Your savings rate is the number one factor that determines when you can reach financial independence. But investment returns can play a factor as well.
Most F.I. calculators assume 5-7% annual returns on investments, but we all know that market returns can fluctuate wildly from one year to the next. It’s actually pretty rare for the market to return between 5-7% in any given year.
So I was curious, using historical S&P 500 returns, what was the minimum savings rate needed to reach F.I. by 2017 over the last 30 years?
Here’s the results:
How to interpret this graph: If you started with no savings in 1982 and invested 8% of your income each year, you would have had enough money by 2017 to be financially independent.
For all you nerds out there, here’s an example of the math behind this graph.
Suppose you started investing in 2006. To keep things simple, pretend your annual income is $100. With a 55% savings rate, you’re saving $55 each year and spending $45 each year. To reach financial independence, you need 25 times your annual expenses. So you need to accumulate $45 * 25 = $1,125.
A 55% savings rate is the minimum savings rate that would have allowed you to reach your mark of $1,125 by the end of 2016.
Some Interesting Observations
- One of the worst times ever to start investing was in 2000. You would have experienced the bursting of the tech bubble, followed by the housing market collapse and yet if you consistently saved 42% or more of your income each year, you still would have reached financial independence by 2017.
- Over long stretches of time, retirement calculators are pretty accurate. For example, if you started investing in 1990 with a 20% savings rate, most retirement calculators would assume a 5-7% annual rate of return and predict that you would reach financial independence in about 30 years. According to actual historical data, it would have taken about 27 years.
- Even if you’re late to the investing game, a high savings rate can allow you to reach F.I. surprisingly quickly. Consider a 40 year old who just started investing in 2004. By investing 50% of her income, she could have reached financial independence by age 53. It’s never too late to start!
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