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How far below your means?
Old 01-21-2011, 10:05 AM   #1
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How far below your means?

One of the questions that I am interested in when people here talk about living below their means is: how far?

When Americans have a net negative savings rate, we can all agree that this situation is not it. But are there some metrics and what is practical. For example, could this be measured in terms of gross income. If I save 20% of my gross income each year, am I living below my means? For the vast majority of Americans, this would be an extreme case but I sense (perhaps incorrectly) that this might be pretty standard or perhaps even low for people here. Or thinking of this another way: perhaps looking at gross income is the wrong approach. It may not even be about income because I bet that many people here have a considerable amount of unrealized income from their own businesses (if The Millionaire Next Door is any indication).

Let's think of this differently. What are the key financial metrics (if any) that could be used to characterize LBYM? Personally, I would start with the basic definition that LBYM means no short-term debt. Perhaps not when you start, but when you are actually there certainly. I have been playing with this metrics question because I have not been happy with what I have seen and people (including myself) benefit from metrics.

The Millionaire Next Door suggests a little equation to measure whether individuals are good accumulators of wealth and it measures this using (a) age , (2) current income, and (3) net worth. Its not a bad measure, but its not great either. The overal measure is clearly skewed to make older people look good. The measure is linear in age when it should be exponential, for example.

The ideal metric(s) should be independent of whether you are wealthy or not, of course. Its not about the level of your means, but whether you can consistently produce more than you consume.

The ideal metric may also need to include your effective tax rate or simply look at net income (both earned and other).

I would imagine--again, perhaps incorrectly--that many of the folks here would distinguish between net worth in terms of assets vs. investments. Non income-generating wealth (such as your home(s) might need to be considered as a distinct class).

Thoughts appreciated.
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Old 01-21-2011, 10:14 AM   #2
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Originally Posted by GeoffC View Post
One of the questions that I am interested in when people here talk about living below their means is: how far?
Like all things worth considering, I think .. it depends.

It depends on your personal ER time frame & circumstances. If you want to ER in your 40s, you better save a very large percentage of your take home money. If you have safe pension, your savings rate could be lower to meet the same retirement income. It also depends on how much you need to spend to be satisfied - location, family status, etc. It also depends on where you are in your earnings cycle. In my 20s, I barely saved anything, but in my 40s we were saving a huge chunk of our earnings - way above 20%.

The thing to remember, is that the more you save, the less you spend. The less you spend, the less you need to accumulate before you can meet your cash flow needs with your savings/investments (become FI)

Try out the free version of ES Planner. It may give you some very good insights into how much you need to save to meet your goals.
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Old 01-21-2011, 10:29 AM   #3
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Originally Posted by GeoffC View Post

Let's think of this differently. What are the key financial metrics (if any) that could be used to characterize LBYM? Personally, I would start with the basic definition that LBYM means no short-term debt. Perhaps not when you start, but when you are actually there certainly. I have been playing with this metrics question because I have not been happy with what I have seen and people (including myself) benefit from metrics.

The Millionaire Next Door suggests a little equation to measure whether individuals are good accumulators of wealth and it measures this using (a) age , (2) current income, and (3) net worth. Its not a bad measure, but its not great either. The overal measure is clearly skewed to make older people look good. The measure is linear in age when it should be exponential, for example.

The ideal metric(s) should be independent of whether you are wealthy or not, of course. Its not about the level of your means, but whether you can consistently produce more than you consume.

The ideal metric may also need to include your effective tax rate or simply look at net income (both earned and other).

I would imagine--again, perhaps incorrectly--that many of the folks here would distinguish between net worth in terms of assets vs. investments. Non income-generating wealth (such as your home(s) might need to be considered as a distinct class).

Thoughts appreciated.
Are you from the Boggleheads forums? I don't visit it but I get the impression they like to debate how many angels can fit on the head of a pin and like to over complicate issues.

