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Financial Independence for Normal People

51efot8iakl-_sx324_bo1204203200_Discussions around here have focused on early retirement and financial independence with a few assumptions: either you own income properties, own a business, or have a side hustle. But what about the other 95% of the people working their tail off, day in and day out, looking for a retirement plan? For those fine folks I have a treat today. We will focus on normal people and wealth accumulation. We will avoid tax talk because income level and type of income create too many variables muddying the conversation.

You would think it should be simple if you are a wage earner only, but it’s not. There are several choices you need to make to maximize your wealthy building. Accelerating to the early retirement line is straight forward if you know where to start. Without passive income like rental properties you only have your earned income (wages) to rely on. Your passive income will be limited to dividends, interest and capital gains.

Building an Empire

There are two parts to living the Financial Independence (FI) lifestyle: the building phase and the maintaining phase. During the building phase you save like crazy. My recommendation is to save half of what you earn. It is more important than ever to have a high savings rate if you don’t own rental properties or have a side hustle. It will take 16-17 years to reach FI at a 50% savings rate assuming a 5% growth rate and a 4% withdrawal rate once retired.

Here is where I get pushback. Save 50%! That is impossible. But it isn’t. I could go into a series of stories of clients at all income levels doing just that, including clients earning $20,000 or less a year. It is possible. The cable has to go. So does the car if you have a lower income. A bike is a cheap mode of transportation. Soda and cigarettes are off the menu. Of course eating better and more exercise biking will go a long way towards better wellbeing.

And it is all a lie. It will not take you 17 years to reach FI. The 5% growth rate assumption is lower than long-term market averages. I doubt you will have 17 years of subpar earnings growth. Real world experience tells me most people reach FI in 10-12 years when they save half their gross income.

There is another benefit to saving. Taxes. I promised not to talk taxes and I will not. What I want to point out is the tax advantages to savers. You see, spenders pay more tax than savers. A portion of your savings will be in tax-deferred retirement accounts. This means saving half your income will not feel like half your income is gone because your taxes will decline faster. Remember, money diverted into tax-deferred vehicles comes off the top where your highest tax bracket is. When you are done saving you will only pay at lower tax brackets and may qualify for a Saver’s Credit and other tax benefits.


Your Money of Your Life: Transforming Your Relationship with Money and Achieving Financial Independence by Joe Dominguez and Vicky Robin is an important resource for living large with small amounts of money. I read this book from the library years ago and tried linking to Amazon. Amazon does not allow linking. The book is out of print, but you can pick up a used copy. Vicky Robin has a follow-up book shown with a link in this post.

Dominguez and Robin said something in Your Money that always stuck with me. They made two claims: one is that you can live on very small amounts of money and still live well. If memory serves, they lived on $9,000 per year. Inflation had little impact on their long-term spending. As prices increase your spending habits change. If beef prices rise, you eat more chicken or more of some other foodstuff.

The second recommendation they made which couldn’t foresee the future was that you should invest your money in government bonds of the country you are living in. Governments may default on their debts, but usually outsiders take the biggest hit, sparing the domestic economy a further body blow. The argument was you could live off the guaranteed interest forever without worry. They published Your Money in 1999. Thing changed since then.

Government bonds in most countries are safe as long as you only consider the return of your principle as the end of the term. With interest rates zero or lower recently, the bond idea espoused by Dominguez and Robin does not work without additional considerations.

How and When to Buy Bonds

Bonds should be purchased with the intention of holding them till term. Trading bonds is not something I consider. I don’t like bond mutual funds either. When I buy bonds (many, many years ago) I bought Treasuries directly from the government. You can do so online at Treasury Direct today. Most brokerage firms also allow you to buy Treasury bonds at issue without cost and hold the bonds in your account. Either way, bonds purchased should be held until maturity.

If you buy bonds to hold them, the only reason to buy bonds is for the interest coupon or for inflation protection if you buy Treasury Inflation Protection Securities (TIPS). As I write this there is no reason to purchase bonds. None. Interest rates have been low for so long most people will have few bonds in their portfolio if they follow my recommendations.

Dominguez and Robin were only partially right. Bonds are not the path to wealth most of the time, but are a safe store of wealth in some instances. People must invest the bulk of their capital in index funds if they are to reach their goals, especially if they do not have other sources of passive income.

So when do you buy bonds? My policy (and preaching to clients) is to start adding long-term (30 year) Treasuries to your portfolio when interest rates hit 7%. It has been a long time since we saw those kinds of yields on Treasuries of any maturity. Those days will come again. When they do the world will tell you to avoid bonds as risky like they did in 1982. The world is usually wrong.

Once Treasury bonds touch 7% you want a small portion of new money to go into the guaranteed investment. You will get 7% for 30 years, plus your original money back at the end. TIPS are an even better deal. Inflation increases your payout every six months. Nice. And you will get your original money back, plus the inflation adjustment. Really nice.

As yields climb, more and more of your new money goes into bonds. At 10% all new money is invested in bonds. The stock market averages 7% over the long haul, plus the inflation rate. That is why you see long-term equity returns of 10% batted around so much.

If we see a return to the late 70s and early 80s with Treasury yields well into the double digits I would recommend a 50/50 portfolio mix of broad-based index funds and long-dated Treasuries. The steady stream of interest income is state tax-free and will continue for 30 years. A good plan if I say so myself.

Tax-Free Bonds

Municipal bonds are another consideration. I am not a big fan of munis and never owned one that I can remember. The interest rate paid is lower, but is exempt from federal tax and possibly state taxes, too. The problem with munis is they are not without risk. There have been plenty of muni defaults over the years. Municipal bond funds are too risky for the benefits involved for the average investor. If you want some tax-free income from your bonds, a broad-based muni bond fund is your best choice. The issue with a muni bond fund is that for most investors the interest income will be taxed on the state level. If there is interest (no pun intended) (okay, it was intended) I will write a detailed post on the issues surrounding municipal bonds and how to invest in them properly. I have experience with several clients building muni bond portfolios even though I never use them personally.

