When I say “retirement plan”, I’m sure the first thing that comes to mind is what are you planning to do “in retirement”. Most people’s retirement plans start with volunteering and engaging in a special interest near and dear to their heart, maybe spending time with their children and/or grandchildren, or possibly embarking on something more adventurous like seeing all the national parks in the United States?
Yes! That is part of “retirement planning” too but as a financial independence guy my focus is getting you to Financial Independence (FI) as early in your life as possible. What I’m talking about is not waiting until you’re 67 years old and can start collecting Social Security.
For clarification, in my world “FI” is synonymous with “retirement”. However, I will never stop working; developing, improving, evolving, and adding value to the world around me will be my work. But, I can spend the hours of my life however I see fit, on my schedule, and no longer need to concern myself with selling my life to the highest bidder.
If you’re like me, you might see a financial planner, preferably a Certified Financial Planner (CFM), to develop a very impressive roadmap to retirement, which is typically 1-inch thick, with nifty charts and graphs that your CFM updates every year.
These are great, don’t get me wrong, but do you understand what’s in that thing? Do you understand how changing the “input” results in a different “output”? Or are you depending on the magical software and the CFM to tell you when and if you can retire?
And then do you chuck it in the file cabinet and not look at it again until the following year when you see your CFM again? What doesn’t get measured doesn’t get paid attention to.
One of the many things I learned from a career in engineering is that you visualize the finished product, or the end result, and “reverse engineer” back to the present what you should be doing today. Do you think this can also be done with a Financial Indepence Plan?
My mission is to develop a FI plan that each person develops and owns. What I am talking about is simplifying the numbers in a way that it can fit on one page (8.5” x 11”) and provide everyone with a simple roadmap to FI. This “one pager” should be updated every couple months and it shouldn’t take more than 10-15 minutes. Developed by you, owned by you, updated by you.
In lieu of complicated financial software calculations, we need short cuts to help us with doing the numbers. This will be a multi-part blog and I will roll it in to a one page template. Contact me at derek@aviaracapitalinvestments.com for a copy.
“Rule of 72”
This rule is particularly useful for quick and dirty financial approximation. The rule states that if you divide 72 by a particular rate of return, you’ll get the number of years it’ll take you to double your money. This isn’t precise but can be used for ballpark projecting.
Let’s say that you can expect a 8% rate of return from your investment account assuming you invest in a S&P Index Fund; it will take you roughly 9 years to double your money (72/8).
Now let’s say you want to work a little harder, increase your financial education, and have located an investment vehicle, perhaps a value-add real estate investment with a targeted return of 18 %. Now you could double your money every 4 years (72/18).
Now for fun let’s say you have 20 years to invest before you want to start living off your net worth. Let’s say you start with $100,000.
With the 8% index fund you will have roughly 2 doubles (20/9)
2^2=4
$100,000 x 4 $400K
With the 18% real estate investment you will have roughly 5 doubles (20/4= 5)
2^5= 32
$100,000 x 32 = $3.2M
Wow! This is precisely why compounding is so very important.
Do you think your retirement lifestyle will be different with $400K vs. $3.2M ?
This is precisely why Einstein says:
“Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t… pays it.”
And on the subject from Warren Buffett, the most successful investor of all time:
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
So remember, divide 72 by interest rate to get your number of years to double and then take 2 to the power of the number of doubles achieved and multiply by your starting principal. You can do this easily in your head when working out FI scenarios.
In part 2, we will discuss how much you can expect to need to retire, how much income can be generated from your net worth, and many other FI hacks.
Best,
Derek
Derek Petersen
Chief Compounding Officer
Aviara Capital Investments
www.AviaraCapitalInvestments.com
www.linkedin.com/in/derekpetersen
Disclaimer: I am a financial independence guy and a financial freedom hack. I am not a financial advisor, a CPA, or a broker of anything. I recommend discussing financial decisions and/or planning with the professionals.