This post will cover both our 2016 progress as well as a look at the last 10 years from a financial perspective. I started tracking data more carefully 10 years ago so this is a perfect time to do a decade in review. Our total financial journey has really been 15 years since graduating and starting work but I’ll focus on the last decade where I measured things more carefully. A key point of this post, in order to help inspire those that are early in their financial independence (FI) journey, is to show the magic of what happens near the end of a many-year journey of saving aggressively and investing. At the final stages of “accumulation” is where your net worth increases a lot each year. It’s a fun place to be and is the reward for saving a high percentage of income over time and investing it in appreciating assets.
I’ll cover our numbers in a relative way, using % values since the absolute values are less important than the % values because everyone has different incomes, expenses, and life plans. What % values do I mean? This is the % of your income that you save, the % you have invested in good investments, the % gain on your portfolio, the % of your annual expenses vs your portfolio, etc. Whether you are a high spender with a high net worth or a lower spending with lower net worth, if these % values are the same, you are equally financially free.
So how was 2016?
For us, 2016 was a very good year financially. Our overall net worth increased a significant 30% which is a very high number late in an FI journey. This is largely because of a sizable income increase in the last few years but also because of a good return on our investments. However, this is not the most our net worth has increased on a percentage basis. For example, it increased 82% during the 2009 stock market recovery (we stayed fully invested throughout the financial crisis). And in many of the earlier years, our net worth increased this much or more since our overall net worth was relatively low in comparison to the amount we were saving from our incomes. But a 30% gain at a point where our net worth is high means that the actual dollar amount of our increase this year set a new record.
As I’ll explain more later in this post, even though our investments did well, the majority of our 2016 gains, at 60%, came from savings while 40% came from investment gains. Generally you’d see investments having a bigger impact at this point in the FI journey but our incomes have gone up recently, allowing us to save even more. As you can imagine, this makes it harder to call it quits but I’m not complaining. It’s a nice “problem” to have.
Savings this year were very high. This is due to mostly to a high income relative to spending. Interestingly our spending has remained relatively constant for the last 10 years. Over the years, how we allocate our spending has shifted significantly but the actual amount has remained surprisingly constant (I should note that I don’t include unusual large expenses like a vehicle replacement or new roof since I’m interested in tracking and managing our core lifestyle expenses).
In the early years, we didn’t have kids and while we spent a bit more on travel and going out with friends, the main difference was mortgage interest payments (I only count interest payments as spending, not principle since that is savings). We aggressively paid down the house and while expenses increased when we had our first child (2009) it didn’t change much when we had our second (2011). You can also see a temporary blip up in 2014 from a relocation. But overall, increases in some areas have been offset by decreases in other areas, leading to a surprisingly constant spending over the last decade.
During this ten year period, our income steadily increased from the common “cost of living” increases and promotions. As mentioned in Save Yourself, this is particularly powerful over time when your starting point is already spending much less than your income (as long as your expenses don’t increase with income increases over time).
Since your spending is the only part affected by inflation, but your total income is used for cost of living increases, each year you get to bank the difference, increasing your savings easily. Over many years, this adds up a lot.
In addition, the effect of inflation can also vary a lot. In our case, if I simply use inflation (even the low amounts we’ve seen recently) to project how our spending should have increased over the last ten years, we should be spending a lot more than we are. And this includes having two children along the way and moving to a higher cost of living area. So in reality, our personal inflation level is much lower than actual inflation.
This is mainly due to becoming more conscious of the link between spending and happiness, naturally leading to spending cuts in various areas over time with us barely noticing. So this gave us an even bigger boost in savings.
The other major income increase components are from promotions as we gained more responsibility in our jobs. In my case, income has increased quite a bit the last few years. By avoiding lifestyle inflation, our % savings increased a lot and without any pain. We currently save ~70% of our net income, or 50% of our gross income. If I take just our gross income, 30% goes to taxes (yes this is a lot but our incomes are high and we no longer have a mortgage deduction), 20% covers our expenses, and 50% is saved. This still leaves us with a nice level of spending that we feel provides a very nice and comfortable lifestyle despite the fact that we spend a lot less than most of our social circle from work. We are fortunate to be in this position and we certainly realize this.
The other 40% our 2016 net worth increase came from our investments. Overall our investment gains were 13% vs the S&P 500 at 11%. This was despite allocating nearly 20% to cash this year to give a cash cushion for a potential early retirement.
I built this cash cushion as part of a “sequence of returns” risk mitigation action which is important in the late stage accumulation period and early retirement years. I won’t go into it here but if you search the web, you will find some good information on sequence of returns risk. I also set aside cash for some expected expenses in the next few years including relocation, new roof, and vehicle replacement.
At the same time, some aggressive investments, particularly in emerging markets, helped boost returns above that of the S&P 500 despite this performance drag from 20% cash. Since we have been saving and investing for many years now, we have a decent portfolio so a 13% gain means real money!
When I review results over the years, it’s quite evident that stock investments (which is our primary investment vehicle) are very volatile. So while our net worth increase has gone surprisingly according to plan over time, this is mainly due to our consistency in savings. Our investment contribution to our net worth has actually been very close to predicted over time but the year to year variation is extremely large as you can see below.
It’s important to remember that each year, the stock market is usually very far from the average return numbers. It’s quite common for annual returns to be +/- 20% to 30%. You have to be mentally aware of this and able to accept it. But our results, even through things like the 2008 financial crisis which you can see clearly on my plot at age 34, over time has given us consistent gains around 8% year over year when averaged out, just as you might expect.
