national average) – 72 / 1.15 = 62 years to double your principal

Over the coming decade, stocks are not expected to return 10% per year.  Currently, stocks are expensive investments and there is not much value to be found.  Jack Bogle who founded Vanguard and the first S&P 500 index fund that was available to individual investors predicts a more modest return of 6 or 7 percent for the coming decade.  Based on that forecast and the rule of 72, how long would it take to double an investment of $3K in the Vanguard S&P 500 fund:

Vanguard 500 – 72 / 6.5% = 11 years to double your principal

Time is on Your Side

When I started investing, I received a brochure from the investment company that provided me with a few charts on compound interest.  The chart showed how the rule of 72 worked with different interest rates. The brochure explained the wealth-building power of stocks vs more conservative investments based on the difference in long-term performance.  It also showed how it benefited an investor who had a few decades to take advantage of this powerful wealth building formula.

For example, a one-time investment of $10K to grow in value to $40K based on different interest rates:

  • If an investor received a return of 3%, it would take 48 years for that $10K to grow to $40K
  • If an investor received a return of 6%, the time would be reduced to 24 years to grow to $40K
  • If an investor received 12%, however, it would only take 12 years to grow $10K to $40K

What to do Now

What can investors do now to follow the rule of 72?  What are some alternatives since the S&P 500 is projected to underperform its historical average?  Is it possible to try to reduce the time it takes to double your money without taking on too much risk?  Here are some options that might help in doubling your money quicker:

Save more money.  By increasing your savings, you will double your money at a faster pace.  Try to increase your savings by 2-3% per year.

Go beyond the S&P 500.  Add a small-cap blend or extended market index fund that includes mid-cap stocks to your asset allocation.  Small-cap stocks have historically outperformed large-cap stocks. If you go with a 4:1 Ratio, you will emulate the total stock market.

Go beyond the United States for investing opportunities.  Add some international stocks to your portfolio. Add both developed nations and emerging markets for their growth potential.

Remember to keep some bonds in your portfolio.  Many experts are telling investors to stay away from bonds because of their current low yield and the raising interest rates.  Bonds have an opposite correlation than stocks. When stocks go down in value, bonds go up. By owning some bonds, you can buy stocks at a lower price when there is a stock market correction.

Conclusion  

As an investor, you should keep the rule of 72 in the front of your mind.  You do not need to know the exact date as to when you will double your money.  From time-to-time, look at how your portfolio performed over the past 5 or 10 years to identify what your average rate of return is.  Apply the rule of 72 to know where you stand. If you are not satisfied with how long it is taking, look for ways to increase your returns that are within your risk tolerance.   

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Be Intentional

I recently attended a leadership training seminar at a local college.  This seminar was about managing the multi-generational workforce.  The facilitator covered many topics and I am not going to get into any of those details in this post.  He said many interesting things, but the one statement that made me think was that he said that we should always be intentional.

Everything we do should be with intent.  Our actions should have an intended outcome.  Our words should have an intended message.  Even our thoughts should be focused and have a purpose.

The purpose of this training was meant for workforce development.  The message can easily be applied into everyday life.  It is ideal for managing money.

Too many people just coast in life.  They walk around making noise and bumping into things.  By not having a plan, they will just land at a random destination.  What could possibly go wrong with that approach?

To be successful in all your affairs, practice being more intentional.  A great place to start is with how you manage your personal finances.  You should know the why behind everything that you do.

Savings

Do you know what your savings rate is?  You should be able to answer this question without giving it any thought.  Is it 10%, 20%, or more than 30%?  Your savings rate is the most important factor that will determine if you will reach financial independence or not.  It is also one of the rare aspects that you have control over.  Nobody can control what the S&P 500 will return this year, what direction interest rates are headed, or if there will be a spike inflation.  Everyone, however, can control what their saving rate is.

Spending

Your savings rate is directly impacted by your spending.  Do you just spend money without thinking?  Do you go to the mall, outlets, or online and buy things that you do not need?  If you want to change this trend, become intentional with your spending.  Before you buy something, ask yourself if you need it or truly want it?  If you must spend the money, did you shop around for the best price?  Is there a low-cost alternative to making the purchase?  Even if there isn’t a better alternative, at least you did your due diligence and gave thought to the purchase.

