Friday, January 26, 2018

You Need 2 out of the 3 Levers To Achieve F.I.R.E

Having financial independence as a target should be a long term goal for everyone.

Achieving Financial Independent Early Retirement (F.I.R.E) on the other hand makes the task even more difficult because we are competing for time where it plays a big factor.

Long term readers of my blog know that I’d like to achieve F.I.R.E sometime in the mid 30s from the start, and I’ve always make this as a personal stretch goal which I will review each year.

I have always believed that there are 3 levers that will determine the outcome of my situation and that I will need to achieve at least 2 out of the 3 minimally in order to be successful.

Before that, let’s go through what are those 3 levers first.




1st Lever: Income Growth

Most of us grows our capital base by being an employee working day job from 9 to 6.

The first salary base that we get from our first employment plays a big part in the future compounding. If we start from a low base, there’s a long way to play catch up at a later stage.

Luck often plays a big part in determining that too but we shouldn’t be dependent on what we cannot control.

There is usually an annual increment exercise for most multi-national companies, so employees should gradually see their income grow higher over time. The growth “g” part is a critical factor like most valuation methodology in investing so we need to play it smart. The “how” part is another matter altogether.

We need to distinguish the difference between progression and promotion.

Progression means you probably did okay and the company survives another year so everyone in the company gets about 3-4% of increment the following year.

Promotion, on the other hand, means you get a new responsibility and are promoted to the next level, so your increment should be higher than usual. The most common increase is about twice the amount of progression minimally, or you can put 2x Progression growth in your excel sheet. Promotion doesn’t come often and depends on many factors, but if you can consistently do it, you’ll win the rat race within the company.

Jumping to another company immediately after your promotion increase will probably give you the best ROI. I’ve seen a lot of people who do this and many employers agree this pose a big risk to the company in terms of losing talents.

The best case scenario for a 10 year career in terms of ROI would look like this:

Progression-Progression-Promotion-Jump-Progression-Progression-Promotion-Jump-Progression-Progression-Promotion.

Again, not everyone can do it well, but we’ll need to strive for it and play our best poker card.

2nd Lever: Savings Rate

While it may seem pretty obvious that we need to spend less than what we earn, the reality is it is not easy to digest until we are accustomed to seeing things differently.

The higher the savings rate, the more likelihood you are going to have excess funds at the end of the day.

That is being straightforward.

The reality is you’d likely to start from a high base and then gradually go down as you tend to start your own families, have children, buy tons of milk and diapers, renovate your home and furniture appliances and many more.

For someone who already started with a low base of savings rate from the time they are single because he may be spending aggressively on gadgets or other needs, he will have a difficult time adjusting his spending pattern once the tough gets tougher.

I’ll leave each reader to imagine what does good looks like in this aspect but the general idea is the higher the better.

3rd Lever: Compounding Returns Rate

The final lever refers to our ability to use the excess funds coming from the first and second lever and compound it over time.

This usually comes in the form of investing, either through bank deposits, equities, bonds, property or any asset class that generates positive returns.

In order to do this well, we will first need a few years to build up our level of competencies in the area of interests where we think we would excel most. The amount of experience and competencies accumulated over the years will play a significant part in the compounding returns.

The worst part of the deal is that compounding can quickly go south and is definitely an accelerator to wealth destroyer.

2 Out Of 3 Levers To Succeed

Fortunately, the good news about this is you only need to be good in 2 out of the 3 in order to achieve F.I.R.E.

Some of us may be good with our job but bad at churning out returns through compounding or vice versa where we may be good at savings but bad at increasing our income growth.

Of course, achieving all 3 jackpot would be nice to have but the idea is to try and achieve 2 out of the 3.

Let’s try to simulate a few scenarios with real numbers how this can look like.

Assumption

Let’s assume John who currently earns a decent salary base of $2,500 and he receives an annual wage supplement (AWS) because he works in an MNC.

For simplicity purpose, let’s assume his annual salary base is $2,500 x 13 = $32,500, without any variable being thrown in.

John wants to retire early at the age of 40 and build up sufficient wealth for his simple financial independence lifestyle.

John is also single and attractive looking.

Scenario 1

This scenario will focus on lever 1 and 2 where John lines up a strong career path by earning a 10% CAGR over the next 15 years and is extremely frugal with his spending. His savings rate appends a high rate of 80% throughout as he continues to maintain his frugal lifestyle.

Unfortunately, John spends most of his time at work and therefore do not have time to build up his competency in growing his money. His money is mostly in fixed deposits over the long term.



From the table above, you can see that the first and second lever plays the big role in his networth while the investing returns are meagre returns that play a supporting role behind the scene.

At the end of age 40, he would still possess a remarkable $953,387 in his networth.

Scenario 2


This second scenario will focus on the savings rate (2nd lever) and the compounding returns (3rd lever) where John is rather slow at climbing the corporate ladder but he lives a simple lifestyle and he builds up his competency in investing in the stock market.

