Archives For Spending

Quiz!

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your savings nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year.

Should Higher Earners have Higher or Lower Saving Rates?

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. Should you keep your saving rate of 10%, increasing your savings to $16k/year? Should you increase your savings by less than that or even more? For many reasons, you should increase your saving rate, leading to new savings greater than $16k/year. Here are a few reasons:

  1. Usually, the higher your income, the lower your job security. Many more people compete for CEO or VP roles, than a fast food restaurant employee. You need to build security through savings faster to make up for your declining job security.
  2. If you lose your job, there are fewer jobs to choose from, the higher the income.
  3. The excess happiness obtained by increased spending goes down quickly as the amount goes up. Reducing financial stress typically brings much greater happiness.
  4. Social security covers a smaller portion of high incomes. If you earn $30,000 per year, social security will give you a retirement greater than half of your earnings. But, at $300,000 per year, social security income covers a small portion of the income you got used to. It is up to you to make up the difference. To get income of $300,000 from a portfolio that can generate 3% per year, you would need to build savings of $10,000,000. If you want to enjoy anywhere near the standard of living you got used to, you need a very high saving rate combined with investing for high growth compounded over many years.

The good news is that even at 20% = $32k saving rate, your income available to spending grows by a substantial: (160k – 32k) – (100k – 10k) = 38k minus income taxes. You get the double benefit of higher spending along with a big increase in your saving rate.

Quiz Answer:

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your saving nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year. [The Correct Answer]

Explanations: Read this months’ article for an explanation.

Disclosures Including Backtested Performance Data

Quiz!

Which rule of thumb for spending can be useful for all personality types?

  1. Save 10% of your income and spend the rest.
  2. Save 10% of your income for incomes up to $200k, and 20% for incomes above that. You can spend the rest.
  3. Keep your spending as low as needed to avoid chronic financial stress.
  4. Save as much as needed to allow you to retire by a reasonable age such as 65 or 70. You can spend the rest.

How Much Should You Spend? A Rule of Thumb for All!

This article offers a rule of thumb for a healthy spending level for all personality types.

Full sustainability: No matter your preferences, you can feel comfortable to spend an amount that is likely to be sustainable for as long as you live, whether you work or not. This is: your current social security payments, pensions and other guaranteed income, plus a sustainable withdrawal from your investments (e.g. 3%-4% for many globally diversified stock portfolios, reduced enough to account for surprise expenses).

Rule of thumb for all: Early in your career, full sustainability is rarely possible. A rule of thumb is to keep your spending as low as needed to avoid chronic financial stress. The benefit of this rule is that it can apply equally to different personalities. Here are a few examples:

  1. Risk averse: If you are risk averse, you may become stressed by any income instability or large surprise expenses. It may be worth keeping your spending as close as you can to 3%-4% of your portfolio. It may involve a large initial adjustment, but in return you will get many rewards. You will take the fastest road out of financial stress. You will enjoy the extra savings, plus the compounded growth of the extra savings. This will lead to a positive snowball effect of fast growing sustainable income along with relaxation.
  2. Time-sensitive spending: Some expenses lead to benefits that may not be available if delayed. Examples include children’s education & healthy eating. If you are risk averse, a compromise may be delaying most expenses, but still retaining your time-sensitive expenses.
  3. Instant gratification: If you are averse to delaying gratification, and don’t get too stressed without much of a safety net, you may choose to spend the bulk of your income, no matter how limited your investments are. Any loss of job, and many surprise expenses will require quick adjustments and potential stress. With low total savings to enjoy compounded growth, you will likely have a lot less money to spend in your lifetime, and your dependency on work will stay consistently high. But if immediate gratification is your top desire, and the consequences don’t stress you, it may be worth the tradeoff.

Important notes:

  1. Be realistic about upcoming expenses. Many types of non-recurring expenses are bound to happen. Examples include medical costs, house repairs, car repairs, new cars, loss of job and business downturns. I’ve heard people refer to these as bad luck. Switching your mindset, and seeing them as expected non-recurring expenses, can significantly increase your happiness and success in life.
  2. The benefit: The rule of thumb of avoiding chronic financial stress can be helpful regardless of your priorities. If your spending creates ongoing stress, you are probably not living an authentic life, and the price could be greater than any benefit you are getting by the spending. This is true whether you think you are spending very little or a lot.
  3. Stable jobs with guaranteed pensions. Because most jobs are far from guaranteed, the ultimate way to avoid chronic financial stress is to depend on sustainable withdrawals from actual money in the bank (investments). If you are lucky enough to have a very stable job that has a guaranteed pension, the pressure to reduce the dependency on work is lower. Please remember, though, that such jobs are rare, and pensions may not be as guaranteed as they used to be.
  4. If you are married, it is worth discussing spending, with a clear goal of resolving and preventing chronic financial stress. To motivate the talks, realize that one person’s stress typically hurts both members of the couple – even the person who is less risk averse and eager to spend more.
  5. Perspective: You can maximize your happiness by comparing yourself to people living in a basic structure with no running water and no electricity, and realize how fortunate you are. No matter how much you lower your spending, you are very fortunate in life.

Quiz Answer:

Which rule of thumb for spending can be useful for all personality types?

  1. Save 10% of your income and spend the rest.
  2. Save 10% of your income for incomes up to $200k, and 20% for incomes above that. You can spend the rest.
  3. Keep your spending as low as needed to avoid chronic financial stress. [The Correct Answer]
  4. Save as much as needed to allow you to retire by a reasonable age such as 65 or 70. You can spend the rest.

Explanations:

  1. Your saving rate depends on how much you have saved, how soon you desire to retire, your spending rate, your income level, your job stability, and a number of other factors. There isn’t one percentage that applies to everyone.
  2. All else being equal, you should save a greater percentage of your income, the higher it is, since it is tougher to replace higher incomes, and your basics are more likely to be covered already. But, spending and saving rates depend on many other factors, some of which are mentioned in #1 above.
  3. Stress is a protection mechanism that tells you that you are not acting in an authentic way. If you are chronically financially stressed, you are acting against your internal beliefs. This rule of thumb can help everyone.
  4. There are many problems with this advice. A few of them: You cannot count on a specific growth rate on your investments to know when you can retire, you cannot anticipate health problems, loss of job, volatile business income, and the list goes on.
Disclosures Including Backtested Performance Data