Debt

Does your credit card bill arrive, and you cringe when you look at your balance due?  Do you make late payments or just pay the minimum balance on your credit cards?  Do you know what your credit score is?  Do you know what your debt-to-income ratio is and what a healthy ratio should be?  Do you know how to calculate your debt-to-income ratio?  If you want to improve how you manage debt, take a more intentional approach.  Learn what your credit score is, identify if you have too much debt for what your income is, and ultimately establish a plan to get out of debt.

Earnings

I bet you know what your annual salary or hourly wage is?  You get a paycheck every week or bi-weekly, so you are reminded frequently about that rate.  Do you feel that you are underpaid?  Doesn’t everyone?  Maybe you are underpaid or maybe you are overpaid.  Before you ask for a meeting with your supervisor demanding a raise, you should do your homework.  Be intentional and research what the market rate for your position is based on your location and level of experience.  If you are under market rate, you might have a case.  If you are over market rate, but not satisfied, you might need to develop more skills or ask for a more challenging assignment.

Investing

If someone asked you what type of investor you are, could you answer them?  Are you a market timer?  Do you buy and hold equities?  Are you a passive investor who invests in a few different mutual funds?  Do you simply try to capture what the market returns with a total stock market fund?  Do you use value tilts?  Do you buy dividend stocks?  Are you trying to get rich by investing in Bitcoin?  You are free to decide how you invest your money, but you should know the why behind your plan.  Your approach to investing should be intentional.  Nobody knows what the future market returns will be, but you should at least know what you are intending to accomplish with your asset allocation.

Financial Independence

Do you know how much money you need to have in savings to reach financial independence?  To declare financial independence, the general rule is to have 25 years worth of living expenses in savings.  That is based on a 4% withdrawal rate that most financial professionals consider to be acceptable.  Do you know if you have obtained this milestone or how close you are?  Most people who reach financial independence do not get there by accident.  They live intentionally for many years.

Early Retirement

Do you have a target-date as to when you want to retire?  It might be next week, or it might be in 10 years.  If you have an established early retirement date, what are you doing to make that goal a reality?  Are you doing everything you can to maximize your salary and taking on side gigs?  Are you saving until it hurts?  Do you have the right mix of investments to both reach your goal and sleep comfortably at night?  If you do, you are acting in an intentional way.

Conclusion

The nice thing about being intentional is that you can start this process now.  Start by reviewing your current financial situation.  Can you answer why for all your financial decisions?

If you have a financial plan, use it as a guide.  If you do not have a written plan, write one.  That is a good starting point if you want to become intentional.  Review your plan for areas of your financial situation that might need to be amended.

Some fixes are quick, and others require time to implement change.  Moving forward, wherever money is concerned, ask yourself why before you make a final decision.  If you cannot answer why you are doing something, give it some thought and find out what your true intentions are.

This is just another example of how to improve your financial situation.  It provides a pause before you act.  Sometimes giving a decision an additional few seconds of thought can turn a bad decision into a good decision or a good decision into a better decision.

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Money & Happiness

Money can do many things.  If you have money, you can live life to the fullest.  Money enables people to cover all their necessities including food, shelter, and healthcare.  Having money is a key requirement to get the best education in the classroom and by way of traveling the world.  Money is also required if you want to add convenience and have some luxury in your life.  Money is tied to almost every aspect of life, but can money buy happiness?

In 2010, a study was conducted to determine if happiness can be increased when income is increased.  These researchers found out that it can.  There were limits though.  The researchers discovered that happiness increased with income, but only up to the amount of $75,000 per year.  People who earned over $75,000 were not happier than those who earned $75,000.

That sounded reasonable to me.  $75,000 would be enough to live a reasonably comfortable life in most parts of the country excluding New York City, San Francisco, or some of the other major coastal cities.  Even in smaller markets, $75,000 will not be enough to afford a first-class lifestyle.  It should be enough, however, to cover your needs, some wants, and have enough left to save for retirement.

A more recent study was conducted by Researchers from Harvard Business School.  This survey was given to 400 millionaires.  They were asked to rate their happiness based on a scale of 1 to 10.  This study found that the people who had at least $8,000,000 were happier than those with less than that amount.  Many agreed that they would be happier with even a little more wealth.  Most felt that they needed much more than what they currently have.  To score a perfect 10 on this happiness survey, the results stated that the millionaires who took this survey would need to have a 1,000% increase in their net worth.

