Disclaimer: I am not a professional financial adviser, and this series in not meant to provide individualized financial advice. I am just one guy who did well enough to become financially independent at age 35. This series simply shares the lessons I learned for your entertainment.
By The Pointer
Poor Travis. He’s psyched about the idea of becoming financially independent, but he just learned that at his current savings rate, he may die before he can quit the rat race. That’s OK, we can help him, starting with cutting his expenses.
Why start with expense cutting?
I recommend focusing on cutting expenses before trying to play with other financial planning variables for a few reasons:
- Expenses are easier to start with – We all have expenses in our lives. We deal with them all the time. I’m certain no one needs a tutorial on what expenses are, but if we were talking about making investments or reducing taxes, you’d likely need some background information.
- A dollar saved is better than a dollar earned – You may think a dollar is a dollar, and “I’d rather earn more than spend less.” Sure, eventually there’s a floor to how much you can cut your expenses, but at first, it’s better to cut expenses. That’s because of taxes. An extra dollar of income is subject to taxes so you probably won’t be able to keep all of that dollar. A dollar from reduced expenses is 100% tax free.
- You’re also reducing your needs forever – If Travis can learn to live with less spending, he’s not only increasing the amount of money he can invest toward FI today, he’s reducing his needs in the future. To support $60,000/year in spending, he’ll need to spend about 49 years building a $1.5 million portfolio. If he could get his expenses down to $50,000/year, he’d only need to spend 29 years building a $1.25 million portfolio. Retiring at age 59 sounds much better than sometime between age 79 and never.
Think in time versus money terms
Remember, we discussed earlier in the series that most people’s decisions are based on trading their time/effort for money. In an office job, it’s clear that most people are giving their day to do what an employer wants in exchange for a salary. However, it’s not as immediately clear to people in reverse.
When you get that premium internet package, and spend an extra $30/month, it doesn’t seem like much. Maybe it’s not, but let’s put it to the test. If Travis’s expenses went up to $60,030/year, his new FI target would be $1,509,000 (+$9,000 versus his old target), and it would take him 50 years to reach it (+1 year versus his old target of 49 years). Is faster internet so important that you’d work an extra year for it? Maybe, but for personal internet use, I’m guessing not. Whether you think that trade off is worthwhile is a personal decision. The more important thing is to change your mindset: thinking of the impact expenses have on your time and freedom.
Start small, then get bigger
With expense cutting, it’s best to start small. Most people in a materialistic society like the United States (myself included at one point) believe that there’s nothing they could possibly cut from their life. For a family of 4 living on $30,000 per year, I believe that. For Travis, a single guy living on over $80,000 per year before taxes, I’m more skeptical. Let’s look at some examples.
Example 1 (Starting Small): Cutting mobile phone costs
Travis currently pays over $100/month for his mobile phone plan with T-Mobile, and they’re one of the lower cost providers among the major companies. He checked AT&T and Verizon to see if he could get better price on the same package (unlimited talk, text and data plus a “free” iPhone XR) so he thinks he’s already saving what he can.
Below, I reconstructed his phone plan so you can see what it includes:
What if he thought about his phone plan differently? Let’s start with the phone. Of that $101.25/month, he’s paying $31.25/month (as part of a 24 month commitment) for the phone itself. The price seems fair. After all $31.25/month x 24 months = $750, which is the current retail price of an iPhone XR 64GB. But how badly does he need the newest iPhone? The iPhone 8 is the next generation earlier, and the XR doesn’t have many features that are true improvements. The biggest advantage that the XR has is that it’s new and shiny. Just searching iPhone 8 prices on Google, it’s clear that it would only cost $450 - $500 to buy a new one outright ($250 - $300 savings):
While we’re at it, it’s worth questioning why Travis needs an iPhone at all? Let’s use what I call zero based buying (similar to the zero based budgeting mentality). Start from zero, and assuming you need a mobile phone, ask yourself, “What do I need in a mobile phone?” This is what Travis feels he needs:
- The ability to make calls
- The ability to text
- Internet browsing
- Access to good apps
- At least 32GB of storage
- A long battery life
- A reliable manufacturer
- Android or iOS operating system
Looking at this list, it doesn’t specifically describe an iPhone. Many types of phones can offer these things. He did some research, and found a much more affordable phone with the features he needs:
Once he was able to get past the cool factor of having the latest new iPhone, and focus on what needs, Travis was able to saving close to $600.
Now let’s see what we can do about the $70/month for service. Travis thought it was a good price because he compared it to major carriers like AT&T and Verizon. Did you know that there many, many more options? There are mobile virtual network operators (MVNOs). They don’t have their own network of cell towers, but they buy space on other providers’ networks. You can search the prices from MVNOs (and major providers) at WhistleOut’s website. Once again, you just need to know what your needs are.
