We live in very different times than our parents. The economy is so interconnected and technology provides the opportunity for us to work when we want, where we want and how we want – as long as we have enough money to support our living expenses. While we should respect the journey our parents went on, we shouldn’t necessarily follow the same one. I’m talking about how much we work and “retirement”.
The traditional journey was to work at one (maybe two employers) until we are 65, collect your pension, receive social security and then enjoy the freedom you always dreamed of at retirement. What’s the problem with this now? Pensions barely exist, social security is massively underfunded, and it is unlikely that those guaranteed sources of income will be there in our mid-60s.
If we remove the idea of “retirement” and replace it with financial freedom, it drastically changes the money and career decisions we make early on in life.
Our definition of financial freedom is the ability to combine working a passion-aligned job when you want, where you want and how you want, with income from an investment portfolio, to financially support a lifestyle that reflects your core values. Sounds pretty nice, right? Yeah – let’s try to make that happen before you’re 65. Here are some ways how.
Change how you save your money
For simplicity sake, I’ll outline the 3 primary ways you can save your money.
- Taxable accounts (Most flexible, least tax-efficient) – Money you put in is after-tax, earnings are taxed when realized, but you can take money out at any time – no strings attached.
- Roth accounts (Still flexible, more tax-efficient) – Money you put in is after-tax, earnings grow tax-free, but there are rules around when you can take out earnings (often penalties on the earnings before age 59.5). However, your contributions can come out at any time – no strings attached.
- Pre-tax accounts (Least flexible, more tax-efficient) – Money you put in is pre-tax, earnings grow pre-tax, but contain the strictest rules around when you can take money out. Your contributions and earnings are subject to income tax and likely a 10% penalty if you take it out before age 59.5
Wouldn’t it be great to achieve financial freedom before the age of 59.5? If you are thinking yes, you probably don’t want to put all of your money into a pre-tax account that comes with income tax and a potential 10% penalty. That’s why we like the pyramid approach where you match the taxable, Roth and pre-tax accounts to specific time frames. Our general guideline is:
- 0 – 5 years = Use taxable account
- 5 – 15 years = Use taxable account and Roth IRAs
- 15 years+ = Use Roth IRAs and pre-tax accounts
Change how you invest your money
There is an overarching theme that is important to note. This approach assumes you value flexibility over tax-efficiency. In other words, your goal is to achieve financial freedom where you can utilize funds at any age, rather than trying to pay the absolute lowest amount of taxes. The IRS makes account rules which prohibit you from using funds before certain ages without tax and penalty. This is our way of working around those rules.
This results in a bucketed investment approach – you have one investment strategy for your 0-5 year funds, one investment strategy for your 5-15 year funds and one investment strategy for your 15+ year funds. Traditional portfolio management calls this inefficient. We call it strategic and goals based.
It’s also easier to understand and stick with. When the market crashes, you sleep better at night knowing that your 0-5 year money is holding ground and it is your 5+ year money that is likely falling with the market. This is especially important since market downturns tend to be fast and severe. According to JP Morgan’s Guide to the Markets, the average bear market since 1929 has decreased 42% and lasted 22 months. In contrast, the average bull market since 1929 has increased 161% and lasted 53 months. This approach can help you stay invested when it is most difficult to do so.
Change how much money you need
This is the million dollar question – how much money do I need to have saved up to accomplish financial freedom? We’ve run hundreds of long-term projections and it often boils down to a few key factors:
- Your ideal spending amount
- Any additional earned income
- Investment returns and inflation – neither of which you can control, so we will ignore this
We know everyone hates math, so let’s show two examples to illustrate the factors. We assume 3.5% to be a sustainable spend rate from your investment accounts.
- Ideal spending amount = $100,000/year
- No additional earned income
- Target investment accounts amount = $100,000 annual spending needed/ 3.5% = $2,857,143. Oh crap that’s a lot…
But realistically, are you really never going to earn income again? The more common situation is that you earn income, but possibly at a reduced amount that fits into your ideal lifestyle.
- Ideal spending amount = $100,000/year
- Additional earned income = $50,000/year
- Target investment accounts amount =$50,000 annual spending needed/ 3.5% = $1,428,571. Well, that’s more reasonable!
The key point here is that generating income matters. The likelihood of you declaring financial freedom at age 40 and then never earning income ever again is really low – what would you do with your time for the next 50 years?
Instead, it is more likely to for you to generate income, but in a manner that fits your ideal lifestyle. In other words, you work when you want, where you want and how you want! As you can see in the two examples, this dramatically changes the amount of money you need to make this possible.
This all sounds good, so what are my actionable takeaways?
- Think about what level of income you could earn if you worked when you want, where you want and how you want.
- Be strategic for how you save your money. Build flexibility into your financial plan to allow you to take money out before 59.5 to fill any gap.
- Spending is the #1 driver of financial planning. Start getting your arms around what you are spending now, but more importantly, guessing what you would need to spend to live your ideal life. The less money you spend, the less money you need saved up.
- Think about your investment accounts in buckets and match the appropriate accounts and investment strategy to each bucket
None of the information provided is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. The content is provided ‘as is’ and without warranties, either expressed or implied. Experience Your Wealth, LLC does not promise or guarantee any income or particular result from your use of the information contained herein.