In my opinion, money can buy many things, but I do not know if it can buy true happiness.  There have been times in my life when I had very little money.  Based on my current lifestyle and expenses, I have enough money to live for a couple of decades without having to work.  I feel blessed, but I do not think I am happier today compared to when I was just starting out.

Obviously, life is better with money compared to being broke, but I do not know if there is much of a difference on the happiness scale.  I view having money as the means to more options in life.  That makes me happy.  In my opinion, money equals freedom to live a life on my own terms.  That also makes me happy.

I just don’t think that money itself makes me happy.  Money pays the bills and allows me to buy things.  I am not overly materialist and don’t want for much.  Material possessions generally do not make me happy.

Accomplishment

There are a few things in life that make me truly happy.  The first is when I accomplish a goal.  Even though I am focused on early retirement, I do get a great feeling when I accomplish a goal at work.  It is not based on the praise from others.  It comes from that internal sense of accomplishment.  The same feeling of satisfaction can be found when I accomplish a home improvement project, complete a workout, finish a book, or make an improvement to my blog.  For example, I am happy that you took the time to read this post.

Laughter

I also find joy in the simple things in life.  Laughter makes me happy.  I take my work and my goals seriously, however, I do not take myself seriously.  I have been humbled enough times to say that my ego is right-sized.  A therapist friend of mine recently told me that a good sign of emotional intelligence is to have a good sense of humor and the ability to laugh.  I find it therapeutic to laugh at myself as well as to laugh at the absurdities of life.  I am also happy when other people laugh.

Nature

Spending time in the outdoors makes me happy.  I love going to the local park with my wife and our dog.  It feels great to breathe in the fresh air while hiking the trails and to take in the wildlife.  One of my favorite hobbies is spending an afternoon in my kayak bass fishing.  There are few things more exciting than catching a bass on a topwater lure.

Service

The closest that I have ever come to experiencing true happiness is when I am being of service to others.  In my experience, if you want to find pure joy, go and volunteer at your local soup kitchen.  The fear of stock market volatility quickly vanishes when you tune into the needs of those who truly have nothing.

Helping people who are less fortunate than myself gives me gratitude that lasts for weeks.  It puts my problems into perspective.  These people are not thinking about finding investments with the lowest expense ratios or finding ways to pay fewer taxes on capital gains.  These folks are literally wondering where their next meal is coming from.

My wife and I try to volunteer a few times per year.  We try to not tell anyone about it.  We Just simply show up at the food kitchen on a Saturday morning and volunteer for a few hours.  Nobody needs to know how wonderful we are.  I feel that if I talk about it, it becomes more about me than about the act of giving back.  That just reduces the degree of happiness that I find in this type of volunteering.

If you are intimidated by the thought of helping the homeless, don’t get discouraged.  There are many ways to volunteer.  It does not have to be a formal process.  Take a ride to your nearest park and bring a trash bag and gardening gloves with you.  Spend one-hour walking around the park and picking up litter.

I have found that many people in the financial independence community have discovered the joy of helping others.  A good example of this occurs at the Chautauqua Financial Independence Conference.  I have read that it is common for a day of community service to be added to these events to go along with the lectures and discussions about financial independence.

Conclusion

Can money buy happiness? I honestly don’t know for sure.  The research shows that it can up to a point for some people.  For others, it seems like happiness is based on having more.  I also don’t know if people should be basing their happiness on how much money they have.  I have found that having money is better than not having money if the rest of your life is in order.  If you have enough of it, you have more options as to how you choose to live.  That will afford you the ability to focus your time and energy on what you are passionate about.  If the concept of being free makes you happy, money is a means to that end.

 

Selling your Stocks at Retirement

Have you ever considered selling your stocks at retirement?  Who wants to have to deal with the ups and downs of the markets when you are no longer dollar-cost-averaging?  Are you afraid of a major market crash when you are drawing down your portfolio?

The market is near its all-time high.  With retirement right around the corner, are you tempted to sell all your stock holdings and call it a day?  It might sound tempting.  This market cannot keep going up, can it?

Every investor has the right to feel exactly how they feel about all of the scary things that are going on in the world.  Don’t lose your head.  The world has always been a volatile place and unfortunately, it always will be.  If it is not one thing, it is something else.

Yes, it might be tempting to pull the trigger and sell high.  You would walk away as a winner.  Before you do that.  Let’s look at how an all-bond portfolio might serve you in retirement.