LBYM is a tactic the last step in planning. The next to last step are the strategies you will employ. The metric or measurement you are looking for is a strategy. The metric you establish supports your goal; the first step in the process.

First you establish your goal, then strategy and finally your tactics.

Simply stated LBYM is spending less than your income. it varies according to the person's personal situation, strategy and goals. It does not mean you can not have short term debt. If 24 year old just out of college needs a car for work then having short term debt is OK. If a 65 year old needs short term debt for a car might indicate a problem.

So, to answer your question. What is your goal, strategies, tactics, personal situation and time frame, etc?
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Old 01-21-2011, 10:40 AM   #4
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The Millionaire Next Door is one of my favorite books.

I'm attempting to answer your question on a simple level. For me, living below my means meant "basic" food, clothing, shelter, and transportation. We ate out only as a rare occasion. Clothing was minimal - three pair of slacks, five shirts, and a pair of black and a pair of brown shoes for work. I bought an $80,000 house in a nice neighborhood instead of a $300,000 house (which the numbers showed I could "afford") in an upscale neighborhood. I drove good used cars I kept at least 10 years. I kept a small percentage of my paycheck for consumables, an emergency fund, and saved the rest. All pay raises went to my 401K. Once I got within five years of retirement I started living as if I was already retired. That's when I knew financially independent retirement was possible.

Living in a modest house avoided the additional expenses of a larger house. I didn't have to get more furniture to furnish a larger house plus I avoided the additional upkeep, utilities, and higher property taxes. My neighbors didn't care I drove an older car.

When it came time to retire (me at 55 and spouse at 50) and move to the ranch we were financially independent and debt free. Once we retired we had the money and the time to see and do the things that were important to us. That was only possible because early on we were frugal. We're still cautious with our money. Every dollar spent has got to have at least a dollar value (sometimes subjective).

I applaud you trying to put your hands around this and create some kind of concrete logic that will guide you through the process. You can run all the calculations available to you and hope there's some sanity and reasonableness in them. Retirement and financial independent are very personal.
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Old 01-21-2011, 10:44 AM   #5
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Metrics aside - don't let the numbers keep you from accelerating your savings. Paralysis by analysis as they say.

Based on a number of threads, you'll find that quite a number of us here are super-savers. For a number of us blow-hards die-hards, saving in the range of 50% or somewhat more of our gross income is common. In my opinion, the actual method of how a savings rate gets counted is less important than the will and the implementation of a serious savings plan.

Perhaps when saving up to buy a house, or just after that the oppressive mortgage limits savings. But as the mortgage becomes manageable savings can accelerate.

Once you decide that you don't really need the newest car, the designer clothes, and all the other useless crap things, your savings can accelerate.

really, what you need to decide for yourself is that the cost of all that stuff is your lost freedom, lost peace of mind, and lost life satisfaction. And that cost just may be way too high.
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Old 01-21-2011, 10:57 AM   #6
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This is so personalized there is no single answer. For someone that makes $40,000 they obviously will have difficulty with a 20% savings rate. For another person who makes $150,000 it is a totally different story- you could conceivably live on 1/3, with the rest towards taxes and savings.

Also, how you determine your net worth is individual. There certainly were tons of people who had as part of their retirement plan a very expensive house that they planned to "downsize" and retire on the profits. Well, that didn't work out so well for many people.

For our income level we tended more towards the scenario East Texas outlined in our spending and saving model. Bought way less house than we could afford and stayed put and paid it off early. Avoided paying interest on anything. We did splurge on travel but for that I have no regrets.

Just decide what each hour in a cubicle nets you in take home pay after taxes, childcare and other work expenses. If say this is $10 then put into perspective when you go to buy something for $35 - is this worth 3.5 hours of work.