Based on his previous usage, Travis believes he’ll need:
- 400 minutes of talk/month
- 100 texts/month
- 2 GB of data/month
When he enters this info into WhistleOut’s price comparison search, he gets these results:
Apparently, he was overpaying at $70/month just for service. He could pay as little as $15/month to meet all of the same needs. There are a few things to be aware of when searching with WhistleOut:
- The first 3 search results will be ads. Scroll down for the best prices.
- They’ll show you promotional rates, not the long term rates. The first result may not be the best rate in the long run.
- Travelers should be aware that WhistleOut assumes you are looking for service within the US. For people spending a lot of time abroad, Google Fi is worth considering. It’s a low-cost way to get one plan that works in multiple countries without having to constantly change SIM cards.
In Travis’s case, the first non-ad result, Mint Mobile, is a good result. It’s actually the provider that I use myself, and they use the T-Mobile network so his coverage won’t change at all. The same $15/month promo rate that’s shown in the results above is also available if you sign up for 12 months:
Just looking at mobile phone service, we’ve helped Travis go from paying $101.25/month to $21.42/month ($15/month for service + $154 ÷ 24 months as an allocation of the phone cost), and that with the pessimistic assumption that his phone only lasts 2 years. That’s a savings of $79.83/month or $958/year. With this small change, Travis’s FI target can come down from $1,500,000 to $1,476,050. That cuts 3 years off of his path to FI. Is it worth 3 years to change phones and providers in this case? I’d say so! He’s still meeting his needs while significantly impacting his progress toward his financial freedom goal.
Clearly, the savings don’t have to stop there. That was just one example. With zero based buying, you have a formula for reducing spending without denying yourself what you need:
- Establish Needs: Ask yourself, “What do I need?” in a ____. Write your needs down so you don’t add a ton to the list as you’re shopping around.
- Search Based On Those Needs: Open your mind to all of the ways to meet those needs. For example, Travis needed a phone, not necessarily an iPhone, and he needed to consider service providers beyond the major carriers.
- Decide Based On The Time You Get Back: Look at the savings in terms of the time it gives you back, and decide if the change is worthwhile.
Example 2 (Going Big): Cutting Car Costs
Now, let’s look at something that can make a much bigger dent in Travis’s path to financial independence: his car. He was leasing his car, and that lease is about to expire. One thing he was considering was upgrading to a nicer car like a BMW 320i. All of his friends are starting to drive nicer cars than they did in their 20s, and he can “afford” it.
The thing about luxury items like high-end cars is that people often forget about all of the baggage that comes with owning them. Not only do you become that guy who parks in the corner of the parking lot to avoid scratches, it hits your wallet, too. In addition to the obviously higher direct cost of ownership, luxury cars come with:
- Higher fuel costs – it will need premium gas, not that cheap regular
- Higher insurance costs – it’ll cost your insurance company more money to fix or replace a high-end car if there’s an accident, and they’re charge you for that.
- Expensive maintenance and repairs – uncommon vehicles often require uncommon parts or can only be serviced by certain shops, who guess based on your car that you can pay more than the average person for service. Plus there are the vanity costs of constantly feeling you have to wash luxury cars to keep up appearances.
- More depreciation – all cars lose a disproportionately large amount of their value early on. Below is an example of what depreciation could look like on a BMW 320i.
Looking at Travis’s thinking so far, I hope you’re as concerned as I am! Let’s start with his “I can afford it” mentality. Sure, he won’t go broke buying a new BMW, but he said he wants to become financially independent as quickly as possible. He should be using the zero based buying approach, and that starts with listing out what he needs in a car. I asked Travis, and he told me:
- Gets him from his home to work every day
- Is comfortable to ride in
- Gets good gas mileage
One thing he clearly didn’t put on the list was “impresses my friends”. It was in the back of his mind when he was thinking about buying a car, but when he had to put pen to paper and write out his needs, he realized it wasn’t a real need.
The next step is for Travis to consider his options. Listing out his needs made Travis really think about how much of the car buying process has to do with prestige and showing off. What he wants is freedom over his time, not being able to impress people with his car. He also realized that’s the main reason cars lose so much value in their first few years. As status symbols, they lose their luster quickly, but if he’s not buying for status, he can buy a used car and get plenty of good driving at a much lower price. He’s willing to consider a reliable used car like a 5-year-old Toyota Camry L.
Now, let’s see what each of these cars would cost. This isn’t easy, but you get the benefit of the work that Travis and me already did:
If you want to learn more about where these numbers came from, you can check out my Google Spreadsheet with the calculations and notes on the data sources. The real question is what this means for Travis’s path to financial independence. Would making this switch impact his FI timeline?