For this exercise, let us assume that you are now sitting on $1,000,000 in your 401K.  At retirement, you want to draw down 4% per year.  How would an asset allocation of 100% in bonds hold up over the course of 30 years?  To find out, I am going to run this test based on the Monte Carlo method by using the Vanguard Retirement Nest Egg Calculator.

There is a 69% chance that your savings will last 30 years.  I do not like those odds.  I especially do not like them for a person who retires early.

What about if a person wants that $1,000,000 to last 40 years?  The percentages are getting much worse.  There is now only a 36% chance that money will last 40 years.

Could you imagine going broke after being retired for 40 years?  What would you do?  Would you go back to work?  Who would hire you at such an advanced age?  Sure, employers cannot discriminate, but let’s be honest about the opportunities for someone who has been unemployed for that long.

What could an investor do to improve the chances of their savings lasting 30 years or even 40 years for those who enter early retirement?  In Benjamin Graham’s book The Intelligent Investor, he gave a few suggestions for defensive investors.  He suggests that a balanced portfolio made up of 50 in equities and 50% in bonds is a good place to start.  He also suggested that an investor should never exceed an asset allocation of 75/25.  In other words, an investor should never have more than 75% or less than 25% in equities or bonds.

I know that you are seriously considering selling your equity holdings and exchanging them for bonds.  You have told yourself that you are finished with the market.  Volatility is no longer for you.  You want to enjoy your retirement without having to worry about how stocks are performing.  If you do that, the odds are still not in your favor of not running out of money.

How would your $1,000,000 fair if you followed what the late Benjamin Graham suggested in his classic investment book?  How would keeping only 25% in equities change the projected outcome?  Would adding a more volatile asset class help or hurt the likely hood of running out of money?

By keeping 25% in equities, the percentages have dramatically improved.  There is now a 78% chance that your money will not run out over the course of 30 years with a 4% drawdown rate.  Over the course of 40 years, there is a 57% chance that your money will last.  By keeping 25% of the portfolio in stocks, there was an improvement of 9% over the course of 30 years and an improvement of 21% for 40 years.

Holding a small allocation of equities sure goes a long way.  What about if you took it a step further and went with a mix of 50% in stocks and 50% in bonds?  I know, I know. You are finished with stocks.  Keeping 25% of your money in stocks is one thing, but going to 50% is just too aggressive for your retirement account.

I understand how you feel.  You do not want to own stocks when the next recession occurs.  A long stock market correction can be scary.

During a drawdown period, how does having 100% in bonds compare to an asset allocation of 50% in stocks and 50% in bonds?  Over the course of 30 years, the 50/50 mix has an 85% chance of success.  Over the course of 40 years, the 50/50 mix has a projected success rate of 74%.  Compared to the portfolio made up of 100% in bonds, the 50/50 mix has a 16% better chance to not run out of money over the course of 30 years.  For the period of 40 years, the 50/50 mix has a 38% better chance of not running out of money.

There are many factors to consider when selecting the asset allocation that is right for your retirement.  How old will you be at the time of retirement?  How long does your money have to last?  How will RMDs impact your drawdown?  What type of lifestyle do you want to live during retirement?  Are you planning on leaving a legacy?

I am not trying to convince you on how you should allocate your portfolio during retirement.  That is ultimately your decision.  Everyone has a unique financial situation.  The purpose of this post was to examine how different conservative portfolios might perform during the drawdown period.  I am just trying to convince you to do your due diligence before you rush to any financial decisions that will impact your quality of life down the road.

After reviewing these results, it shows that diversification is still important during the drawdown period.  Just as holding 100% in stocks is too aggressive for most investors during their working years, holding 100% in bonds might be too conservative for investors during the drawdown period.  When an investor is working on building their wealth, holding a percentage of bonds helps to reduce the impact of how stock market volatility impacts a portfolio.  During the drawdown period, holding a small percentage of equities greatly improves the likelihood of not running out of money in retirement.

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Financial Unmanageability Transcends Money

I believe that financial unmanageability transcends money.  When it comes to finding ways to better manage your finances, there are unlimited resources.  There are many great books, blogs, forums, websites, and apps.  There is not a shortage of information, tools, or even professional services.  If a person wants to make improvements when it comes to spending less, paying down debt, saving more of their earnings, or learning to invest, they could find out how to do it in a matter of minutes by doing a few simple online searches.

