In the personal finance community, we know that there are 2 ways to increase the amount we can save each month, and that’s by:
- Making more money and increasing our income by getting a promotion or by changing jobs.
- Reduce our monthly expenses by cutting costs, cutting out unnecessary spending, or finding cheaper alternatives for things we buy.
However, which is more effective at actually increasing our savings and actually play a bigger role in getting us to Financial Independence (FI)?
Well let’s find out.
Take 2 scenarios: Bill Budgeter and Eric Earner
Bill Budgeter and Eric Earner are both currently earning S$3,000 per month in gross income and are both spending S$2,000 per month. As part of this example, we will assume that they both receive no bonus at the end of the year. Since they must both put 20% (S$600) of their salary into their CPF, they are only able to save and invest the remaining S$400.
Here’s the breakdown of both men’s monthly finances:
|Gross Monthly Income||S$3,000|
|Income Tax (Divided by 12 months)||S$15|
|Other Monthly Expenses||S$1,985|
Now let’s figure out their savings rate (SR) as well as their FIRE number:
Savings Rate = S$400 / S$2,400 = 16.67%
FIRE Number = (S$1,985 * 12 months) / 4% Withdrawal Rate = S$595,500
At this point, if we assume that they both invest their savings at a rate of 5% p.a., both will reach their FIRE Number and become financially independent in 475 months or almost 40 years.
Now let’s change their finances just a little
Eric Earner was a great performer at his job and his boss just announced that he would be receiving a S$500 raise! That’s a really nice 16.7% increase.
As for Bill Budgeter, his company wasn’t doing so well and he was told that he will not be receiving any increments this year, in fact nobody in the company would be receiving one. However, since Bill Budgeter was a FIRE enthusiast, he was determined to increase his savings rate and looked for ways he could reduce his expenses wherever he could. In the end, he was able to comfortably reduce his monthly expenses by S$500.
Both men knew the importance of saving and investing and so made sure to put all of the extra funds into their investments.
This is what their finances look like now:
|Description||Bill Budgeter||Eric Earner|
|Gross Monthly Income||S$3,000||S$3,500|
|Income Tax (Divided by 12)||S$15||S$27|
|Other Monthly Expenses||S$1,485||S$1,985|
As you can see, Eric Earner’s CPF contribution increased with his income as well as his income tax. Even though he received a S$500 increase in income, his savings only increased by S$388 while Bill Budgeter was able to increase his savings by exactly S$500.
The difference is even more pronounced when we take a look at their Savings Rate and FIRE Number:
|Description||Bill Budgeter||Eric Earner|
Based on this, we can calculate how long each will take to retire again – with 5% p.a. Returns:
|Description||Bill Budgeter||Eric Earner|
|Months to FIRE||269 months||343 months|
|Years to FIRE||23 years||29 years|
Both men reduced the length in which they need to work before becoming financially independent by more than 10 years! However, you will notice that Bill will be able to retire 6 years sooner than Eric!
This is because of a few things:
- Increasing income increases payable CPF as well as payable income tax where reducing expenses does not.
- Reducing monthly expenses reduces the amount needed to FIRE while increasing income does not.
- Also once you’ve found out how much you need to spend each month to be happy, any increase in income after that goes straight to savings since you know you don’t need to spend more to be happy – this allows you to accelerate your savings even more.
This shows that if you wanted to accelerate your journey to FIRE, you will be more effective by focusing first on cutting your expenses and thus increasing your Savings Rate.
Relationship between Savings Rate (SR) and how long you need to work
It might be clear by now, after the above demonstration, that what plays a critical role in how soon we can retire is not really our income, but our SR.
Sure making more money is great, it’s encouraged that you try to increase you pay, but if you make S$500 more per month but also increase your expenses by S$500, you’re actually falling behind, not pull ahead!
If you are able to increase your savings as a percentage of your income, you are essentially contributing more percentage of your income towards saving for retirement. Plus, you can do this without having to wait for your boss to give you a raise!
