The Best Offense…

In thinking about my first few posts for this blog, I considered covering all of the basics of Offense (investing) first, and then moving on to Defense (saving). That seemed like it would flow logically, and at least some understanding of Offense is required to really appreciate Defense. But I decided to take a break from Offense to introduce Defense sooner rather than later because of one key point: Defense is more important than Offense. I hope to convince you of this point by the end of this post.

A recent survey found that the majority of Americans would be unable to cover an unexpected $1000 expense…

Ummm, what?!?!?!?! This is out of control! A recent survey of Joe, myself, and the Third Roommate Who Shall Not Be Named found that 100% of us would be able to cover an unexpected $1000 expense, despite the fact that we are all graduate students earning only a stipend (people refer to us as “poor”), living in a not-so-cheap city, and have only been making money for a couple years.

As we saw in my last post, many people are bad at Offense. But most people aren’t even aware that Defense exists. This is deeply concerning for a few reasons:

1. Savings rate is much more variable than investment rate of return.

We know that the long term rate of return, or performance, of the stock market is 7% annualized after accounting for inflation. Some people named Warren Buffett might beat that by just a little bit, while financial advisors and other people who haven’t read How The Stock Market Works will do a good bit worse. So the range of variation here is not huge–a terrible investor might make close to 0% while a top 1% investor will be closer to 7%. But savings rate–the percentage of your income that goes to your savings/investments–can vary wildly, from large negative numbers for people who take on debt or buy cars on credit, to very high numbers like 75% or more for frugal people earning good incomes. The effect this has on your ability to reach Financial Independence is staggering. Sometimes it’s kind of funny to listen to people, especially young, higher income professionals, talk about how they can get such a great return on their investments as they literally leak money out the other end by buying brand new cars on credit and carrying credit card debt at 20% interest!

2. We don’t really think about how much things COST.

When you go out to lunch instead of packing your lunch, you might spend $5 more than you would have on the self-prepared meal (you might spend way more, but I’m being very conservative here!). People might say, “Oh, $5 is not bad and I’m really too busy to spend 30 seconds putting some leftovers in a tupperware”. But let’s assume you do this 3 days a week, so $15 a week. Still doesn’t seem so bad. 50 weeks a year would be $750. Over a 10 year period that’s $7,500, or $15,000 every 20 years, or $22,500 every 30 years. And you better believe people do this over a 30 year career. While >22 THOUSAND dollars might already seem like a high price to pay for a lunch that’s probably less tasty and healthy than something you’d make on your own, it actually gets much worse. Since you are a savvy, top 1% investor, you’re not just sticking those $5 bills you save under a mattress. You’re gonna put that money in the stock market where it will compound at 7% each year. So what does $15 per week of unnecessary spending really cost? It’s more like $11,157 every 10 years, $33,105 every 20, or $76,279 every 30 years! Now that is a high price to pay for some mediocre lunches! That money could be worth years of your financially independent life. And this was a silly, small example. Think about more serious things like purchasing a $50,000 new car (on credit, with interest!) instead of a good-quality, $7,000 used car. Or paying an extra $300+ a month for rent to live in a higher end apartment. You can play with the numbers yourself here, but they are mind blowing. Unfortunately, people don’t think this way about spending. They think, “Five dollars? That’s not so bad for lunch.” But that’s simply not the case.

3. Achieving Financial Independence really depends on only one factor: your annual expenditures.

Recall the definition of financial independence from my first post:

Take your yearly expenditures (that’s all the money you spend on everything in one year). Multiply that number by 25. Once you have that much money, you are financially independent.

Besides the implicit assumption that your money is invested and earning a modest rate of return, the only real factor that determines how much you need to achieve financial independence is your annual expenditures. This point specifically is what makes Defense such a two edged sword. If you exercise some wisdom with your spending not only will you have more money to invest, but you will also need less money to live.

Truly, the best Offense is a good Defense.

A quick final note: I’m not trying to suggest that we should all eat only beans and rice and live in the cheapest place we can find. Some things are worth spending money on, and it’s important to think about what those things are for you. But there’s a difference between living a comfortable, even somewhat luxurious life and a wildly inefficient one while not considering the consequences. And as Joe and I have found in our own lives, the former still provides you with everything you need to live a satisfying and fulfilling life!


2 response to "The Best Offense…"

  1. By: Ray P Posted: April 26, 2018

    What do you think the first thing a person who wanted to get on the right track towards financial independence should do? What should be their first investment (in general) and how much should it be?

    • By: Joey Posted: April 26, 2018

      Ray–excellent question! If you’re just getting started, the first thing you should do is pay off any high interest debt that you have, if you have any. Any debt costing over 5% interest should be paid off before you start investing, and every spare dollar should go towards paying this debt.

      Once that’s out of the way, I highly recommend investing all or the majority of your savings in US Stocks, particularly the Vanguard Total Stock Market Index Fund (VTI), due to their low fees and coverage of the entire US market. Ideally, you’d first want to invest within tax-advantaged accounts like a Roth IRA or a 401(k) if those options are available to you (there will be an entire post dedicated to how these work in the near future). If you have access to a 401(k) that’s not with Vanguard, just look for a very low cost index fund that covers all or the majority of the market (S&P 500 is fine). Once those are maxed out you can create a regular brokerage account with Vanguard (or use a free trading brokerage like Robinhood) and continue to buy VTI there. Of course, as highlighted in this post, it’s important to remember that how good your Defense is will ultimately determine how much you can invest and have drastic effects on your ability to accumulate wealth.

      At some point, maybe once all the basics have been covered, I should probably do a comprehensive “getting started” post, which could also serve as a nice review. There are also some pretty good guides out there describing what types of accounts you should invest in first (like this one:

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