When I first started taking control of my personal finances and planning for early retirement I thought investing was the number one thing that I needed to figure out in order to retire early. I would read personal finance articles on yahoo, or othe news sites and they would constantly post articles that had some variation of a title that read “How to save 1 million dollars by the time you retire”. I thought that was the only thing that matter when it came to retirement savings.
While I have always largely believed in passive investing through index funds, I would be lying if I didn’t admit that part of my plan to retire turned into finding that one fund, asset class, or investment that was about to outperform the market. Then I would put a portion of my portfolio into it and reap the rewards of being smarter than the market. I thought that even if I only used a small portion of my portfolio (5% or less), I would do so well with these investments that I kept finding, that it would propel me into early retirement and financial indepdendence. So I started developing these forecasts of my portfolio that included finding that one lucrative investment, and was focused on how that one investment would impact the value of all my accounts at different potential retirement ages. I was more interested in seeing a retirement forecast showed that I had $1.5 or 2 million dollars in it than anything else. I figured with that kind of money I would be able to retire no matter what.
Then about 18 months ago I had a wake up call. I had been reading the early retirement forums for a couple of years and every time someone would introduce themselves and list their assets and ask if they had enough to retire. Every single time this happened there was one question that would be asked in response: “What are your expenses?” And funny enough, despite hearing that time and time again, it took me a couple of years to actually “hear it” and look in the mirror and realize that I had some housekeeping to do in my own financial life. It wouldn’t matter how much money I had in my retirement accounts if I wasn’t managing my spending. I could have $10 million dollars in assets, but if my annual spending is $1 million dollars year per than it’s highly unlikely I was going to have enough to sustain a 20-25 year retirement. In fact, I probably would only have enough for 10 years of retirement. While this is an over simplification, it paints the picture of a key factor in the retirement equation.
This was an intriguing for me. I started to wonder if it would be a good idea to start tracking my expenses, if for no other reason to give myself comfort and reassurance that what I thought I had been spending (in my head) matched reality. I had always assumed I had a pretty good handle on what I was spending, or perhaps I should say I assumed I had a good handle on what I thought I should be spending. I knew how much money I was bringing home and what I was paying monthly for rent, student loans, and utilities. That gave me a general idea of how much I had left over to allocate for food, entertainment, gas and things like that. And I had a pretty good idea of what those things should be costing me. I knew I overspent a little bit on food, but probably $20 or $30 a month. Certainly not more than that.
What I found shocked me. As a single person, I was spending between $500 and $600 a month at the grocery store. Probably another $50 on fast food. I was dating my wife at the time and we had just moved in together so I also looked at what we were spending. The results terrified me. We were spending between $1200 and $1400 a month on groceries and eating out. I also realized that the overspending was more my fault than my wife’s. I was the one spending more money at the grocery store, and in many cases wasting food.
This also changed my outlook on retirement planning. I stopped worrying so much about finding that one investment that I was going to make with a small percentage of my portfolio that was going to beat the market. Part of the reason that had been so interesting to me was that it was fun and it made me feel like I could control how quickly I could accumulate enough money to reach financial independence. While I really do enjoy trying to find that needle in a haystack stock, mutual fund, or ETF that will outperform the market, I knew it had a low probability of success, and that the stock market is completely out of my control. Ultimately, it was a lie I was telling myself to help me feel like I could do more than I really could to reach financial freedom. On the other hand, managing my day to day, week to week, month to month spending was something I had complete control over. And if I could continue to get my spending under control, that could impact my savings rate, the only other factor that would influence the size of my investment portfolio that was within my control. Increasing savings rate through reduced spending also had the trickle down effect of reducing the amount of money I would need to reach financial freedom because lower spending means lower withdrawals from my portfolio.
There was something very liberating about this realization for me. No longer was (or is) it about investments. I know what I want my asset allocation to be. I know that I am going to rely on passive index funds. I know that I may take a small part of my portfolio to invest in stocks for fun. What the returns on those investments are is out of my control. Instead I can focus my energy on something I can control that will ultimately probably have a bigger impact on my ability to reach financial freedom: my spending. And that helps the days to financial freedom go faster because I know that when I am making decisions its actually making an immediate impact on my plan for financial independence. Even the small ones like whether or not to buy that latte. If I am thinking that through and making a decision not to buy that latte because it isn’t something that really adds value to my life then I am moving closer to financial independence. Not so much because I saved $4 on the latte, but because I have changed my behavior and made a decision that better aligned with my value system. And at the end of the day that’s what financial freedom is largely about – building a lifestyle to better align with what we care about what we value. So step back, enjoy those investments and savings. But also take a hard look at your spending. Because in the long run, there’s a good chance your spending is going to have more of an impact on your ability to reach financial freedom than your investments, and its something you can integrate into you daily living that gets you a little bit closer to that ultimate goal of financial freedom.