Let’s take a look at how different SR percent affects the length of time you will need to work in order to become Financially Independent (FI). For this calculation table, we will assume a similarly modest 5% rate of return:
|Savings Rate (%)||Time to FIRE (Months)||Time to FIRE (Years)|
Let’s see what that looks like in a chart:
As you can see, if you’re saving just 10% of your take-home pay (ignoring CPF) you’re on track to retire in 51 years! (Basically never.)
However, if you are diligent with your expenses or managed to push up your income without increasing expenses and increase your SR to 40%, you’ve just shaved 29 years off your working years! You’ll retire in just 22 years.
For those in this FIRE community, that may still be too long, graduating at in our 20s, if we want to retire by 35, we’d need a savings rate around 60% – 70% to really be done working within 9 to 13 years.
This chart really helps you visualise the tradeoff for large spendings, especially spendings that will be recurring over many years like expensive yearly vacation or buying a car – be aware of how it will affect your savings rate and your FIRE timeline.
However, this does not mean you must deprive yourself and live in abject poverty in order to become FIRE. That is not sustainable and is not the point.
This does not mean depravity
Many people when hearing the words “cut your expenses” they immediately think of eating rice and beans, having no social life, clipping coupons and living in poverty.
“Nobody wants to live like that!” you say, “Only the hardcore weirdos put up with that in order to retire early into a life of misery!”
That’s not at all what I or the FIRE community advocate.
Frugality does not mean depravity. We are advocating being very intentional with your life and choosing exactly what really brings you happiness. Today, with the amount of advertising and marketing that everybody is exposed to, it’s hard not to feel inadequate as you are constantly being told to compare your life to others.
Determine what makes you happy. Is it more stuff?
We are made to believe that we need that new car, we need the new clothes, we need the new TV or new gadgets each year. Especially when you see your friends and colleagues driving around in new cars and living in a newly renovated house filled with expensive designer furniture. We mistaken that as the way to go when in fact, all this stuff doesn’t necessarily make us happy.
By living in Singapore, we are already lucky to be living in a country filled with conveniences and luxury that other parts of the world do not have. We have:
- Great, affordable food with wonderful variety from around the region.
- Great, cheap public transportation.
- Great, cheap public schools.
- Great public spaces, parks, natural reserve, and city planning.
- Great public safety.
- Great internet & telecommunications infrastructure.
- Great healthcare (though this can be a bit expensive without insurance.)
All of the basic needs for a wonderful life has been catered for in Singapore. It’s important to know whether the “other stuff” are really necessary to make you happy?
- Is a BMW important for happiness?
- Is a brand new phone every 2 years going to do it?
- Do you need to live in a private condo?
- Do you need a 65-inch TV to be happy?
- Is a lavish vacation each year necessary? Is it worth working an extra 10 years for?
What the FIRE community advocate is to really examine your personal values and find what really makes you happy and optimise your life around it. Don’t let others tell you what is required for you to be happy, especially not faceless corporations who just wants you to buy their “next big thing” or “this season’s trendy clothes.”
To help me make this point, I highly recommend this talk by Mr. Money Mustache on “How to be Rich, Happy … and Save the World!”
It’s highly entertaining and really highlight the idea that having more stuff isn’t always what makes us happy, and it’s extremely important for your FIRE plans to figure out what does and build your life around that.
So there you have it, why cutting costs is more effective for boosting your FIRE plans than making more money. Take the time to look at your finances to see if there are things you can cut out as a first step.
In my case, I am aiming to save around 70% of my monthly expenses and only spend 30% of it so that I can achieve FIRE within 9 years.
I’m not sure I can achieve that all the time, as I also indulge in expensive dinners every now and then and also spend some money traveling, however I am currently sitting at around 60%-65% and am still looking for ways to get that extra 5%.
However, if I am not able to find anything else to cut, increasing my income is also not going to hurt, and I’m not going to stress about the extra 1-2 years. In the end, there has to be a balance and some vigilance on my lifestyle so I don’t let major lifestyle inflation take over when I do earn more.
How about you? What savings rate are you targeting and at what age are you planning to FIRE? Let me know in the comments below or tweet me at @firepathlion. I’d love to know what you think!
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Until next time!