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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Zach is the author behind Four Pillar Freedom, a blog that teaches you how to build wealth and gain freedom in life.
Zach's favorite free financial tool he's been using since 2015 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
His favorite investment platform is M1 Finance, a site that allows him to build a custom portfolio of stocks for free, has no trading or maintenance fees, and even allows him to set up automated target-allocated investments.
His favorite way to save money each month on his recurring bills is by using Trim, a free financial app that negotiates lower cable, internet, and phone bills with any provider on your behalf.
His favorite micro-investing app is Acorns, a free financial app that takes just 5 minutes to set up and allows you to invest your spare change in a diversified portfolio.
His favorite place to find new personal finance articles to read is Collecting Wisdom, a site that collects the best personal finance articles floating around the web on a daily basis.
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