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I want to touch on an important subject today, something called the biggest lie of personal finance. You will often read success stories from people getting rich by tracking their expenses and having a budget or doing some simple things.
However, these stories often miss some critical context. In practice, you will not get rich simply by spending less. You may save more money, but this is quickly limited, especially in such an expensive country as Switzerland.
So, I want to discuss the problems with this biggest lie in personal finance.
If you are reading personal finance blogs and news, you have probably read these kinds of stories:
- 38-year-old retiree: America, stop wasting your money on these seven things – if you want to retire early
- Live by these five rules and become rich
- Our six steps to retire by 40
There are tons of stories like that on websites like CNBC, Forbes, and Marketwatch. But this does not mean any of these stories are good for the readers.
They all talk about how everybody can get rich easily by following a few simple rules. The simple rules or habits generally are tracking your expense, budgeting, focusing on your financial freedom, and cutting down on spending. They often refer to the theory that just cutting down your daily coffee will save you so much money.
The problem is that most of these stories miss the main points: people do not retire very early by spending less – people retire very early by saving a huge portion of their income.
We have seen before that your savings rate is the driving factor for the time it will take you to retire. And there are two ways to get a very high savings rate:
- A very high income
- A very low level of expenses
Many early retirees in the United States are living in a trailer or have 300K USD or more in income when they retire. Neither of those things is something that everybody can do.
So, why do these blogs and news outlets share these stories? Simply because they sell! People want to hear that things are easy and they can get rich without doing much. If you tell people that it is hard to retire at 35, they will not like it. And websites only want to write about things that make their readers happy.
Income is a crucial factor
Many people do not want to read this: Income is an essential factor to reach financial goals.
Optimizing your expenses is excellent, no doubt about this. But you quickly reach a point where you cannot spend less without living in an RV or in the woods. Many people do not want or cannot live like that.
So, if you want to increase your savings rate without decreasing your expenses, you only have one choice: increase your income.
Unfortunately, increasing income is not as simple as reducing expenses. And some jobs indeed have more opportunities than others. That is not to say that people cannot increase their income. However, increasing income is easier in some careers than in others.
There are many ways to increase your income:
- Focus on your career
- Develop a side hustle
- Invest in bonds, stocks, or other assets
Ultimately, it mostly boils down to building your human capital and investing in income-generating assets.
Most people do not have money to save
Another problem with saying people can become rich by spending less is that most households save very little. Sure, they could cut their expenses a little, but the capacity to lower their expenses is extremely limited.
I looked at savings statistics from The Federal Statistics Office (FSO). I am using data from 2015 to 2017, the latest available for the data I am looking for.
This graph shows how much each 20% of households save, based on their gross income. We can see that 20% of the population does not save money in a month. And the next 20% save less than 200 CHF per month. 60% of the households in Switzerland save less than 1000 CHF.
Asking a household with less than 4500 CHF in Switzerland to accumulate 1.5 million CHF by age 40 to retire early is just unreasonable. To retire early, such a household would need to spend extremely little. They would need to spend so little that they could not live in Switzerland.
But people will argue that people are not careful with their money. And it is entirely accurate. Most people are unaware of how much they save and how much more they could save.
But let’s look at another statistic, the free income of these same households. The free income is how much you have left after mandatory deductions, taxes, and mandatory health insurance.
We can see that most households have a significant amount of free income. But at this point, they have no places to live, nothing to eat, and nothing to wear. At the very least, you will need 1500 CHF to live in Switzerland, which is very low. We are talking about the bare minimum to survive, not live.
So, our 20% household that earns less than 4530 CHF, with a free income of 2249 CHF on average, removing 1500 CHF to survive, would have about 750 CHF left. So, the best savings rate they could achieve is about 24%. Based on the 4% rule, this would take about 32 years to achieve “early retirement”.
And again, that is with barely surviving and not counting any insurance, health costs, no leisure, and no transportation. This is an unrealistic lifestyle.
Even the next bracket would only save about 44% by barely surviving. But if we take what they spend (based on the statistics), remove everything that is not necessary, and remove 20% of that total (assuming they can save more), they would only get about a 27% savings rate.
Even doing the exercise for the third bracket would give a 32% savings rate. This is not necessarily the best they can achieve. Some people can save more than that. But again, it depends on the lifestyle you want. And we are talking here bout necessities. I have not included leisure, going out, or even communications as a necessity.
Also, I have considered that people can cut their expenses by 20%. For most households, this is already difficult.
Let’s take our expenses as an example. We are not big spenders but also not minimalists. Without taxes, we are spending an average of 4500 CHF to 5000 CHF per month. Considering such a lifestyle, you would need at least 10’000 CHF of net income after taxes to retire in less than 17 years. And this is with a perfect track record.
Having such an income generally means a few years of study. So, lets’ say starting work at 25, having an average savings rate of 50%, would take you a retirement of around 42. It is not bad, but also not early enough to be on the news. And once again, this is with consistent savings and investing over 17 years, something most people can’t achieve.
These results show that you need a significant income to become financially independent (or rich) early. And this also shows that extremely early retirement needs a very high income or surviving on basically nothing (living with your parents or in an RV helps).
Getting rich is pointless
It is also essential to realize that getting rich is pointless. Having a million dollars will not change your life in one day. Many people think that becoming rich is what they want. But most people can have a great life without being rich. And being rich will not make people happy.
What matters with money is that you have enough money to not worry too much about it and live the life you want.
I want to achieve financial freedom to be independent of my day job. This would bring me security. But achieving this goal will not change my life entirely.
If you are living a sad life now, becoming financially free will not make you happy suddenly. Many people have discovered after early retirement that they were happier before. And many people have burned out on their trip to financial independence because they focused too much on their end goal and not enough on their current life.
It is essential to realize that early retirement or getting rich is difficult. And in fact, it may not even be possible for many people. This is not great, but this is the state of things.
Too many online articles perpetuate the lie that early retirement results from a few good spending habits or a good budget. But in fact, it all boils down to either having a huge income, which many people will not have, or having an absurdly low level of expenses (think living in the woods), which many people would not like.
There are no secrets to becoming rich! What matters most is building your human capital and investing in income-generating assets. Reducing your expenses is less important.
I am probably guilty of making several of my articles too optimistic about early retirement. Please let me know if you feel like this, and I will try to amend these articles. I have never considered early retirement easy. Early retirement is simple but far from easy.
I also do not want this article to be too negative. Most people spend too much and do not realize it. Cutting your expenses will help your financial goals. Depending on your goals, it may even be enough. But do not leave income out of the equation.
The term “Biggest lie in personal finance” was coined by Nick Maggiuli, a famous blogger. I recommend reading his article on the subject if you want to know more.
What do you think about this issue?