Why Financial Flexibility Is the Most UNDERRATED Key to Financial Success

what if i told you that there was a way that you could cut the time it takes to reach financial independence nearly in half while increasing the amount of income you could live on once you've reached fi all without actually saving any more money in the here and now you'd probably say it sounded too good to be true right and to be perfectly honest before looking into it myself this week i would have totally agreed with you so i can completely understand that reaction but looking at the historical data we have available to us it actually does seem like it is possible with a couple of tweaks if we embrace what may just be the most underrated key to our own financial success financial flexibility so let's talk about it but before we get going be sure to like this video if you haven't already as it really does help out the channel a lot and subscribe with notifications on for more money related videos like this one every single week and if you want to further support this channel you can check out some of the links i've left in the description below which includes a link to my patreon page this is the best way to show your support for this channel and in addition to that you can also get early access to new videos and exclusive content such as spreadsheets based off the ideas we discuss in these videos spreadsheets will allow you to play with your own numbers and see how big of a difference some of the ideas we discuss can make for your own personal financial situation so when i say financial flexibility what i mean is the ability to at any given time shift your spending levels up or down depending on the situation you're facing the more you can shift your level of spending and the faster you can complete that shift and the longer you can hold that new level of spending the more financial flexibility you have as you can imagine having greater levels of financial flexibility comes with many benefits for one having the ability to suddenly downshift your spending for prolonged periods of time if necessary can significantly lower your stress levels surrounding financial matters sure it doesn't change the fact that losing a job or watching your investments fall in value or getting an unexpected bill sucks but it does make your response to those events clearer as a result you're usually going to be able to recover from them faster and more reliably for another increasing your financial flexibility can have surprising ancillary effects in other areas of your finances the reason for this is that if you're capable of significantly downshifting your expenses on command and holding those new levels of spending during hard times you may begin to view other financial decisions quite differently perhaps you start to value long-term growth potential in your investments far more than their other qualities like tranquility because the short-term ups and downs in your portfolio's value become a lot less significant to you individually beyond that as i hinted at a minute ago it can significantly speed up your journey to reaching your financial goals like achieving financial independence or really any financial goal you may have and we'll get into exactly how much of a difference this can make when we run the numbers later on in this video but for now just take my word for it it's pretty extraordinary but how do you become more financially flexible as far as i can tell it really comes down to one thing you need to be able to find a way to lower the cost of if not outright eliminate the need for as many of your expenses as possible without negatively impacting your life satisfaction in any significant way that is crucial because if you do end up cutting a bunch of your expenses that allow you to do things that you genuinely enjoy without replacing them with similarly enjoyable but more cost effective options then you aren't going to be able to maintain that lower level of spending for very long no matter how impressively low it is you might even actually find yourself breaking down and going on a spending binge after forcing yourself to live in this state of deprivation for a long time which limits the effectiveness of this strategy pretty significantly obviously this is going to take quite a bit of trial and error as things that we get enjoyment out of vary from person to person and while we can and probably should look to other ideas to get ourselves started it's ultimately going to come down to experimentation and keeping an open mind over time we'll slowly find more and more cost-effective things to see have and do which we can use to replace our other high cost activities so gaining financial flexibility is not like flipping on a light switch it's going to take time to build up at least once we get past the obvious cuts such as high interest debts that we've accumulated at this point if there are any because i've yet to meet a person who genuinely enjoys making interest payments even if they enjoy the thing that they got into debt for but that doesn't change the fact that the debt itself is a hindrance to our ability to be more financially flexible and it can be easily cut without significant negative impacts on our lifestyle satisfaction with that being said let's run some numbers to see just how big of an impact becoming more financially flexible can have on our financial lives let's say that jon has a 1 million nest egg and is getting ready to pull the trigger on financial independence he's not the most financially flexible person in the world and partially as a result of this finds himself on the cautious side of things when it comes to his investments he prioritizes investing strategies that try to minimize short-term volatility and the damage that can be done by market meltdowns in this case he has chosen to invest into harry brown's permanent portfolio which has you split your money up equally into four different assets a total stock market fund long-term treasuries cash and gold as we've seen in previous videos the permanent portfolio does the job of protecting one's assets during economic hard times reasonably well but its long-term growth potential is less than stellar i should note that since making those videos i've updated the return figures to include data from all of 2020 but as some of the historical returns are estimates since we don't actually have actual index funds to invest in before the 1970s some of the older returns have been updated as well to reflect those updated estimates so the figures i'm going to be using today may differ a bit from the ones you'll see in those older videos but anyway based on the figures we currently have available to us and our best current estimates the permanent portfolio would have maintained a minimum 30-year safe withdrawal rate of around 3.14 since 1927. if we looked at every possible starting year that gives us a full 30-year cycle between 1927 and 1991 now and assume that we adjusted our