On getting to financial freedom faster.
I’m not into unnecessary suffering or struggle and I’m all about maximizing life for the greatest enjoyment, freedom and happiness so it bothers me to see so many of the FIRE bloggers cutting expenses to the bone, not going out and enjoying life and putting all their focus on the day they reach financial freedom and can quit their jobs and finally enjoy life.
This all seems a bit of a hard slog as they say in England–unnecessary struggle.
Financial freedom doesn’t have to be so difficult.
In fact, by focusing on the big-ticket items, one can save a bundle without any sacrifice to overall happiness or freedom along the way. After all, why trade a lack of freedom now for financial freedom later when you could feel free and be happy throughout your entire life?
The good news is that the research on happiness has shown that it isn’t cutting the little expenses that makes the biggest difference. It is cutting the big expenses—your car, your house and your investment fees that make the biggest difference in happiness. That’s because these are the biggest roadblocks to financial freedom.
Yes, that’s right, you’ll be happier in a smaller house and driving a less expensive car if that means you can then take a family holiday, fund your retirement and have a bit more cash on hand.
I’ve never owned a new car in my life simply because I couldn’t stomach losing a few thousand for the extremely short-lived pleasure of driving a new car off the lot. I’ve always bought good quality used cars for cash and then driven them for years. When I married, I quickly got my husband off his fancy leased car and into a nice used BMW station wagon as a more sensible family car.
He has converted to my thrifty ways now that he can afford a personal trainer at an expensive x-Fit gym and still save money. However, I seem to be the only one of my friends who thinks it an absurd waste of money to buy or finance a new car. So I am quite happy to read that I’m not the only fan of buying used or inexpensive car as a way to accelerate financial freedom.
I like Financial Samurai’s 1/10th Rule for Car Buying
You can buy a new car if it costs 1/10th of your income; if you earn $100,000 a year, your new car can cost a total of $10,000. This simple strategy means you’re much more likely to have enough cash flow to sock money into your financial freedom or retirement fund.
Our two cars, a cute Nissan Cube and a very sleek Honda Elysium, (neither of which are one bit “crappy” by the way) come in well under this rule, which leaves plenty of money on the table for funding retirement, weekly massages, personal trainers and house cleaners—all of which make me much happier and healthier than driving a new car.
True, it’s all about personal choice, but so few people seem to think that buying a quality used car is even a choice. Do we really think about all that we are giving up when we buy a new car?
Have you factored your overall life happiness into the equation?
I think most people don’t consider all their options. They need transportation and then rush to get a new car and finance it. What if you started thinking about your life happiness instead?
I told my husband when I married him that I’d rather have a cleaner to clean my house and live in a less-expensive house than live in a more expensive house I’d have to clean myself. Way too much work! And, I’d rather drive a used car as it gives me just as much freedom to go where I want to go as a new car, but then I also get the added freedom of having a nice retirement nest egg and the added pleasure of a weekly massage.
No sacrifice or suffering required, thank you!
The premium one has to pay for the pleasure of driving a new car just doesn’t compute on any level, neither for overall happiness nor certainly not for freedom or financial security. Your new car will soon get a little ding and then you’ll feel bad about it. If you scratch or ding a used car, you won’t feel so bad about it because it wasn’t new to begin with.
Now, if you are into the driving experience and want the pleasure and joy of driving a great car like a Maserati or a Ferrari, then you’ll be happier by joining a car club and using that car for a limited time — say, a year, according to the authors of Happy Money.
Why Your Financial Advisor’s “Reasonable” 2% Fee isn’t Reasonable and could be Blocking Your Path to Financial Freedom
While there might be some debate on the new versus used car on happiness levels, I’d wager no one would disagree that reducing investment fees would make you happier.
Intuitively, we tend to assume that you get what you pay for and assume that by paying more for investment management is going to give you the best and smartest fund managers, increasing your returns. Unfortunately, in investing, this rule of thumb doesn’t apply. In fact, it works in reverse; you get what you don’t pay for when it comes to investing!
There is no evidence that paying for managed funds will lead to greater financial returns and there is plenty of evidence that the less you pay for your funds, the more likely that you will have more money at the end of the day—a lot more money!
This is why there is a steady influx of money moving from expensive managed funds to low-cost indexed funds.
People are realizing that a seemingly insignificant 2% annual management fee is truly extortionary.
Would you give half of your hard-earned wealth to a financial advisor in compensation for his or her investing acumen? If you pay a 2% fee, you are doing just that. Small fees make a massive difference in your ultimate wealth. Funny thing though–people are more likely to go to a “free” financial advisor who charges an annual fee that they don’t see than they are to pay $2,000 for a fee-only advisor who charges by the hour or session. The latter is a bargain in comparison to giving up half one’s wealth.
Financial advisors are definitely good to have as they can help you with a financial plan, but there is no need to give them half your life savings in exchange for a few hours of their time.
Now you are probably thinking, how could these financial advisors possibly get away with charging that much?
No one would willingly agree to part with half of their portfolio.