A funny story, when I was at the end of my worklife I had a 10 year old basic standard Honda. People would sometimes ask me when I was going to get a new car. Well, using the example above I figured I would have to work most of a year to get a brand new car. When I walked out at age 52 some people were astonished. Recently I met up with some ex-coworkers and I drove up in my old car, now approaching 15 years old, although I did have to put several thousand dollars into it, but insurance is really cheap and it gets over 30 mpg. Some of them still didn't get it and someone actually said "I can't believe you still drive that old thing."
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Old 01-21-2011, 10:58 AM   #7
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As others have said or implied, defining living below your means is, well, meaningless. What you need to be concerned with is what your goal is and what you need to do to get there.

There are lots of on line calculators that will help you figure out how much you need to save to have a certain amount of investments by a desired retirement age.
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Old 01-21-2011, 10:59 AM   #8
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By the way we did the RE thing with no business, no rental income. Just plain old go to work for the man and spend less than you make.
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Old 01-21-2011, 11:09 AM   #9
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For example, could this be measured in terms of gross income. If I save 20% of my gross income each year, am I living below my means? For the vast majority of Americans, this would be an extreme case but I sense (perhaps incorrectly) that this might be pretty standard or perhaps even low for people here..

I save 35% of my gross...this year, last year & the year before. It's a little tight. Wife saves 20+% of hers as well. Together we only grossed $85k last year, and we're living in 2 separate places for almost 2 yrs now, so yeah...it's a little tight! But, it's doable & we still manage to dine out. Why does this work? Because other than a $139 zero-interest car payment, we have NO debts, besides living expenses. Being debt free is not "overblown", it's the key to the whole thing, afaiac (as far as a I am concerned). We'll stay that way from now on.
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Old 01-21-2011, 11:09 AM   #10
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I don't think GROSS INCOME is the right number for the denominator. I can't possibly save more than my income after certain deductions (taxes, FICA, any mandatory insurance premiums, etc).

Take home pay isn't always a good number either, if you have deductions for 401K, etc, those are savings also.

Anyway, the number will vary depending on your where you are in life. Just starting out, you may have low income and lots of start-up expenses. It's just a matter of considering what you value from time to time. Save as much as you can (regardless of the number), while still buying what you value, while not going into debt. I'd track the savings to see if I'm meeting my target (can I use that word?), the % seems irrelevant.

If you find you can't save much/any while buying what you consider to be of value, you either need to reconsider your consumption/income values, or reconsider how important funding a retirement is to you.

-ERD50
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Old 01-21-2011, 11:12 AM   #11
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When I was in the accumulation phase, I really didn't know or care what anyone thought was LBYM (didn't even know the phrase back then). I determined what I expected of myself and challenged myself to meet those goals and improve on them. I always maxed out my TSP contributions, and tax and medical insurance was also deducted from my paycheck too. After that, my own method was to divide my take-home pay into thirds. One third could go towards housing and related expenses. One third could go towards other expense. The last third was to go towards my future. Early on, this meant paying off my debt. After that was done, this was the foundation of my nestegg. I would have been seriously disappointed in myself had I not done this, and most months I crammed more than a third into the portion dedicated to my future (thinking "Hah! Take that, world!").

