Why You Should Pursue Financial Independence

Why in the world would I need to write an article to convince you that pursuing financial independence is a worthwhile goal?  Everyone wants financial independence right?

Well, actually, most people don’t.  They like the idea of financial independence.  It’s hard to argue with the idea.  But most people don’t like the steps it takes, particularly the necessary part about saving a lot of the money you earn.  If you’re not highly motivated to achieve financial independence then it’s going to be difficult to achieve before you are old.

So let’s talk about WHY financial independence is worth the effort.

First, let’s start with the current state of savings in America.  For any international readers, the American situation I describe in this article will be quite different from many other places around the world.  I apologize, but it’s Americans who seem to have the most difficulty saving money and have the most potential to improve their personal financial situation.

Americans on average currently save about 5% of their income.  This means it takes 20 years to save one years worth of spending.  What!?!

Here are some arguments as to why we don’t save.

  1. Social security provides money later in life so we don’t need to save as much.
  2. Plus there is medicaid and medicare.
  3. And pensions.
  4. I’ll save later when my income is higher and I don’t have as many expenses (kids, mortgage, etc).
  5. Things will always get better over time in America so worrying and preparing for the future isn’t necessary.
  6. My kids will take care of me when I’m old.
  7. Cost of living is too high…..there just isn’t much left over after paying the bills.
  8. Yada Yada

Let’s quickly address these key points with some data.

  1. Social security is actually pretty great.  Many people in other countries wish they had something similar and it’s pretty nice the government does this.  We do pay into the system over time but it’s still a major portion (along with medicare and medicaid) of our federal spending and a large portion of people get back much more than they put in.  SS accounts for 39% of retiree income on average (average benefit of $16,000 per person) and many people are even more dependent on social security than this.  But social security is running out of money.  Many young people are not expecting SS at all when they are older.  I think this is too pessimistic, given how important it is to citizens in America (i.e. voters), but I expect benefits will be reduced such that they are about 75% of what they are now (which solves the current financial gap).  However, SS is not enough for the lifestyles that most people want to live.  More importantly, for those that want to (or are forced to) retire early, SS will not help until they are at least 62.
  2. Medicare and medicaid are also pretty nice.  However, they are in even more financial trouble than SS.  Plus you have to pay a lot of your own medical expenses in America vs other countries that have national health care systems, even with these programs.  It’s unclear what health care in America will look like in the future.  Obamacare is a huge boon to early retirees but providers are losing money the future is uncertain.  Low cost catastrophic health plans are also a great option for early retirees since they tend to be much healthier than average (having a lot of free time to eat healthy and exercise is pretty key here).  However, in general, you can’t neglect your health and expect the government to help when you need it……medical issues are by far the leading cause of bankruptcy in the US.
  3. How about pensions?  Many people still get pensions.  But they are rapidly declining.  In 1990, 42% of private sector full-time workers received a pension.  It’s half that number now.  If you’re lucky enough to work in a union or for the government, you likely have one but there is a lot of pressure to scale back pension commitments.  In the private sector, newer employees rarely get a pension and those that do get one, have a much less generous pension than was previously offered.  Based on the aggressive future investment returns that most pension plans are using (~8% real returns), I have concerns about many of our public pension commitments in America.  The youngest workers will be the ones to see their future benefits cut the most if pension funding shortfalls continue to increase.
  4. Save later when you have less spending obligations?  If you wait too long to start saving, you won’t benefit from compounding and you’ll have a much harder time becoming financially secure.  Plus the human tendency is to procrastinate and kick the can down the road, delaying things further.
  5. Really?  Then why do surveys show much American’s are pessimistic about the future right now and expect their kids will have a lower standard of living too?  This one doesn’t hold water.
  6. Unlikely.  This isn’t a strong part of American culture and your kids will likely have their own financial challenges.
  7. Nothing left over after paying the bills?  Hmmmm.  Maybe your bills are too high?  Who chose those expenses?

Ok, let’s put this all together.

Do we avoid saving because we don’t need to?  It doesn’t appear to be the case. While some safety net programs are helpful, everyone knows they won’t provide the income that most people would like so there is an awareness that everyone needs to save.  Europe gives us a nice contrast here.  Retirement income from the governments are quite generous, job security is significantly better, health care is free, and education for their kids is free (a huge expense for Americans).  Yet their savings rate is much higher than ours.  By the way, incomes are lower, taxes are higher, and the cost of living is quite high in many places as well.

So, this means we Americans don’t save because we feel we can’t, but not because we really can’t.  It will take a separate article to tackle that topic, but first let’s focus on why you should.  I’ll give three major reasons as to why, though there are many more that could be added.

