Remember Why You Started - Retiring Early
Recently caught up with a friend who has been in banking since UG. For context, this friend has out earned me every single year since college, and rightly so. He has worked crazy hours in banking and never left. While I have had a fairly lucrative career path, I have been in a different tax bracket from him for a few years now.
As we caught up, I mentioned that my SO and I were looking to buy a home in the next few years, and I broke down the math on what we would need to put down and how close we were to hitting that goal. My friend seemed very surprised and it became very clear to me that he was not positioned to do the same, despite making materially more than me for years on end. It made me realize that despite earning so much more, his savings accounted for a much smaller % of his capital allocations.
This post will not resonate with everyone, but for those of you who are sacrificing now in hopes of retiring early, I would encourage you to keep making sacrifices and know that every dollar saved and invested will get you closer to your goal. There is nothing original about this post, but if your goal is to retire at 50 with a family, don't let anyone tell you it cant be done. My folks have many friends whose parents were both retired by 40 - 50, and they did it without ever being the CEO of a large corporation or being partner at a top PE fund. Most of them took a major risk early in their career and became an equity partner in a small venture or climbed the corporate ladder while saving as much as they could.
If you are one of those folks with your sights set on early retirement, the grind needs to start in your 20s so you can maximize the value of your savings compounding (again I know everyone is familiar with this). Yes it is important to budget for fun trips and things that matter to you, but if you aren't careful lifestyle creep will happen and you'll find yourself like my banker friend, having spent nearly a decade in the field without meaningful savings.
The other important consideration is your significant other. They don't need to be a rainmaker, but they need to at least be a net neutral. I have other friends with SOs who are buried in credit card debt and despite making 6 figures for a long time, have hardly anything saved. If your goal is to retire early, you need to ensure your SO shares those values and will help you get there.
Again, none of this is likely new information. But hopefully it does serve as a reminder to stay focused on hitting your personal goals from a savings perspective. To those of you who have no desire to save and want to live comfortably, there is absolutely nothing wrong with that and I am not trying to influence how you ought to live. But for those of us who want nothing more than complete financial freedom, as early as possible, continue to reassess if you are hitting your short-term goals to get you there.
Can you give some color on examples of short-term goals? Maybe a ladder of milestones by certain ages?
Ex.) 1mm liquid by 30?
How I really think about saving (Granular)
I come up with investing and saving goals based on a % of my net income because it is easier to control. That way, I am less reliant on a bonus or material increase in salary to achieve my goals. This is why I say a 1M net worth by 30 is not the right way to think about it. I like to think about total capital invested in the market and create my goals at the beginning of the year. I also like to have different objectives based on how bonuses may play out. For example, I often only invest ~10-15% of my post-tax earnings into a personal investment account (not incl. 401k / Roth). However, I intend on saving 80-90% of my bonus. So I do the math on what the best and worst case outcome could be, and have a range of capital I hope to have invested by year end. Let me provide another simple example to illustrate:
Realistic Example: I have a base of 100k, and am told my bonus will be in between 5-40%, depending on a myriad of factors. So, here is how I calculate the lower and upper bounds of that range.
1. Start by figuring out the range in which you can afford to save. I mentioned 10-20%, depending on COL or supporting other family members, this % may not be feasible for you.
Base - mandatory COL expenses = POSSIBLE amount you could save per year
Assume after rent, food, health insurance, car insurance, etc. I have 40k in pre-tax earnings I can hope to save from just my base. 40k * 70% (assume 30% tax rate) = 28k, divided by 12 months = $2,333.33 per month. So of the 70k in post-tax earnings, I approximate I can save a maximum of 40% of my post-tax income (or 28% of my pre-tax).
2. Adjust for Non-Essential But Important Expenses
However, this is before birthday parties, weddings, gifts, trips, etc., so I don't use that 28% as my upper bound. Say I decide I have a lot of major annual expenses, and that I can really only afford to save somewhere within the previously mentioned range of 10-20%, so I will opt to invest between $7k and $14k off my base over the course of 12 months.
3. Calculate Your Lower and Upper Bounds for Regular Paycheck Contribution Amounts
So for the base, my lower bound would be 10% of post-tax income (which if you remember is $70k), or $7k saved. My upper bound would be 20%, or $14k saved. I usually start the year off conservatively to leave a little extra cash on hand (saving closer to 10% per month as opposed to immediately shooting for that 20%) and gradually up the monthly % invested as I accumulate more cash on hand. But the minimum, unless I lose my job or hit financial distress, is $7000/12, or $583 per month that I invest. The maximum is 20%, so double that, at $1,167 per month.
Using this method allows me to feel good about my savings goals without having to worry about the impact of bonus. I also take the same approach for my bonus:
4. Calculate Your Lower and Upper Bounds for Bonuses
So say I want to save between 60 - 80% of my bonus:
Bonus lower bound: 5% of pre-tax income = 5k * 60% = $3,000 saved from bonus
Bonus upper bound: 40% of pre-tax income = 40k * 80% = $32,000 saved from bonus
This way, I am not dependent on my bonus to achieve my financial goals. Yes the amount saved can vary a lot in this scenario, as the aggregate lower and upper bounds are $10,000 vs. $46,000, but in finance, bonuses vary greatly on factors beyond your control, so I focus on what I can control, which is the percentage of each paycheck and bonus allocated toward investing.