If the solution to finding ways to improve your financial situation is so readily available, why are so many people struggling?  Yes, we can blame the marketers for always trying to sell the newest gadget.  That excuse, however, only carries so much weight.  Consumers are more educated than ever and many tune ads out.

What if the problem is more pervasive?  What if the problem is beyond simple behavior modification? What if the problem is based on unmanageability?  Yes, the inability to have mastery over your life.

If the problem is based in unmanageability, there is not a blog or app to solve the problem.  If your life is truly unmanageable, trying to get a better handle on your financial shortcomings is just treating a symptom.  To gain control of your life, it will take a little more than spending less and saving more.

Denial

Nobody truly wants to admit their life is unmanageable.  Just like nobody wants to admit they drink, spend, eat, or gamble too much.  It is natural for many people to think, I don’t have an issue with my finances and then go spend more money.  It is common behavior for people who have addiction problems or a spiritual malady to deny what the problem is.  The thought process is like a broken record that skips the same verse over and over.  I do not have a problem with my finances – go spend more money.

Resentment

To resent is to keep going back to a negative feeling.  Instead of feeling and processing those bad or negative feelings, you spend money.  Resentment is not always based on harboring ill feeling towards someone who you believe wronged you in some way.  Resentment can also be rooted in harboring ill feelings towards someone who did exactly what you expected them to do.  The problem was that you were still not satisfied.  They were unable to fill that void that exists within you.  To find temporary relief, you continue to spend and try to fill that void with an external fix.  Unfortunately, it does not last.  After you exhale out and feel relief, you almost immediately inhale the resentment back in.

It is All About You

When you live an unmanageable life, there will always be a conflict with self.  It is all about you.  You cannot be of real use to others.  Sure, you might be physically present in their life, but are you truly living in the moment?  Or are you just physically there, but mentally bound to your troubles?  When your self-centered thoughts and feelings are the focus of your existence, it is difficult to make meaningful connections with others.

Anxiety 

You are not a bad person.  You might even do nice things for others.  You believe that you are thoughtful and caring.  You spend money on the people you care about and on those who you want to care about you. Externally that all might be true, but aren’t you just doing all those things to find more relief and to feel better about your current state of unmanageability?

Do you live in fear?  Do you spend more than you earn and panic when the bills arrive?  Do you lay awake at night and worry that you will never be able to get out from under all the debt you are in?  Do you see retirement as a possible option for others, but something that you would never be able to afford?  Do you obsess over your finances in one thought, but follow it up with more spending that pushes you further away from having healthy finances?  Do you feel hopeless?

Is this fear leading to other health concerns?  Is it leading to weight gain or panic attacks?  Have you gone to see your doctor because you feel overwhelmed?  Did your doctor put you on meds to take the edge off and to help you cope?

There is a Solution

Yes, getting your finances in order is great, but you first need to get your mind right.  I am not a therapist.  I am just a guy with a personal finance blog.  If you are honesty suffering from the symptoms that I listed above, you should seek outside help.  Find out if your health insurance covers visits to a psychologist without a referral from your primary care doctor.  If not, ask your doctor for a referral to one that they recommend.  You might have to pay a low co-pay, but it will be worth it.

There are also 12-step programs.  As I stated earlier, your spending might be just a symptom of a larger issue.  There are 12-step programs for spending, gambling, drinking, and just about any other type of obsessive disease.  It is up to you to dig deeper and decide if you think a 12-step solution would be a good fit for you.

Conclusion

Don’t beat yourself up.  Don’t wallow in guilt, shame, remorse, or any other negative feeling.  The past is the past.  It is time to move on.  Pick up the pieces.  You are not a bad person.  You might have made poor decisions and you might suffer from the disease of addiction.  After you put your own house back in order, you can make amends to those you feel you might have harmed including yourself.

There is hope.  There is also help available.  It is now up to you to find the right help that will be a catalyst for positive change.

Once you get your mind right, great things will start to happen in your life.  Not only will your financial situation improve, but every area of your life will get better.  How could it not, you will be moving away from the problem and in the solution.

You will be able to better accept people and situations as they are.  You will be able to let go of the past. You will better assimilate into the mainstream of life.  You will become more useful to the people around you.  You will finally find the peace that you have been searching for all along.

As a bonus, you should be able to better budget and save money.  Your whole life will become more manageable.  Having a few more bucks in the bank will just make life more enjoyable.

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