Since people weigh risk twice as high in their mind as an equivalent magnitude opportunity, let me start with risks of not pursuing financial independence aggressively.  It’s unfortunate we’re wired this way but if it helps provide some motivation, then I’ll use it without apology 🙂

Key Reason to Pursue Financial Independence #1

You may lose your ability to generate a good income sooner than you expect.  It’s difficult to envision the future accurately and may people who aren’t saving enough just expect to work longer to make up the difference.  Surveys indicate that about 60% people expect to retire at 65 or later.

Expected retirement age.png

However, the average retirement age is 62.  It doesn’t seem like that big a difference but the last few years of working and saving can make a big difference in your finances.  More concerning is the fact that only 20% of people over age 65 are still working.  There is an irrational gap between expectations and facts.   In a given year, about half the people that retire say it was not their choice.  The top reason cited was health issues.  The second rated reason was being fired.  Even for those in the prime ages of their working careers, with a good track record of performance, being forced out of your job is quite common.  If you are over 50, it can be very difficult to get a new job (often taking a year or more) and it’s often at a salary 20% lower.

The bottom line is that your job and income-making prospects become more uncertain than you realize, especially past age 50 in many fields and companies.  This causes a great deal of financial stress if you don’t have a good nest egg by this point, or some diversified income streams outside your job.

Key Reason to Pursue Financial Independence #2

Financial stress is widespread.  I’ve seen surveys citing 75% of people having stress about money at a given time and 25% under extreme financial stress.

Financial stress is caused by many things and leads to many negative effects but a big one is relationship troubles.  This is quite important as happiness research clearly shows that the quality of your closest relationships are one of, if not the most, important factor for happiness in life.

Financial stress is a leading cause of divorce.  This is a double whammy.  Divorce is expensive so your money troubles only multiply.  It’s also a pretty terrible situation to go through personally.  The most important thing is to agree on your financial plans as a couple.  In my opinion, it’s important to have saving, investing and financial security as a key part of that plan.

To be fair, couples fight over money for a lot of reasons, particularly when one is a saver and one is a spender.  And the spending portion is usually the focus of the fights so it’s important to agree on the spending portion.  If you’re the spender in the relationship, understand that you are likely causing a lot of stress for your partner and putting your joint finances in worse shape than they could be.

But despite the complicated nature of our thinking about money and how it affects our relationships, it’s fair to say there are more arguments, and much more emotional arguments, about money when there is little savings vs spending commitments.  There aren’t too many people who get divorced over money when they are getting wealthy together.  It’s a bit like the fact that there are fewer large-scale, global military conflicts today because all the major economies are so tightly tied together economically.  Everyone has too much to lose by going to war.  I’m not going to argue cause and effect but it’s clear that long-term marriage and wealth are correlated (Hollywood actor, politician, sports star, and CEO statistical outliers not withstanding).

Whether you have stress over job security, retirement, financial commitments, providing for your kids, or other reasons, if you can save well early, your net worth grows and money will be less and less of an issue over time.  You will shift from a feeling of scarcity to one of abundance and little stress in less time than you think.

Key Reason to Pursue Financial Independence #3

Let’s end on a positive note.  The most important reason I can think of to convince you that pursuing financial independence is worth the effort is that it gives you options.  Money is nothing more than a tool.  It’s a medium of exchange for other things.  The breadth of what money can be exchanged for it what gives it so much power and importance.  Hate something in your life?  The amount you travel for work, where you live, time you have to spend on things other than what you’d like because of money?  We all typically know what makes us unhappy.  When you have enough money you can say no to these things.  You have protection from any real or perceived repercussions from saying no to others.  Interestingly, sometimes you even find your perspective changes and you see a positive side to things that you just couldn’t see before, once you realize you have a choice.

In addition to minimizing the negative things in your life, you can make positive changes you would like to make.  You can spend more time doing the things you love and are passionate about.  You can take risks you otherwise couldn’t consider.  You can start your own company, or switch to a “passion” job that pays less (or nothing at all), you can focus on helping others, you can exercise more, or cook more, or spend more time with your family and friends.  You can live in another country, or move to a dream location.  You can relax.

Or you can just make more minor changes to your life knowing that much of your happiness isn’t your circumstances (another important and clear finding from happiness research), but is more strongly tied to your thinking.  Financial independence isn’t necessary for this type of zen but for many of us, it seems to help a lot.

Once you have enough money, it turns out that money is less important in the choices you make.  You are truly independent from the need to earn money and you start to make choices based on other, more important criteria without much regard to money.  It’s then that you realize how big a role money played in your life choices when you didn’t have enough and how much it held you back from other choices you could have made.

And that is why it’s worth pursuing financial independence.

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