Our frustration is greater when we have much and want more than when we have nothing and want some. We are less dissatisfied when we lack many things than when we seem to lack but one thing.
— Eric Hoffer
As I have noted in the past, the simplest, most reliable way to achieve financial independence quickly is to save most of what you earn. Truly aggressive savings rates (like 75%) can take you from flat broke to fully financially independent in a stunningly short period of time.
The trouble is that hearing someone toss around savings rates over 50% can lead to some serious sticker shock. When you’re living paycheck to paycheck, the idea can seem ludicrous. But like so many other pieces of the financial independence puzzle, looking at things from a slightly different angle can lead to a big change in perspective.
To demonstrate what I mean, let me introduce a concept I call the wealth ratio. Note well — if debt is a big part of what’s holding you back from saving more, you’ll want to pay extra close attention.
The Wealth Ratio — A Different Angle on Your Savings Rate
I define the wealth ratio as:
Debt service includes all the debt payments you may be making, including principal and interest. What’s yours? Think it over and make a quick estimate before you continue.
Why is the wealth ratio important? Well, ask yourself this question: what would happen to your day-to-day lifestyle if all of your debt magically disappeared, and you put 100% of the payments you’re now making into savings, instead? The answer, of course, is nothing. Your debt payments don’t contribute to your standard of living at all — they just disappear into a black hole. So if your debts were gone, and you shifted your payments to savings, your lifestyle would be exactly the same.
What this means is that the wealth ratio is what your savings rate could be if you eliminated your debt, without making any other changes in your life. It’s what your savings rate will be once your debts are paid, so long as you keep your income steady, and don’t succumb to the danger of lifestyle inflation.
A Source of Inspiration
Many people are surprised to find that their wealth ratios are a lot closer than they might have imagined to some of those savings rates that seemed so outlandish a moment or two ago — the kind of savings rates that can lead to permanent financial independence, and quickly. It can give you a feeling that there might be light at the end of the tunnel — that it might just be possible to save a high percentage of your earnings after all, in time — once you’ve cleaned up whatever debt mess you’ve gotten yourself into.
And again, it assumes you make no other sacrifices at all. Now imagine how much closer you could get if you also dialed down your consumption a notch or two, or negotiated a raise with your employer.
Once you convince yourself it’s possible, you might just manage to shift your thinking toward ways to make it happen, rather than reasons why it can’t. And then you’re on your way.
I recommend keeping close track of your wealth ratio, and trying to increase it gradually over time. Mint is a great tool for doing this.