Key takeaways
There is nothing wrong with a goal of $1M net worth by Y30, but you need to think critically about what you can control. Two lessons I've learned the hard way:
1. Bonuses rarely live up to expectations, unless you perform really well AND the company performs really well. Even then, it is not improbable to be let down
2. You will have a tough time predicting your income 2-5 years down the road. Unless you take a very traditional path, income levels will fluctuate in surprising fashions. For example, I took a pay cut one year, and wouldn't have modeled that in when I was 22 years old. Surely your salary only moves in one direction, I always thought.
3. Factoring in your IRR on your equity or otherwise investments is tough, and you cant count on shit. Say you have 200k invested when you turn 26. You could see a 2-4 year bull run that yields you a 20% IRR on that 200k (plus all the additional capital you invest over the upcoming 2-4 years) and see that you're at nearly 500k 4 years later. Or you might hit a recession and realize your 200k + continued investments is now at $235k. It happens. This is why it is so hard to be 22 years old and create a realistic path toward a $1M net worth by 30, although plenty of people model out very conservative cases (save ~50% of each paycheck, 90+% of each bonus, 4% IRR on all market investments), and position themselves so well that their downside case is $1M net worth at 30 and upside is say $5M NW by 30, and fall somewhere in the middle.
4. Having friends is way more expensive than you might think. The amount I spend on dinners, drinks, trips, weddings, all to maintain my friendships is way WAY more than 22 year old me couldve ever guessed. Yes, these are expenses by choice, and many of them are far from frugal, but they are the source of much of my happiness. I certainly nevered budgeted for a $4K trip to Hawaii one year with all my friends or the number of destination weddings in foreign countries, but these experiences are important to me so these are things that negatively impacted my savings goals. I never considered the impact they might have had at 22.
For anyone curious, I did the math and INCLUDING Roth IRA payments, I am saving 26% of my post-tax salary in FY24. This will also be one of the most costly years of my life.
Love this post. Bravo.
One thing I'd recommend to people is remove the word "afford" from your vocabulary because your decisions should never be about what you can "afford", at least in the sense that word is traditionally used: we usually say we can afford something if other people at our income level tend to buy it.
This is a recipe for mediocrity, because no matter your income level I can guarantee it's not your personal goal to end up in the financial situation of the average person at your income level. Vast majority of people find a way to screw it up. Goal is to be different and better.
Make every financial decision about incremental gain & loss. Common example: do you pay up for that $3000 apartment or do you make it work in the $2500 place that isn't the perfect neighborhood or isn't the most convenient. Most people I know face this kind of choice, and ultimately decide they can "afford" the nicer place. The question of course, is whether the added convenience/location is really worth an additional $500 every single month . . are you really going to enjoy that situation so much more over the next year that you'd pass on $6k cash in your pocket right now to live in the lesser place.
Maybe you will. Maybe it's worth it. But if you think about it that way, instead of "what can I afford" you'll make the right decision. Most other people will think about it the wrong way, and end up like many of my friends: 35 years old, disappointing level of savings, and full of weak excuses about how their high income isn't truly high because their city is so expensive.
Thank you, I've read a lot of your posts and find they are full of great insights.
I couldnt agree more on removing "afford" from your vocabulary. I structure the majority of the decisions I make by thinking "what is the value play here". I cook 3 out of the 4 meals I make each day. For the one meal I eat out, I opt for the consistent $11 option over the standard $15-20 options, because I know when you eat out one meal a day 365 days a year, you can save >$1,000. I dont feel that the alternative lunch options would be worth the premium, so I opt not to pay it. Similar to the rent option, you need to critically think about which premiums are worthwhile, and worth the alternative cash in hand equivalent to what you're giving up.
It feels meaningless at a few dollars a day, but people would put up with a lot of inconvenience for a year if they were paid a few grand lump sum.
Research LeanFIRE, it has good tips.
Great post. Lifestyle creep keeps everyone in the rat race and can really reduce future optionality to quit, change jobs, move cities, etc. Although saving as an analyst seems pointless with your forecasted pay increases, at least starting the habit with a small percentage can make a big difference.
To add to this, most folks start in banking with the notion that they will be able to stick it out. The reality is that 50+% dont make it past the two year mark and are pivoting to other industries. So if you come out of the 2 Analyst years stronger than ever and dive into PE, well done and I applaud you, and you are likely on the right path for financial freedom if that is your goal. However, if you burn out with limited / no savings and have to leave for something "less lucrative", well then suddenly you will wish you did things a little differently.
Repellat eaque doloremque sed culpa. Ex velit doloremque praesentium ut.
Doloremque nisi sit voluptatem aliquid deleniti nesciunt. Est beatae itaque ad rerum eum enim quis et.
Et in delectus vel harum blanditiis sunt. Et consequatur ea id. Ut qui id est excepturi adipisci et. Quibusdam impedit ut aut sed ab. Qui quasi nesciunt tenetur distinctio recusandae voluptatem enim.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...