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I frequent several financial independence forums, and it’s always exciting to hear people report in on achieving a major milestone. There is occasionally talk about what, if anything, will change now that they’ve hit X milestone, and the answer is usually just a plan to stay the course.
One of the most exciting things about achieving FIRE is how there are distinctly different phases in the journey, and in these different phases there will be different skills which accelerate your journey the most. Most people see their first major successes by flexing their spending and budgeting muscles. They could certainly get very far without changing a thing, but isn’t it worth noticing when new doors have been opened to us and layer on new skills that take advantage of those new opportunities? We don’t spend nearly enough time talking about that when it happens. So let’s talk about it now.
Why Investment Eventually Trumps Savings
At some point, managing your money more efficiently will exceed the returns you get from spending more efficiently.
Say you make $80k a year, and you have a stash of $160k. You save – if you are a fairly hard core dude – $30k a year in your retirement and savings accounts.
Meanwhile, that $160k stash is passively doing work for you. If you were able to get 10% returns out of it each year, you’d generate $16k a year. That’s half the amount all that scrimping and budgeting has generated for you each year!
And if you can figure out how to improve your returns by a few percentage points, or pay less taxes on your gains, plus a host of other money management techniques, you could possibly add $10k+ more to your nest nest egg each year, which is much easier to do than paring down your already fairly efficient budget by that amount.
So when should you switch your attention over to the investment portion of money management?
The 2x Income Rule
2x income in savings is when you’ll want to pause from building systems to save money and spend more time building systems to manage your money more efficiently.
Since the world doesn’t send you an announcement, a lot of folks end up ignoring this completely. This is how you find a couple in their 50’s clipping coupons religiously but never talking about tax planning strategies. It’s why my aunt is still focused on getting $3 ziploc bags vs $2.50 generics but hadn’t considered how many thousands of dollars she’d earn by taking a mortgage out on her new house at historically low interest rates and deploying that money in municipal bonds, which could fund her ziploc purchases for her entire lifetime.
If you’re going to get good at these strategies, you’ll have to take time to learn them, and it won’t happen overnight.
That’s why you should start at 2x income in savings. Investing takes years to learn. You need time to observe the results of what you do, and those results are measured in years. There’s no way to rush it.
By the time you are 6x or 7x your income in savings, it is entirely feasible that managing your money optimally (say, 10% net effective returns) will throw off enough to pay all your annual expenses. There will be a point when managing your nest egg will throw off more money than your entire full-time job and thus deserve your attention more than your 40-hour-a-week job. When that happens, you’ll want to be prepared and knowledgeable enough to take on that new role.
For more about the distinctly different phases to achieving retirement, check out The Four-Step Blueprint to Retirement. Folks, any stories of where you are in your own journey to learn more about investing? All stages welcome: the good, the bad, and the absolutely terrified.