Why cookie-cutter personal finance does not work

Marie (speaker, blogger, investor) agrees with my simple plan for wealth creation:

I have to go with your 2 step plan. All my years in PF it seem to work best than the cookie cutter approach.

The ‘cookie cutter’ approach that Marie refers to are the approaches that I was talking about in my provocatively titled guest post at Budgets Are $exy: “Why Most Personal Finance Blogs Are B.S.“, and includes: paying off all debt; maintaining an emergency fund; frugality and expense-cutting; paying yourself first via max’ing out your 401k; and, so on.

[AJC: To be fair, I was asked to write something ‘feisty’ so you should head on over and read the article (and the comments) now …]

To prove any personal finance strategy you need to have an objective against which you must measure the outcome.

To me, that goal must be: financial freedom.

But, what does ‘financial freedom’ mean?

That depends entirely on you …

If your goal is to simply replace your income, say, within 20 years, and you can train yourself – through frugality – to live on a lower income than your peers then it is possible to save your way to wealth (simply defined as financial freedom, or having enough passive income to replace your then-current income from employment).

For example, MB writes about her 12 year plan to replacing her and her husband’s dual working income:

After a couple years of full-time work I started to wonder, how can anyone possibly tolerate doing this for 40 whole years?!

[Now] our number is somewhere in the $1-2M range depending on how many kids we end up having (if any). But, then again, we are saving >50% of our salaries.

By ‘training’ themselves to live on only 50% of their salaries – or 1/4 to a 1/2 less than their peers – MB and her husband accomplish two purposes:

1. They save a lot more than most people,

2. They live on a lot less than most people

So … they need a much smaller Number than most people and they’ll be able to reach that number much, much sooner than most people.

According to my calculations, if you start off earning, say, a combined $50k p.a. and are prepared to live off just $25k of that (assuming your combined salaries increase by 3% per year, and you get a very hefty 8% after-tax return on your savings) you will be able to retire on a combined $40k passive income in not the 12 years that MB is hoping for, but a still-healthy 17 years time.

The catch is that just 4% inflation would mean that you really have the earning power of a little less than $25k p.a. today.

In other words, to actually make this cookie cutter personal finance plan work, you need to be debt-free and be able to live on just half your current annual income for your whole life.

Is this you?

If not, I recommend that you spend a little time with an online retirement savings calculator and work out what income you would need in today’s dollars (i.e. assume you retire today) …

… then, leave a comment and – in my next post – I’ll explain what that means and what you need to do to get there.



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7 thoughts on “Why cookie-cutter personal finance does not work

  1. What if I make a lot more money than average, and by living of half my income I am still living above the average person? I don’t feel like I am living below everyone by saving half my income. I think most of my friends probably think I live way above my means, but they have no idea that I make a lot more than they do. You make it seem like it is so hard to “be able to live on just half your current annual income for your whole life.”

    I put my info into that calculator and it said I have a 20% chance of being able to retire in 8 years and have $80,000/year (when I am 40 years old). Which I am fine with. If I don’t hit it, I will just work another year or two. If I bump my number down to $50,000/year in income, I have a 99% chance of hitting it.

  2. @ Dillon – You’re right, if your friends all earn $100k and you earn $200k (all after-tax), it should be relatively easy for you to simply spend $100k a year to match them and save the rest …
    … assuming you haven’t become used to living on close to the full $200k 😉

  3. A number of responses to your guest post seemed to misunderstand what you were saying about emergency funds. Your standard PF emergency fund is cash that is sitting in a bank account and earning a microscopic return that is being outpaced by inflation. But if that cash is invested wisely and managed properly, there’s a very good chance that it is earning money at a rate faster than inflation (and benefiting from compounding!).

    Some people respond to this by worrying that the market will tank at the worst time. These appear to be the same people who defend the standard emergency fund by telling us that emergencies can strike at any time and that they always seem to happen at the worst time. This kind of thinking paralyzes people into inaction, and is why so many PF bloggers are sinking in debt, paying 18-25% on debt while their emergency fund earns less than 1%. It’s as if they don’t understand that those high-interest debts ARE THE EMERGENCY.

    Keep doing what you’re doing with this site. Not everyone will get it, because self-defeating thinking is very widespread. But those of us who managed to break away from that mindset appreciate the information.

  4. “many PF bloggers are sinking in debt, paying 18-25% on debt while their emergency fund earns less than 1%”

    @ Milton – That would be beyond comprehension 🙁

    But, take that one step further: “many PF bloggers are saving 2% – 4% by paying down their cheapest debt (student loans, home mortgages), while their investment funds (that should earn far more) lie empty”.

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