income to keep up with inflation each year then on average the permanent portfolio would have generated around ninety five thousand seven hundred and fifty dollars a year on a one million dollar nest egg with a median nearly income hovering around ninety one thousand five hundred dollars the average minimum income for each cycle was around forty eight and a half thousand dollars which is higher than the thirty one thousand dollars we'd expect based off the minimum safe withdrawal rate but remember that was the minimum withdrawal rate in other words 31 000 was the worst case scenario most starting years wouldn't have had to start off that low to make it through a full 30-year cycle with cash to spare the average maximum income was around 158 400 in the first five years of financial independence those same figures clocked in at around fifty three thousand four hundred dollars for the average and median forty eight thousand seven hundred and fifty dollars for the minimum and fifty eight thousand three hundred dollars for the maximum however if john had been more financially flexible he might have been able to do quite a bit better let's assume that throughout his life of experimentation john discovered how to live quite happily for extended periods of time on the equivalent of 24 000 a year he doesn't normally live this way of course but if he really had to due to some type of economic meltdown or emergency he could and he could still enjoy life how much would that change these figures well let's see let's say that john will downshift his spending to an inflation-adjusted 24 000 a year in any year where his investments are valued at least 10 below all-time highs in order to ensure that he isn't withdrawing too much from his nest egg when it's at a low point once his investments get back to within 10 of their all-time highs he will return to spending like normal for now that's the only change we'll make what we see is that his minimum 30 year safe withdrawal rate rises from that 3.14 to 3.67 his average income generated rises from nearly 96 000 a year to nearly 97 000 a year which isn't a ton but it is an improvement the median income does stay about the same however the minimum and maximum figures diverge the minimum figure actually drops down to around thirty six thousand two hundred dollars with the maximum rising to over a hundred and seventy thousand the reason the minimum went down is of course because john purposefully lived on less during down markets this allowed his nest egg to recover back to baseline quicker and judging by the average income figures it was a net positive strategy but of course if you're able to sustain a higher safe withdrawal rate and financial independence using this more flexible approach doesn't that also mean that you could retire with a smaller nest egg than if your budget was more rigid yeah it does and we see that impact bear out in the financial independence accumulation metrics assuming john's expenses changed in line with inflation as measured by the cpi then originally he would have reached financial independence in 74 of all starting years with a 50 savings rate and 88 of all starting years with a 70 savings rate he actually wouldn't have made it if he had used a 15 or 30 savings rate even if he had started all the way back in 1927. on average it would have taken john 51 years to reach fi with a 50 savings rate and 16 years at 70 with a more flexible budget and the higher initial safe withdrawal rate that it allowed he would have reached his goal in 77 and 90 of all starting years with those same 50 and 70 savings rates he also would have made it with a 30 savings rate twice though it would have taken him quite a long time to do it at those 50 and 70 savings rates he'd have reached fi in 44 years and 13 years on average both of which are multi-year improvements over the original scenario but for those who are investing a little more cautiously especially as they get closer to financial independence due to the negative impacts that market downturns can have when you're withdrawing money from a nest egg we might actually see a much bigger shift in the figures in reality because what financial flexibility really does for you in this sort of situation is significantly lessen the importance of market turbulence to long-term success so what if in the process of becoming more financially flexible john actually becomes comfortable enough to change his investing strategy what would the figures look like then well if we assume that john shifted to an all stock strategy represented this time by an s p 500 fund his baseline minimum safe withdrawal rate assuming a rigid budget would be about 3.45 if he instead utilized a more flexible budget downshifting his expenses whenever his investments were at least 20 below all-time highs as opposed to 10 because unlike the permanent portfolio we actually do have a decent amount of years where the s p 500 was down by at least 20 percent that withdrawal rate jumps up to around 4.3 percent you'll notice that this is actually a larger jump than what we saw with the permanent portfolio despite having a somewhat looser threshold the ability for an investing strategy to scale up its safe withdrawal rates and financial independence income metrics when utilizing optimization techniques such as flexible budgets are what i refer to as the strategy's scalability and there can be quite a difference between strategies especially if you start stacking multiple optimization techniques on top of one another but that's a topic for another video for now let's get back to the figures john's average median minimum and maximum income figures also improve across the board to a hundred and thirty thousand four hundred dollars a hundred and twenty eight thousand eight hundred dollars thirty six thousand seven hundred dollars and two hundred and forty seven thousand three hundred dollars a year respectively even in the first five years of financial independence the numbers show across the board improvements with the income figures clocking in at around eighty five thousand three hundred dollars eighty seven thousand five hundred dollars sixty seven thousand six hundred dollars and ninety eight thousand nine hundred dollars a year respectively that's quite a difference if you ask me john's nearly doubling his average income over the course of financial independence due to higher initial safe withdrawal rate and better long-term returns jon's also reaching fi more often and faster than he was before he reaches financial independence in about thirty percent of scenarios with a fifteen percent savings rate seventy one percent of scenarios with a thirty percent savings rate eighty-eight percent of scenarios at a fifty percent savings rate and ninety three percent of scenarios at a seventy percent savings rate on average it takes him around 54 30 18 and eight years to do so at each of those levels of saving compare that to the 44 and 13 year averages we saw from the