My point is not that my method is something to emulate, but simply that we each must devise a plan for LBYM that WORKS for us and will get us to the goals we have in mind at the speed that we have in mind. Nobody is grading us on our performance but ourselves. On the other hand, devising and implementing a big plan like this successfully and reaching one's goal as planned can be very satisfying.
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Old 01-21-2011, 11:16 AM   #12
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My goal was a lifestyle in retirement that matched my last few years of w*rking life, plus a little for added activities like travel. I would say meeting that goal is living at your means. If you end up leaving an estate that could have supported a more expensive lifestyle well past 100 years old, then you have lived below your means. If you run out of money before you die, or have to reduce your lifestyle due to financial concerns, you have lived above your means. The problem is figuring out how much money you'll have left when you die, and how much safety margin to maintain for the uncertain future.
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Old 01-21-2011, 11:19 AM   #13
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To me LBYM definiton is that you spend less than you take in over your life time. The rest is as stated a personal in the calculation will be different for everone based on their needs and goals. For my DW and I of 14 years we both work and have managed to the following rule for the past 10 years and lived for the most part with the stuff we felt we needed. Spend 1/3 ,Save 1/3 ,taxes and gifts 1/3 of our annual income. Clearly we could spend more however meeting our ER goal is more satisfying to us than more stuff. Our net worth we feel should provide us income we need to cover our needs and goals in retirement based on several calcutors including FIRE. We plan to ER in 16 months at 51 and 53. Some would say were are financially rich some would say we are not. For us financially rich means we have enough to meet the needs and goals we have in retirement. So in my own world I feel we are rich. At some point we had to come to a conclusion has to how much $$ was enough and the calcutors and the post retirement expense budget planning help us derive how much was enough.
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Old 01-21-2011, 11:20 AM   #14
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This is one of those 'I don't have a clue' questions. I think we LBOM's, as we arrived at retirement with enough in pension, SS, and savings to make it to the end. However, we never thought of it as LBOM's.

We had our savings goals, and we made sure we met them. i.e. the old pay yourself first. After that we lived life! We bought what we wanted when we wanted without using debt. When we arrived at retirement, we did not feel as if we gave up that much to get here.

I am a big proponent of you need to enjoy the trip as well as the destination!
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Old 01-21-2011, 11:32 AM   #15
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If you want a metric, try this . . .

Using the annuity formula you can replace the Future Value with (1 - Savings Rate) / (Withdrawal Rate). From there you should be able to solve for any variable in the equation . . . i.e. how many years will it take me to retire given a specific savings rate and annual return, what savings rate do I need to retire in a given number of years, etc. etc.

If you run the numbers with your given savings rate and conclude it takes too many years to reach your goal, then you're not saving enough.

Of course a detailed spreadsheet model is better, but what you wanted was a metric.
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Old 01-21-2011, 11:37 AM   #16
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If you spend less than you bring home, you are living below your means. But that may be insufficient to retire early. The earlier you want to retire, the farther below your means you have to live. We had to save 54% of our net income on average over our working careers to reach financial independence in our mid 30's. Last year we saved over 73% of our net income. Granted, a high income helps tremendously. Living on 25% of $400K is a lot easier than living on 25% of $40K. At any rate, save as much as you can, as early as you can, and you probably won't have to worry about metrics.
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Old 01-21-2011, 11:39 AM   #17
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No disrespect intended, but I'm not sure what the purpose of a metric would be. Why would anyone care what anyone else does numerically (I've published my % before, but stated 'who cares' in that post too)? What's possible at $40K/yr and $150K/yr would be very different as pointed out above. On the other hand, if you make $1,000K/yr and save $500K/yr, it's clearly LBYM but not in the spirit as I know it. LBYM is not just numbers IMHO.

To me, LBYM is simply saving all you can, but that's highly personal. I guess I'd arbitrarily say one must consistently save at least 20% of income to be considered for the "LBYM club" - but that's just an opinion anyway.
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Old 01-21-2011, 11:45 AM   #18
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Old 01-21-2011, 11:49 AM   #19
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I started working full-time just before I turned 21. By the time I was 22 I was saving at least 20% of my income despite only making ~35K/yr. Now, at age 31, i've paid off my mortgage and have no debt. I saved 8% pre-tax and 60% of my take home pay last year. I only made $48K gross. I expect to save well over 50% of my income from now on even though I still make under $50K/yr and won't increase faster than inflation.

There is no right answer. You need to decide what your goals are and save what's needed. That may be 10% or it may be 75%.
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Old 01-21-2011, 11:55 AM   #20
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Are you from the Boggleheads forums? I don't visit it but I get the impression they like to debate how many angels can fit on the head of a pin and like to over complicate issues.
So unlike the discussions we have here

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