Savings and Investments Relative to Spending
What is really cool about being in a late-stage accumulation phase is that the increases in net worth often are large relative to spending. This is certainly the case for us this year and it’s a fun place to be. Our savings this year were enough to cover about 4 years of our expenses. Our investments contributed an equal amount for a total net worth gain equal to almost 8 years of expenses. This is a really nice gain for a single year.
We’re even more fortunate than that because 25% of our spending is for daycare, which we would no longer require if my wife or I retired. On top of that, we’re one of the few that will get a pension from our work (which we can actually collect at any time vs waiting until a later age). If I factor these in, even with an expected increased cost of health insurance, this year’s progress is equivalent to about 13 years of living expenses. Pretty incredible for a single year and the type of thing that is possible near (or beyond) an official financial independence point.
It’s important to note that this isn’t due to a huge investment gain. 13% is quite high and certainly more than anyone can expect over time, but it’s not an unusually high yearly gain in stocks. The personal wealth gains here are from a powerful combination of increased incomes, continuing low expenses, and investment gains once a large portfolio has been saved up. For many of you early in your FI journey, you can look forward to a similar situation in the late stages of your journey, even if it seems hard to believe right now. My wife and I certainly wouldn’t have believed you if you told us we would be in this position by our early 40’s. Keep the faith!
Some other interesting analysis
I’ve looked at our progress over time in a few ways and you might be interested in a few other findings. Here are a few that I think are relevant and helpful to those on their own FI journey.
- Savings is king. Despite a high risk tolerance supporting a nearly 100% stock allocation (up until this last year), which has paid off nicely, our net worth gains were still dominated by savings, not investment gains. Overall, 70% of our wealth has come directly from savings.
Spending a lot less than you earn is the key to wealth. There is no getting around this. This should be considered the first law of financial independence.
- Investment gains do matter though , especially later in the journey. Even though savings is the dominant way to gain wealth, investments help a lot to protect and further grow your wealth once you’ve collected it. 30% of our wealth came from investment gains. This is a significant boost. This is equivalent to years of work in your FI journey, regardless of whether you’re planning to work for 10, 15, 20 or more years. The longer the journey, the more it matters. It’s critical to learn about and become comfortable with investing because investment gains will likely determine whether you financially succeed in a very long retirement once you stop bringing in an active income. The biggest financial risk for (early) retirement is long years of inflation. Investments that outpace inflation over time are the only way to protect against this risk. It’s not short term volatility that matters, which is often erroneously focused on by individuals and financial planners as risk.
- Early in the journey, % net worth increases tend to be large, because the $ amounts of net worth are small. This is particularly true for those saving a good % of their income. Later in the journey, depending on how much your income has increased, the % will decline but the absolute $ values are high. It will also become more volatile, assuming you have more volatile long-term investments like stocks that fluctuate each year.You can see from this plot (green line) how volatile our % net worth change per year has been over time, due to the volatility of our investment returns since we have been almost 100% invested in stocks over this time. However, the actual net worth increase has been a much smoother increase over time due to the significant role that annual savings (and keeping expenses under control) has had. The upward trend is powerful and consistent if you look at a trend of several years. In our case, our average yearly net worth gain has been 25%. This is pretty crazy but it’s possible for those that save a large % of their income. As mentioned before, ~70% of this gain, or 17% of the yearly wealth increase, was from direct savings. The other 8% was from investment gains, which is a reasonable long-term gain for someone 100% invested in the stock market.
As a side note for astute readers, it looks as though we just achieved financial independence this year based on the standard 4% rule (equivalent to the number 25 on our investments vs expenses ratio in the plot above). However, I’m not including the pension I mentioned before or the fact that 25% of our spending is on daycare that we would no longer need if at least one of us was no longer working so in reality we passed the FI point a few years ago.
For reasons I touch on in Extreme Rebalancing, I also believe a 3% SWR is more appropriate than 4% for early retirees to target (this would be 33 on the plot above). I don’t think it’s necessary to be any more conservative than that. We happen to actually be near a 2% SWR but this is not because I think it’s necessary. It’s for other reasons, including that our current high incomes are a bit tough to walk away from especially given the fact that we generally like our jobs (especially now that we don’t need them!).
If I aggregate all this together and look at our net worth progression over time, I find a surprisingly consistent, rapid increase in net worth. Despite the volatility in investment returns each year, since our net worth gains were determined twice as much from our savings, upward progress was relatively steady and smooth. The plot below shows this well. It also shows the exponential progression. This is due to investment returns being exponential but also the effect of an increasing savings amount over time due to increasing incomes while expenses stayed constant.
So certainly 2016 was a good year. But more importantly, following the key tenants of the FIRE community of living well below your means, and investing well, really works. It has certainly worked for us and I’ve seen it work for many others. The math is solid and will work for anyone that is able to save a large % of their income, with this % determining how fast your nest egg grows in relation to your expenses.
In our case, I admit it’s easier since we have good incomes. At the same time, our jobs are quite demanding and many colleagues get burned out or fired at a relatively early age so I’m very glad we prioritized financial independence and now have relatively low stress about our work.
Despite feeling like we were being too frugal at times early in the journey, over time it got easier and easier to the point where we were saving a lot of money with much less effort. It was at this point we started feeling a happy abundance mindset instead of stressing about how competitive and hard life was. This was a very nice transition that we’re still in the midst of and without the many years of saving and investing, we would not have this great reward.
I hope this personal case study brings some benefit of perspective in your own journey. In particular, I hope it gives those considering FI or early in their own journey, encouragement that it both works, and is worth it.
How many of you can relate based on your own experiences? How many of you have a different experience? Please share your comments on similarities or key differences and add to the community!