TL; DR: This second post in a series for Colorado teachers describes in general terms the process of “how” you would design a path toward Financial Independence. Hint: it’s pretty straightforward.
Part 1 in this series describes the “what” and the “why” of Financial Independence. This post will focus more on the process, the “how” do you achieve it. While future posts will go into more (perhaps excruciating) detail, this is just a high-level discussion to give an overview of the most important factors you’ll need to look at and the most important decisions you’ll want to make. To be clear, there is not “one right way” to do this, but most folks’ approaches include many common themes, so we’ll explore them here.
In some ways, achieving Financial Independence is remarkably straightforward – spend less than you make, and then save and invest the rest. There are several important decisions you have to get right (the “big rocks”), and then a bunch of smaller decisions you can make (the “little rocks”) that will certainly help, but aren’t as critical, and then the even smaller decisions that will probably have very little effect (the “sand”). The main categories of personal finance are earning, saving, investing, and spending (lifestyle). Within each of these categories (and they are very much interconnected) there are just a few, relatively simple, “big rocks” you have to get right (or mostly right) in order to achieve Financial Independence.
Your earnings – how much you make from your job – is obviously an important piece in your financial picture and your ability to achieve Financial Independence. But many folks think you have to earn a very large salary (say, six figures) in order to do this, and that’s just not the case. It is certainly much easier to do this the larger your salary is, and there is definitely a lower limit in terms of practicality (if you’re making minimum wage, then there’s not much room for saving and investing). So, there is definitely some privilege involved here, but perhaps not as much as many folks think.
Since this series is aimed at Colorado teachers, we can throw out both the six figures and the minimum wage and talk about salaries that typically begin somewhere between $35,000 and $45,000 a year and then increase over time. In future posts I will use the salary schedule for Littleton Public Schools (which starts at just over $40,000 with a BA degree) as that is the district I’m most familiar with and is reasonably representative of the salaries along the Colorado Front Range. (Salaries outside the front range are often lower, but often so is the cost of living.)
Because almost all school districts in Colorado have a well-defined salary schedule, it makes it reasonably easy to predict what your future salary will be and what, if anything, you can do to increase it. (While there is some inherent uncertainty regarding future salary schedules based on future economic events, we can make some reasonable assumptions about annual cost-of-living increases to the salary schedule that should be close enough to allow us to plan.)
There are four main ways to increase your salary as a teacher in most districts: have more years of experience, increase your level of education, take on extra roles, and move into administration. Accumulating more years of experience happens automatically and, for the purposes of this series, we will assume you don’t move into administration. (If you do move into administration, obviously your salary will increase and make achieving FI even easier.) So, to maximize your earnings as teacher, you should focus on increasing your level of education and perhaps taking on extra roles.
As most teachers have figured out, it pays to increase your level of education so that you can move horizontally as well as vertically on the typical salary schedule. So from the beginning of your career you should be focused (financially) on moving horizontally through the different education levels as quickly as you can until you hit the “maximum” educational level on the schedule. For most folks, that means getting your Master’s degree and then accumulating additional hours beyond that to the max on the schedule. (Some districts have a PhD category, but most folks probably don’t want to go that far.) For example, on LPS’s salary schedule they recently added an MA+90 category, so to maximize your income you want to get your Master’s as soon as possible and then start accumulating additional hours until you reach MA+90.
The second way to increase your income is to take on additional roles. This is often coaching, sponsoring an activity, or working athletic events. Again, looking at the LPS schedules, you can make anywhere between about $1,200 and $4,000 coaching or sponsoring an activity the first year, and then get small raises each year you continue after that. You can also work athletic events (supervising, taking tickets, working the chain gang, etc.) to earn additional money (not sure what the current amounts are, they are low but not insignificant). Obviously, if you have the time and interest, you can combine several of these options, perhaps coaching in two or even all three seasons, or coaching in one season and working athletic events in the other two seasons. How much you take advantage of this will depend on your interests and preferences as well as your goals that we discussed in part 1.
Finally, you can increase your income outside of your school employment. This can be working a second job (often during the summer) or doing side hustles (with tutoring being a natural one for teachers). Again, how much you take advantage of this depends on your personal preferences and your goals, but you can increase your income by a not insignificant amount with a reasonable time commitment.
Saving and Spending (Lifestyle)
These two “rocks” go together because they are pretty much inseparable. It’s surprising to some people that your savings rate is the most important factor in achieving Financial Independence, not how much you earn on your investments (although that is important as well). Your savings rate is really determined by your spending rate, and your spending rate is really determined by your lifestyle. So, ultimately, the most important factor in your financial well-being and your possible attainment of Financial Independent is your lifestyle.
