More Money, Less Budgeting
Imagine a world without budgeting, a fixed savings rate, lifestyle creep, busywork of transferring investment money, or having to make decisions based on money. Imagine an automatic path to financial independence. That is the world I live in and I’m inviting you to join me.
I have never budgeted or had a fixed savings rate. I never reduced my spending or lifestyle despite two very large voluntary pay cuts when moving practices. How did I pull this off? Keep reading my friend.
Monthly Cash Burn Rate
Although I never followed a budget, I did need to figure out how much I spend. I pulled my checks and bills and credit cards for a month or two and estimated my Monthly Cash Burn Rate. What is the typical amount of money that my family and I spend each month?
The rest of my non-budgeting method involves adjusting for periodic expenses. Those include semiannual property taxes, semiannual disability premiums, annual car registration, and annual homeowners’ insurance. The big optional stuff is in that category too like our new hardwoods and our trips to China, South Korea, and Ireland.
So, let’s say my routine wants and needs are covered by $6K per month and my periodic expenses plus vacations and home upgrades cost $12K every six months. Those periodic expenses are equivalent to $2K per month. So, I will need $8K per month, $6K of which can go to checking and $2K to savings. The rest will be invested. The savings account serves as a temporary holding area for money that will be spent during the year.
Automate Your Savings
You may have heard the phrase, “Pay yourself first.” I first read it in George S. Clason’s book, The Richest Man in Babylon.
The idea of pay yourself first is to automate your savings. Make your “purse fatten” by adding to that first and then living off the rest. It is a solid plan, especially for those who aren’t natural savers and who tend to spend every penny in their hot little hands.
Normally, people pay all their bills after their paycheck comes in. Then they pay for the fun stuff they want. There are no “leftover” or “excess” funds that can then go to a retirement account or for long-term savings. This results in a low or negative savings rate across America. That habit also explains why 45% of physicians feel they cannot afford to max out workplace retirement savings plans. They don’t see any money left over after they covered their other needs and wants.
The key to implementing this idea is to request money be electronically sent to a separate account for savings and investments.
Richest Doctor in Babylon
The 10% that is recommended in The Richest Man in Babylon is more than the average American saves. Nevertheless, 10% is likely a bare minimum. It may lead to a subsistence level retirement after 40 years of work.
So, the method is fine, but 10% is too low. The rate is within our control and is the surest way to shorten the time to financial independence.
Rather than pick a fixed savings rate and follow a budget, I send myself a falsely low “paycheck.” I created an economic scarcity. Mind you, I set my “paycheck” at a comfortable level. I made sure it would cover all my family’s needs and most of their wants. As my income grew and my student loans were paid off, I found it easy to divert more money into my taxable accounts. Also, any bonus money, dividends, or other investment payoffs went into investment accounts. This method worked well for us without needing to obsess over a budget. No busywork. No sacrifice or sense of deprivation.
Looking back, I averaged a savings rate of about 38% of gross income and achieved FI (Financial Independence) after fifteen years at the age of 46. A 38% percent gross savings rate works out to about a 50% net savings rate. That has been shown to allow FI by 17 years.
Many stressful occupations like military, police, and firefighters encourage their members to retire after 20 years. There is a reason for that. The physical, mental, and psychological stress can wear people down. That may happen to you too. I felt the effects of cumulative stress and sleep deprivation after 20 years of clinical practice. Wouldn’t it be good to have options if that happens to you? If you no longer must depend on your job for the money you could cut back, go part-time, take a sabbatical, or retire early.
Pay Yourself Last
I have previously (in a guest post for Physician on Fire) referred to this as the “Pay Yourself Last” method. I’m recommending it to you here. Don’t set a savings rate and spend the rest. Set a monthly spending amount and invest all the rest. The percentage may go up or down depending on a dozen factors, but you will automatically grow your wealth. You will also have a system for guarding against a common threat to early retirement: lifestyle creep.
Before setting this up I struggled to automate my savings. I was never sure what savings rate I should set. My check and savings seemed to change almost monthly. There would be a CME reimbursement on one check. I would reach the max for my 401K or 457 and those contributions would stop. I would get a bonus or a raise. It didn’t make sense to have the same percentage of all that goes to investing. Also, if I got a lot of extra money in a check for some reason and I didn’t need the money I would have to write a check or transfer that into an investment fund. Or it would be easy to spend.
Anatomy of a Paycheck
Some readers enjoy seeing specific examples and numbers rather than just concepts. For them, I will add some detail. Let’s say I’m a 31-year-old doctor just starting out. The average compensation is now around $300K per year. I lived on $60K during residency but am looking forward to a pay raise as an attending. My goal is to be financially independent by age 48. To reach that goal I set up my investments in both taxable and tax-advantaged accounts.
I would set up my electronic transfers for direct deposits from my employer.
My “paycheck” in my checking account is for my routine expenses and short-term wants. I also have some money sent to a “savings” account for periodic expenses like property taxes, vacations, disability insurance
All the rest goes into investment accounts.
It would look something like this assuming I’m paid every other week.
To execute this in payroll I would have them send $3K per pay to my checking account, $1K to my savings account, and any remaining net pay to my investment account. In this example, the extra investment amount is $2,814 but that may vary wildly during the year and over time. The “paychecks” to checking and savings remain rock-steady.
Fixed Paycheck, Variable Investing
The percentage savings may vary depending on my salary, productivity, contract, incentives, tax rates. Those factors seem to be in constant flux. This method makes my cash flow smooth. Also, if I get a raise, there is no temptation to spend that extra money since I never see it.
This “Pay Yourself Last” method works great for me, and I think it would help others. You don’t have to spend time budgeting.
Now that I have been financially independent for several years, my income has grown. My spending has not increased, so my gross savings rate has slowly crept up over 40% without me doing anything differently. I love how the increased savings requires no action on my part.
What about you? Have you heard of this before? Is this how you manage your cash flow and investment?