Yes, it clearly does make a difference. It makes a BIG difference! Even before there was any discussion around new cars, Travis’s existing expenses and savings meant he’d reach financial independence at age 79 (approximately when he’s expected to die). If he buys a new BMW and continues to buy this standard of car every 5 years for the rest of his life, he stands absolutely no chance of reaching FI before his life expectancy (79 for US men). Meanwhile, if he buys the used Toyota and continues to buy this standard of car every 5 years for the rest of his life, he could shave 12 years off his FI journey. That’s a big difference! And we won’t even get into the fact that he could do even better extending his ownership horizon beyond 5 years.
Yes, all expenses can be reduced
Right about now, some people will say, “That’s all well and good for mobile phones and cars, but it wouldn’t work most other costs.” To that, I say, “Why not?”
Most people’s biggest cost is housing, but they rarely use the zero based buying approach (when buying or when deciding if they should stay in their home). People don’t ask themselves if their home is meeting their needs. How many people do you know with a “spare room” they use for storing stuff they don’t use or need? That room is part of their mortgage payment, taxes, homeowner’s insurance, etc. How many people do you know with a guest room or two that they use maybe once or twice a year? Again, that comes with the same costs plus the cost of furnishing those relatively unused rooms. Would it make sense to have a smaller home and just pay for a hotel when that rare guest comes by? Probably. Again, if freedom over your time is really the goal, these are things to consider.
Even if you already own your home, run the numbers. It may be worth selling and moving. Maybe it’s not tomorrow or even in the next 5 years, but most people have a lot of waste in their lives that they haven’t even paid attention to. Recognizing that waste can accelerate your path to financial freedom.
Reverse lifestyle inflation to accelerate your progress
Have you heard of lifestyle inflation or hedonic adaptation? Even if you haven’t you may be able to guess what it’s referring to. It’s the phenomenon where we introduce more and more luxuries to our lives over time, and it becomes “normal” for us to expect those luxuries. Don’t let that happen!
Too many people order takeout food because they’re “too busy” to cook for themselves. They get used to having tasty meals that they don’t have to prepare or cleaning up after. Then, when it comes to evaluating their finances, they say that they “can’t” cut down on ordering food. The difference between someone ordering takeout lunch and dinner every work day (assume $25/weekday), and someone who only orders twice a week while cooking and storing meals the rest of the time (assume $4/day) is $3,276 per year. There could be a difference of 10 years in FI dates between the person who constantly orders out, and the person who cooks more than they order (and this doesn’t even factor in weekend restaurant meals where people can go crazy on spending).
If you feel deprived, you’re doing this wrong
Some people will say, “Who is this guy? Yeah, I can retire early if sacrifice all of my happiness now but who wants to live like that? You only live once.” I call B.S.! This reaction misses the point. In all cases, I’m suggesting that you list your needs before making a purchase so you can make sure you spend money on what you need, not what someone else wants to sell you. If you spend your money in a way that meets your needs while allowing you to save money, that’s a great thing.
Consider the reduced stress as well. At a 6% savings rate, Travis was financially insecure, and probably never would have retired. If we combine the two changes we looked at above (mobile phone and car savings), he’s now at a 14% savings rate. He’s going to be more financially secure, and has a path to reaching financial independence 13 years earlier.
This illusion of deprivation is what prevented me from pursuing FI earlier. It’s something I never should have feared. Living frugally is liberation, not deprivation. I know that my life is focused on what makes me happy; not things; not status. The savings bought me control over my time.
Now that I cook most of my own meals, I’m not yearning for more takeout. I like knowing what I’m putting into my body. Now that I don’t have a premium cable package, I’m not thinking about all of the shows I’m missing. I can get just as much entertainment out of Netflix at a lower cost. Now that I don’t own a car, I don’t worry about all of the places I can’t go. I love the exercise of walking around my neighborhood and not having to worry about finding parking, maintaining the car and all of the other headaches of car ownership.
Yes, it is possible to go too far in cutting costs, but too many people in this country have the opposite problem. To anyone spending frivolously and saying, “You only live once”, I say, “Then why are you wasting your life working in a job you don’t want to pay for things you don’t need.” Spending responsibly and prioritizing your own happiness don’t have to be diametrically opposed.
The Living Freely Series Table of Contents
Step 3, Part 1: Cutting Expenses
Step 3, Part 2: Increasing Income
Step 3, Part 3: (Legally) Avoiding Taxes - Part 1
Step 3, Part 4: (Legally) Avoiding Taxes - Part 2
Step 4: How To Invest Your Savings
Step 5: Achieving Financial Independence