Well, the financial advisors will say that their returns are much better than the market average so it is worth paying the fees. The problem is, there is no evidence that paying for managed funds is worth the fees over the long run. In fact, you might think you’ve spotted the next Warren Buffet only to find that they are doing dubious things to juice returns in the background, like using too much leverage or in the recent case in the UK, using illiquid investments.
The UK has just had a huge scandal with Neil Woodford, a superb investment manager who left to start his own investment funds on the back of a long and stellar track record. He certainly proved his investment skill and ability and was widely recognized as a super safe bet for investors. But after his recent spate of poor returns, investors started leaving in droves. Woodford had to freeze the assets in what was supposed to be a liquid fund. It turns out, his investments were not actually liquid and the public had been misled by one of the best in the business. Just when everyone thought they’d found a real winner; his reputation couldn’t have been better before this fiasco.
If you think this only happens abroad, you only need look at the USA’s, Long Term Capital Management fund run by real geniuses. LTCM not only went bust, taking with it numerous private investment portfolios, but also nearly bankrupted the entire financial industry.
Now, a few of you might be wondering how a mere 2% fee is taking half of your investment portfolio. Wouldn’t they need to charge a 50% fee?
To understand why this is, you have to have to understand the 4% Safe Withdrawal Rate. Once you retire, you can only safely withdraw 4% of your entire pot of money if you want to ensure you don’t run out of money over a 30-year time horizon. (This assumes you have a 50/50 stock/bond portfolio).
William Bergen was the first to come up with this withdrawal rate rule of thumb.
It was more recently re-calculated in The Trinity Study. This basically states that you’ll have a 95% chance of not running out of money over a 30 year period if you withdraw 4% a year and increase those withdrawals by the rate of inflation each year.
If you have an investment portfolio of $1,000,000 this means the first year you could withdraw $40,000 and then the second year you could withdraw $40,000 plus extra to keep pace with inflation. If you have a longer time horizon as an early retiree, you could withdraw a 3.5% inflation-adjusted rate annually for 50 years with a nearly 100% success rate. See Vanguard’s research on the current viability of the 4% Rule here.
Now, you can see why 2% fees are actually extortionary. If you can only take out 4% each year, and hand over 2% to your advisor for the privilege of meeting with you a few hours a year, then you are, in effect, giving half your retirement pot to your advisor.
Here is the simple math (don’t panic, we aren’t going to do anything more complicated than subtraction and simple division):
Let’s say you want an income of $25,000 a year in retirement to supplement your pensions and Social Security income.
Using the 4% rule for safe withdrawals…
$25,000 /4% = $625,000 needed invested in 50/50 stock/bond portfolio
Now, you’ll have to pay some fees because investment companies have to answer the phone and manage their website and send out statements as well as do the actual investing, so let’s compare the average indexed fund fee of .36% to the average managed fund fee of 2% and see how much money we’d need invested to get an annual income of $25,000.
- One example: $25,000/ (4% – 0.36% fee) = $686,813 needed in an average indexed fund
- Another example: $25,000/ (4% – .09 fee) = $639,386 in a low-cost indexed fund (Vanguard, Fidelity, Blackrock)
- And finally: $25,000/ (4% – 2% fee) = $1,250,000 in an average managed fund with 2% annual fees
It is shocking to see this very simple math.
You really would need to double your investment pot for a 2% fee and, if your financial advisor charges 3% fees a year, then he is actually taking a shocking 75% of your hard-earned retirement income.
If there were evidence that it was worth it, I’d be in there in a flash, but unfortunately, the biggest indicator of a fund’s investment success is the lowest fees because it leaves so much more money on the table for the investor.
I know for sure that I’m happier NOT paying this fee and, knowing how much I’m saving, I’m very happy to pay for fee-only financial advice. Suddenly that $2,000 a year seems a bargain in comparison so think twice before you sign up for “free” financial advice with a “reasonable” or “standard” 2% management fee.
Now, what about the other big expense, housing?
Robert Kiyosaki, the author of Rich Dad, Poor Dad and the very excellent, Cash Flow Quadrant, says that you must think of your home as a liability, not as an asset.
His rule is simple: an asset puts money in your pocket and a liability takes money out of your pocket.
Based on this rule, your home is likely costing you money in insurance, mortgage interest, repairs and maintenance not to mention décor, so it is clearly a liability, not an asset. What complicates matters is that your home could become an asset if you rent it out on Airbnb or for photoshoots, filming, weddings, etc. In this case, not only could you have a lovely home to live in and enjoy, but also you could make money on your home. Thus turning a liability into an asset.
Your home could also be an asset if you bought a fixer-upper and then sold it for a profit a year or two later, which is what I did in my very first house. That house is one of the best investments I’ve made. Giving a nice boost in capital in a relatively short period of time, resulted in doubling my initial investment in only two years. Not bad given I also got to live in and enjoy the house for those years as well.
The research on money and happiness reports you’ll be happier if you buy the smaller house and spend the money on experiences as that is more likely to make you happier than a bigger house.
Yes, we may like the big house. But due to hedonistic adaptation, we adapt to it quickly. Then it doesn’t give greater happiness. Problem is, once you have a big house, downsizing afterwards can feel unpleasant (speaking from experience here!) so you are better off to buy the just right-sized house and not upgrade.