A Better Way to Invest

To provide blanket advice is a disservice to the readers around here. I give the blanket advice often because it is expedient to do so. Dropping all your money into a broad-based index fund and forgetting it is not a complete truth. Qualified money (funds inside a retirement plan) can take the advice and be satisfied. Non-qualified money will cause some problems on your tax return.

Index funds are an awesome tool for wealth creation and preservation. In the early stages of your FI career the index fund works fine. Once you start accumulating a larger nest egg, the capital gain and dividend distributions begin to cost you tax dollars. There must be a way to mitigate this tax problem and there is.

Once you fill retirement accounts you will have extra money to invest. By default it will go into index funds. As the account grows the taxable distributions grow larger. Somewhere between $50,000 and $100,000 you start to feel the tax pain. Taxes start consuming more money you would rather invest. At this point we need to change our strategy.

51arz4ef3xl-_sx331_bo1204203200_Index funds are too powerful of a wealth building tool to change investment types. Rather, consider tax-loss harvesting using index funds within a framework offer by companies like Betterment. The cost of Betterment is so low even frugal people will be delighted in using the service. By allowing Betterment to do all the heavy lifting, your taxes are lowered so more of your money stays invested. In effect you are diverting your taxes into your investment account. I don’t know about you, but I like that idea. A lot.

Normal People

The process for people without income properties, business, or side hustle is pretty straight forward. I think it takes a slightly longer time to reach FI without some of these traditional streams of passive income, but still doable in a relatively short time. Going from start to full retirement in 17 years or less in the worst of economic environments is exciting to me. Getting there in 10 or so years is more likely and more exciting.

Reaching the finish line happens faster than you plan. As a Dave Ramsey Endorsed Local Provider for years, I saw people with large debts pay them off much faster than anticipated. For some reason the debt payoff accelerates into warp speed as long as you stick with the program. The same applies to wealth accumulation. The folks over at 1500 Days to Freedom reached their goal early, in less than 1500 days. Pete over at Mr. Money Mustache reached retirement by age 30. The Mad Fientist made the news recently for retiring at age 34. Yours favorite accountant hit FI somewhere around age 32. It happens faster than you think.

The above post is a simple outline for living right at every stage of the FI process. Stay on course and your dreams will come true.

Ed Mills

Tuesday 2nd of May 2017

Warm Merida, Mexico greetings Keith. Back in 2009 my wife and I got serious about our savings when we began fully funding our 457, 403b, and IRA accounts. I cannot overstate how much hardcore savings will grow your net worth; it's simply mind-blowing. A nice side benefit of using our retirement accounts was that we usually stayed in the 10% tax bracket (with an occasional dip into the 15% bracket). While most of our money is now in low-cost Vanguard index and target retirement funds, we still have "too much" in cash. It's a problem I can live with for now.

My wife's mother is from little bitty Merrillan, Wisconsin. I love visiting in the summer; it's awesome. The winter is fun, but a little tough on this Georgia boy. One December I did have the pleasure of enjoying a Packer play-off win with the mandatory beer and brats. Thanks for all the posts you crank out. Ed

Mr. 1500

Wednesday 11th of January 2017

Hi Wealthy Accountant! Thanks for linking to me! Also, you have a pretty cool story. I loved this part:

"By the time I was 22 I retired. Sounds insane, but it is true. I bought a home and a beater car and a Huffy bike. I spent my days reading, learning, hiking, biking and taking a few classes at the local college."

I lived in Wisconsin for a while too and loved it there. The taxes and winters were a little too intense for me, but I get back every time I can. I hope your 2017 kicks ass!

Keith Schroeder

Wednesday 11th of January 2017

The taxes and winters are starting to wear on me, too, 1500. I know it is insane, but you can retire just about any age. I did so very young and then found my bliss in taxes. Thanks for reading.


Monday 9th of January 2017

Keith, what would you advise your client to do if he or she is sitting on a large amount of cash or bonds given that market levels are elevated?

Keith Schroeder

Monday 9th of January 2017

The risk is to be out of the market, Todd. The best advice on the market I ever got came from a man named Nick Murray. He said he could not predict the next 10%, 20%, or even 50% move in the market, but he had no doubt the next 100% move in the market is up, not down. The risk is trying to guess where the market is going. Best to stay the course.


Monday 9th of January 2017

Sorry for the multiple questions, but bonds are newer to me. What do you think about Buffett's recommendation to "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund"? It seems like you recommend long term only.

Keith Schroeder

Monday 9th of January 2017

Kyle, I think a portion is cash (bank/short-term bond) is fine. You always need some money available for an emergency. I assumed only money placed in investments.


Monday 9th of January 2017

Keith, are you suggesting a 100% allocation to stocks until interest rates go above 7%? I think that's what you said, but I didn't see you really say it (if that makes sense).

Keith Schroeder

Monday 9th of January 2017

Of the money you have invested, if you don't own anything else (the focus of this post) , then the bulk should be in stock index funds with a small amount liquid for cash flow management (bank/short-term bond). I am not an advocate of investing in bonds based upon age. Rather, I invest in bonds based upon the expected return. Buying any bond today with no real return does not make sense to me regardless of age. I will personally only consider Treasury bonds at 7% or more. I have selectively invested in corporate bonds in the past. Buying riskier bonds to chase yield is something I never do. Stock index funds (S&P 500) is where most money goes until rates are higher. You also might consider alternative investments like Lending Club for a small percentage of your portfolio.