The Path to Fuck You Money
Opulent decadence is a very old mistress to man.
What's money to you? To me money is what translates work into consumption. So if I have enough money saved up, I can eventually choose not to work at all – or just work on what I want. That’s financial independence, but before you reach that, you can get to "Fuck You Money". It doesn't mean that you never have to work again, but it means that you've got your consumption covered for so long that you can afford to quit your job, say no, look for a job that pays less if it’s more fulfilling.
So on the slider we start "broke and indebted" move on to "fuck you money" and end up at “financial independence”.
How can we move along that slider from left to right? Let’s investigate that. We need to pay off any debt that we have and start saving money. Depending on our annual income and expenses we'll get a "savings rate" – the percentage of our salary that we save each month. The more we save the faster we move to the right on the slider.
Can we have our savings work for us - so that we don't have to?
Albert Einstein can answer that for us:
Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it
So what's compound interest? That's like a snowball rolling down a hill picking up snow. You have 100 dollars earning 6 percent and after a year you have 106 dollars earning 6 percent and so on. It grows and grows until it runs you over. But the more you add to it in the beginning the faster all of this will happen.
But I could lose my money in investments - I might as well spend it all now on shiny things and women at least I'll have fun? Today you don't have to know anything about stock investing, real estate investing, starting companies or shorting oil in Timbuktu. You can put your money in an index fund like Vanguard that pays quarterly dividends. The stock market has historically returned 6-7 percent a year (deduct inflation and trading costs). With an Index Fund you own a fraction of just about all of the publicly listed companies that are worth owning – hence you get the average market return.
Why shouldn't I select stocks myself? Because your odds of beating the market are slim and you run the risk of underperforming the market. The factor between Warren Buffett (best investor in the world) and your Index Fund gains are likely to be a 4 to 1 ratio (he'll make an average of 20 percent and you'll make 6-7 percent annually). So it’s not a bad deal since you don’t run the risk of underperforming or have to do any research or work associated with picking stocks.
The dividends and capital gains add to your snowball. You can take out part of those gains to live on. If 4 percent of your fortune is enough to cover your expenses you’re set for life as you’ll maintain your fortune against inflation with what’s left. MrMoneymustache does a great job of recommending taking out 4 % if you depend on the money to live.
When saving and investing is the rational thing to do – why is it so hard then?
Because your desire to spend money on status symbols, convenience and shiny new toys is boundless. So you have to cultivate your mindset or the money you make will never translate into significant savings regardless of how high your income.
So the real progression towards economic independence look more like this:
- Use rational mind to wrangle with desire (this is by far the hardest step and you will be likely to fail like almost everyone else). This is the step you use to get rid of all spending that you don't need and refrain from buying the latest shiny thing that pops into your mind, and it certainly will pop in there and keep popping.
- Get rid of all debt (High interest loans first and then eventually your mortgage) to arrive at low expenses
- Save money like your life depended on it and stick it into an indexfund so that your money can work for you day and night.
When you have debt you go to bed and wake up poorer in the morning
But hey! That's not you anymore, now you wake up richer every morning because your money is working for you - not against you.
That sounds great but I make too little for this to happen? Don't make up excuses, if you want to have financial independence you save now to spend more in the future, that's the nature of investing and the power of compound interest will make even your currently tiny snowball become an avalanche of cash given enough time. Besides, if you're broke and in debt now, your bar is set so low that you'll feel rich soon - that's the power of perception and mental anchoring.