This habit is crucial if you want to achieve financial freedom. In order to save money by definition you must live within your means. You will always strive to keep your expenses below your income. If this is not your money mindset then you must change your mindset as soon as possible. This one concept will give you emotional control over your spending and free you from a life of financial stress. This mindset will drive you to generate enough income to meet your necessary expenses and your other spending needs. It will give you the discipline to avoid unnecessary spending when income is not sufficient. It will cause you to keep a financial cushion at all times and that will give you peace of mind and cover unexpected expenses in times of unusual need.
Some children are taught the importance of this concept from an early age and adopt it into their value system and philosophy around money. They have a great head start on the road to financial independence and freedom. Unfortunately, most people either do not hear this message when they are young, or they fail to abide by the principle when they gain decision power over their own finances. Advertisers and marketers in particular have great understanding of human nature and are extremely adept at getting people to believe they want or need certain products and services. There is a natural human tendency to compete and seek social status, and if you are susceptible to this influence like most, it can easily cause you to purchase status enhancing things that outwardly convey wealth and success, even when they are beyond your means to afford. This is particularly true when it involves use of credit, which is a necessary and useful part of the economy, but a sure and fast way to set your finances back for years if you do not understand its wise use. Borrowing to enhance comfort and social status is generally not a good idea. We all need shelter and transportation, but these are two of the biggest misuses of credit which overextend the borrower and create ongoing financial hardship, increased life stress, and overall reduction of freedom and autonomy.
It is certainly reasonable to borrow money for the purchase of a primary residence, particularly one that is likely to appreciate in value over time. Often credit is also necessary to leverage the purchase of reliable transportation, particularly when it comes to commuting for a job or other income source. However, keep in mind that houses and cars are two of the most common status symbols that cause people to overextend their borrowing, and result in disproportionate loan payments for years to come which create budgetary hardship, loss of flexibility, and lack of savings. This situation results in inability to weather financial storms created by unexpected expenses, further compounding debt burden and extending time required to create financial independence. Be very careful to keep housing and transportation costs affordable, particularly when it involves luxury and status.
Travel is another potential financial hazard when it comes to using credit for luxury. Travel is an extremely life enhancing activity and a great way to escape the usual routine of work, study or other productive but sometimes mundane pursuits. As with most things, there are inexpensive and very expensive ways to travel. Destination, conveyance, accommodations, and food are all indulgences that overextend budgets for enjoyment, but also sometimes to enhance status with others. A vacation is much more enjoyable if it does not create debt and increased financial burden for years to come. Use your budget to save for a vacation that you can truly afford periodically.
The sooner you understand and implement the formula for financial freedom, the more likely you are to take control of your spending, expenses and savings in order to expedite arriving at this goal. The higher your savings rate, or percent of net income saved, the sooner you can be financially free and make work optional. You can increase savings rate by increasing income without increasing expenses, or you can decrease expenses relative to your current income. Increasing income while simultaneously reducing expenses increases your savings rate further and reduces the time needed to reach the goal. This concept is easy to understand, but harder to implement in practice because of the relationships between income and expenses in real life, as well as our tendency to spend beyond our true means for various reasons, including emotional comfort, luxury, status and pleasure seeking.
It takes approximately 25 times your annual living expenses to be able to stop working and live off of the interest from your savings, assuming modest 5% investment return and 4% withdrawal rate, with reasonable mathematical likelihood. This allows enough investment income to cover expenses while keeping enough invested to keep up with inflation. The lower your living expenses relative to income, the faster you can be financially free. While a 20% savings rate will take 37 years to reach the target, a 50% rate will take 17 years, whereas a 75% savings rate will take only 7 years. This exercise shows the power of savings rate. Of course, value judgments will cause people to choose other paths and they may want to continue to work longer or with lower savings rate in order to elevate their daily standard of living. Regardless, earning, saving and investing are the primary and most accessible pathways to financial freedom. If that is one of your goals in life, prioritizing your goals and focusing on them with daily habitual action will lead to their achievement in time. Pursuing and achieving financial freedom is one of the powerful ways to enhance joy and relieve suffering.