He still gets his annual increment of about 3% per year while he saves almost 80% of his income from it. He uses the funds for investing and he managed to obtain a compounding return of 15% per annum.


At the end of the 40 years, he is still able to amass a networth of more than half a million and retire early because of his frugal lifestyle.

Scenario 3

The third scenario will focus on the income growth rate (2nd lever) and compounding returns (3rd lever) where John climbs up the corporate ladder and at the same time compounding fast on his returns. He is however spending rather heavily on entertainment and travel in order to relieve his stress from work.

He still saves 20% at the end of the day, and used the money to compound at an average of 15% per annum.


At the end of the 40 years, he is able to amass a networth of $953,387 and retire early.


Which Scenario Do I belong?

This is the first time I am doing this exercise so it'll be interesting to see where do I end up.

This sharing is by no means a point for showing off but rather for academic purpose.

If I have to choose among the 3 scenarios, it will most likely resemble scenario 3 in my case.

I started my career at the age exactly 10 years ago, with a very decent salary base, and I managed to work on my income growth and climb up the corporate ladder. There were some difficult times but each progression and promotion was almost always a new challenge. I also had 3-4 jobs in my 10 year career so the trick was always to monitor the CAGR growth over the years.

Having a high capital base means a higher capital injection that I can put for my investment.

If I was to draw a flowchart, it'll be like this:

Progression-Jump-Progression-Promotion-Jump-Progression-Promotion-Jump-Promotion-Progression-Promotion

My 10 year CAGR in terms of income growth is at 12.1%.

On the savings rate, I am a crazy saver when I was single, until I get married and have children and that's when savings rate started going south. I probably saved about 80% for the first 4 years, 50% for the next 2 years, and then 20% for the last 4 years. This is probably my weakest lever at the moment.

On the investing front,  I was fortunate to churn out a return of 17.8% in the stock market over the last 8 years. This helped to boost my networth significantly especially the last couple of years.

I still have a few more years in the corporate world (hopefully) in terms of energy level and then hopefully I will move on to improve my savings rate lever.

Final Thoughts

The maths are simple.

Crazy Income + Crazy savings rate + Crazy Compounding rate = Crazy F.I.R.E

This serves only as a means of exercise to illustrate that one doesn't have to be strong in everything but focus his resource where he excels most.

If you are those who excels in your job, go for it because it can reward you tremendously and you can pick up other things at a later stage (or at the same time).

You just need to make sure that you are good in 2 out of the 3 and the maths will take care of itself.

There are many assumptions that I've purposely left out such as preparing for housing, wedding, parents allowance, this expense, that expense, etc. Two person in the same household could perhaps also accelerate F.I.R.E. This isn't the purpose of this article. 

What about you? Which scenario do you belong?

Thanks for reading.
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24 comments:

  1. Replies
    1. Hi TFM

      I'm working as a support function in accounting and finance :)

      Delete
    2. EDWARD JONES FINANCE IS THE BEST PLACE TO GET A LOAN {Jonesloanfinance@yahoo.com},
      God bless you sir, I will not stop telling the world about your kindness in my life, I am a single mum with kids to look after. My name is Emily Thomas and I am from Convention Center Drive, Miami Beach, FL . A couple of weeks ago My friend visited me and along our discussion she told me about EDWARD JONES FINANCE, that they can help me out of my financial situation, I never believed cause I have spend so much money on different loan lenders who did nothing other than running away with my money. I have been in a financial mess for the pass 7 months now, She advised I give it a try so I mailed him and explain all about my financial situation to him, he therefore took me through the loan process and gave me a loan of $390,000.00 at a very low interest rate of 2% and today I am a proud business owner and can now take good care of my kids, If you must contact any firm to get any amount of loan you need with a low interest rate of 2% and better repayment schedule, please contact EDWARD JONES FINANCE email:- {Jonesloanfinance@yahoo.com} OR Text +1(307) 217-5388

      ....

      Delete
  2. Nice post Brian, I really like this perspective with the scenario examples. So many people focus on the 'crazy FIRE' when there are other slow and steady routes if that's more your thing.

    I'm most definitely in 1 and 3 - my savings rate is relatively low being the sole income earner of a relatively large family to support, but it's positive, so we're going in the right direction for financial independence at least!

    ReplyDelete
    Replies
    1. Hi Frankie

      We are in the same category!

      Like you I am also the sole breadwinner and because of that savings are low

      I have a feeling our circumstances are very close :)

      Delete
  3. Any recommanded some suggest about compounding invest? Wish to get some advise.

    ReplyDelete
    Replies
    1. Hi Unknown

      I think for as long as we can get decent returns in the long run at 8% it will make a big impact to our lives.

      Delete
  4. Hi, just wanted to point out that you need to factor in CPF. Dont think you can save 80% of your gross income.

    If you include CPF as part of the savings, then you can't use a 15% compounding as you would need to average it down with the (up to) 4% you get on the CPF monies.