permanent portfolio using a flexible budget and you can see the difference but believe it or not we can actually go even further as we've covered in previous videos on this channel there are numerous tactics that investors have used to make the most out of financial independence one of them of course is a flexible budget but is far from the only one what if we combine the flexible budget with some other strategies well that's when we start getting into some pretty extraordinary territory for example many people choose to have a little extra cash on hand beyond their investments and even their emergency fund before pulling the trigger on financial independence the idea is that if the markets hit a couple of rough years right after you take the leap you can use the cash to live off of while your investments recover this is usually a pretty effective strategy as you're basically protecting yourself against one of the two most likely reasons that you can find yourself running out of money during financial independence and if we combine that cash buffer with a flexible budget it becomes even more effective let's say that john had a cash buffer equal to two years worth of his tight budget expenses in this case that would be forty eight thousand dollars a year since he can live on twenty four thousand dollars a year when he's really tightening his belt well say he puts that money into a high yield savings account or somewhere similar and earns half a percent interest on it everything else will be kept the same as our last hypothetical in this case john would be working with a minimum initial safe withdrawal rate of 4.44 he would have reached fi as often as he did before but would have done it a little bit quicker on average it would take him 54 28 17 and eight years to cross the fi threshold using those savings rates the average median minimum and maximum income figures would be roughly 133 200 hundred 131 thirty six thousand seven hundred dollars and two hundred fifty two thousand nine hundred dollars overall and eighty six thousand eight hundred dollars eighty nine thousand sixty eight thousand two hundred dollars and a hundred thousand nine hundred dollars over the first five years but we can still go further than this by adding financial guard rails to our strategy financial guardrails attempt to ensure that your income never grows so high that you run the risk of running out of money but also never so low that you're unable to put food on the table it does this by checking to see if the income you're projected to have during the year is above or below a certain threshold that you set at the start of financial independence for instance if you had an initial safe withdrawal rate of five percent you could say that you never wanted to be withdrawing more than six percent of your nest egg in a year because you feel that doing so would eventually lead to you running out of money but you also don't want to be spending less than four percent of your nest egg in a year because you feel that doing so would eventually lead to you accumulating such a gigantic pile of money that you'd never know what to do with it all those would be your guard rails if your rejected income for the year happened to be above six percent or under four percent of your remaining nest egg you'd adjust that projection up or down by a predetermined amount say by 10 to hopefully get back within those guard rails or at least get closer for this video we'll say that john's guard rails will be 20 above or below whatever his initial safe withdrawal rate is and his adjustment will be 10 of his projected income for the year and just to ensure that our income never goes ridiculously low during normal years we'll put an inflation-adjusted spending floor of 30 000 on ourselves so assuming that our investments are within 20 of all-time highs which is our threshold for determining whether or not we'll be tightening our financial belts we won't be seeing john spending less than 30 000 after adjusting for inflation regardless of what the guard rails tell us to do assuming that john used those guard rails that spending floor a cash buffer and a flexible budget he'd be working with a minimum initial safe withdrawal rate of 8.18 john would have reached financial independence in 66 85 92 and 96 of all scenarios using those previous savings rates on average taking 39 20 10 and four years to do so the average median minimum and maximum income figures would be roughly ninety six thousand four hundred dollars ninety nine thousand six hundred dollars thirty six thousand seven hundred dollars and a hundred and fifty five thousand three hundred dollars overall and a hundred and thirteen thousand seven hundred dollars a hundred and seventeen thousand one hundred dollars eighty four thousand five hundred dollars and a hundred and thirty six thousand nine hundred dollars over those first five years and look at how far jon has come even though he hasn't put any more money away though he certainly could now if he wanted or seen a huge rise in his salary he's managed to increase his average income and financial independence by over 30 thousand dollars a year using a flexible budgeting strategy and the more scalable asset allocation that that flexibility made him more comfortable using with some further tweaks he went from not being able to reach financial independence with a 15 or even 30 savings rate to reaching it in a majority of scenarios and in about a quarter of the time to boot if he were to optimize his budget and really crank up his savings rate history suggests that he could very well reach financial independence in about the time it takes your average college student to earn a degree you know how crazy that is that's the power of financial flexibility and really optimization as a whole and if you want to play around with some of these numbers yourself to see how your own personal financial situation could be impacted by making some of these changes i've left a link to my patreon page in the description below this video the spreadsheet that i used to make this video as well as the one i've been using in the asset allocation series is finally available and i've updated it to include the ability to utilize things like flexible budgets cash buffers and financial guard rails separately or together it's available to all patrons in the investor tier and above but that'll do it for me today once again if you enjoyed this video be sure to smash that like button if you haven't already subscribe and hit that bell next to my name so you'll be notified of all my future uploads i generally upload every single monday and if you have a friend that would be interested in this kind of content be sure to share it with them let's really get this information out there and start our own financial revolution

Channel: Next Level Life

Views: 30,706

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Id: e-TQZAKT27c

Length: 16min 58sec (1018 seconds)

Published: Mon May 31 2021