    Not trying to shoot down your article, I enjoyed it. Just felt that the numbers could be more realistic.

    ReplyDelete
    Replies
    1. Hi Anonymous

      Thanks for your input.

      I did think of that when I was computing but decide against it because it would complicate the numbers a bit.

      But you are right, we need to deduct 20% off but add additional 17% from the employers portion and compound it at 2.5%, i think the numbers would make more sense, thanks.

      Delete
  5. Hi B,


    Thanks for the nice write up and i do agree with you.

    My saving was still zero 8 years ago. But i was lucky to go into investing in shares in 2010. I have accumulated about 200k so far and my investment has turned to half a million now. So i guess i belong to Scenario 3!

    ReplyDelete
    Replies
    1. Hi Anonymous

      Wow thats a very high return. Either you excel in all the 3 levers or you must really excel in at least 2 of them. I'm glad to find someone in the same category with mine.

      Delete
  6. Hi B,

    I think there’s a computation error for the column under savings for scenario 3.

    ReplyDelete
    Replies
    1. Hi Anonymous

      Ah yes!! You are really sharp!

      No wonder the numbers looks so high im starting to question, thanks for pointing out, I'll make the changes.

      Delete
  7. Hi Brian,

    I like your article. 12% CAGR is a lot. Also do you include variable bonus in lever 1?

    Just wondering, if you write all this about FIRE and how you gonna retire in mid 30s, suppose your employer do not know about this as if they know, it would not end so well? or maybe your employer is fine with it already :)

    ReplyDelete
    Replies
    1. Hi Cheryl

      I did not include the variable. If i did, I probably edge out a bit more higher.

      To be frank, I think I'm fortunate to have such a high cagr when I seriously dont think im smart up there.

      Must be blessed with good fortunes.

      My boss actually knows about this and my plans and we are often open about it when we have our appraisal discussion. I understand where you are coming from it can be a bit ackward, but hopefully they will see it differently that i am coming from the perspective of sharing and they dont include personal with work :)

      Delete
  8. Hi B

    Good post and realistic. I attained FIRE 5 years ago, and have accumulated a property portfolio of multiple rental properties and a stock portfolio with multi-7 digits, passive income prob $200+k per annum. All with a normal well paid but not C-suite job but 20+ years of Scenarios 1, 2 and 3 - all 3 levers! Took advantage of the AFC, Iraq Wars, SARS, GFC.

    Still working at a busy well paid job but now doing it for the passion and love of the job and people. Missus left FT work some years back to take care of the kid.

    Yes it’s possible to achieve FIRE young - but it’s all about deferred gratification and patient investing and being a good responsible employee. And value investing, not trading.

    ReplyDelete
    Replies
    1. Hi Anonymous

      Thanks for sharing.

      It is precisely guys like you that shows us the way why it is all possible. You guys make the impossible possible and the dream comes true.

      Delete
    2. Hey B - thanks for the kind affirmation. Definitely achievable and financial emancipation feels so so great and you can live life fully and without fear of bosses! Haha.

      Anonymous A

      Delete
  9. Hi B,

    I was looking for the significance of John being attractive looking as I read the 3 scenarios. Lol :)

    ReplyDelete
    Replies
    1. Hi Alcus

      Haha you spotted it!

      I just added for fun, in case somebody disputed I can say that he can get a sugar mummy with his attractive looking features. Lol

      Delete
  10. I am wondering if one should achieve only average for each of the 3 scenario..ie:work with 3% increment yearly, save ~20% pa & 5% yield pa on investment. What is his prospect of F.I + R.E?

    ReplyDelete
  11. EDWARD JONES FINANCE IS THE BEST PLACE TO GET A LOAN {Jonesloanfinance@yahoo.com},
    God bless you sir, I will not stop telling the world about your kindness in my life, I am a single mum with kids to look after. My name is Emily Thomas and I am from Convention Center Drive, Miami Beach, FL . A couple of weeks ago My friend visited me and along our discussion she told me about EDWARD JONES FINANCE, that they can help me out of my financial situation, I never believed cause I have spend so much money on different loan lenders who did nothing other than running away with my money. I have been in a financial mess for the pass 7 months now, She advised I give it a try so I mailed him and explain all about my financial situation to him, he therefore took me through the loan process and gave me a loan of $390,000.00 at a very low interest rate of 2% and today I am a proud business owner and can now take good care of my kids, If you must contact any firm to get any amount of loan you need with a low interest rate of 2% and better repayment schedule, please contact EDWARD JONES FINANCE email:- {Jonesloanfinance@yahoo.com} OR Text +1(307) 217-5388

    ....

    ReplyDelete
  12. A well written article and I enjoyed reading it. I'm more on lever 2, but trying to hone my skills for lever 3.

    ReplyDelete
  13. Friendly and quick. For a person who hated going to the dentist I am not dreading my next cleaning!
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    ReplyDelete

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