To be perfectly clear right up front, you don’t have to live like a monk in order to achieve Financial Independence (not that there’s anything wrong with that). But it is really important that you live within your means and, actually, live below your means (which is how you increase your savings). Like most everything else in life, this is a choice, but it’s one that we often make on autopilot. This is where being intentional in how you want to live your life can make such a huge difference.
There has been a ton of research in the last few years that indicates that, once you achieve a certain level of income, happiness and personal fulfillment do not increase simply be earning more money. It is necessary to achieve that initial level of income that covers your basic needs (and at least some of your wants), but after that making more money doesn’t correlate with increased happiness and fulfillment. In general, the research also indicates that “possessions” don’t increase happiness, but “experiences” do. As a teacher in Colorado, you make enough (particularly if you increase your earnings as mentioned above) that it is very possible to achieve this level of income to meet your needs and some of your wants and still have enough left over to save (and eventually invest) in order to be on the path to Financial Independence.
There are three “big rocks” that you need to focus on in terms of your spending: housing, transportation and food. While there are certainly many additional “little rocks” that can help make a difference, housing, transportation and food are the majority of most people’s spending and the areas that you want to focus on.
Americans have a love affair with the idea of a house. It’s a certified part of the “American Dream” and, when combined with expectations from those around us, often ends up being an area we overspend on. There are many blog posts you can read on this topic, so I’ll try to keep this reasonably short.
Whether to rent (an apartment or a house) or buy is a very personal decision, but don’t assume that buying is always the right answer. I grew up in a time when the conventional wisdom was that renting was “throwing your money away” and that you should try to buy a house as soon as possible because it was an “investment.” Turns out that when you look at the numbers, a house does not have a particularly good return on investment when compared with other investing opportunities. The main reason that many people believe that it does is because it’s really a “forced savings”, so it does end up being many people’s best investment because it’s really one of the few investments they consistently put money into.
This is not to say that buying a house is a bad idea, but you should buy a house because you value living in a house and not because you think it’s the right thing to do financially. For many folks, renting is actually the better option financially (but, again, that’s moot if you want to live in a house that you own). If you do decide to buy a house, it’s very helpful if you’re extremely thoughtful about doing it.
Again, conventional wisdom when I was growing up was to “buy the biggest house you could afford” and then “trade up to the biggest house you can afford when you’re able.” From a Financial Independence perspective, those are both wrong. You should buy “the smallest house that meets your needs” and try to “never trade up” by making your first home purchase your “forever” home. (The transactions costs around buying and selling a home, moving, and making improvements to the house are a huge drag on your saving and investing, especially if you do it multiple times.) The key is to identify your values and act accordingly. Since buying bigger and more expensive houses doesn’t automatically lead to more happiness and fulfillment, buy a house that meets your needs (and no more), so that you can focus your financial resources elsewhere in ways that do increase your happiness and fulfillment.
Renting (either an apartment or a house) is often the better alternative financially, allowing you to save (and invest) more as well as allowing you to be more flexible in where you live. As we’ll discuss in the transportation section, minimizing your commute (and the expenses associated with that commute) is a huge driver (no pun intended) of both financial success and happiness. Renting often gives you more flexibility on where you live, which often allows you to optimize your commute (walking, biking or public transportation). You can (and should) also do this when considering buying a house, but there is often less flexibility on location when buying instead of renting. Just like with buying, when making the decision to rent you also want to rent the smallest and least expensive place that meets your needs.
After housing, transportation is often the biggest budget item for most people, and it’s also one of the easiest ones to spend less on. Many folks I know just assume that a car payment (and often two of them) is a given, but it really isn’t. When I was growing up, buying a used car was a bit of a gamble because used cars weren’t very reliable. But cars made much better today and, if you choose from the particularly reliable ones, buying a used car is not much of a gamble and will save you a ton of money. While some folks will even need a loan for a used purchase, it should be much smaller and you should be able to pay it off quickly.
Even better than buying a reliable used car is not buying a car at all. If you can eliminate one (or more) cars from your life, you will save a tremendous amount of money. Most people really don’t have any idea of how much their cars are costing them. This is where the location of where you live (either renting or owning) is one of the most important “rocks” to get right. If you live close to where you work (ideally where both of you work if you’re married, but at least one of you), then you walk, bike, scoot, or take public transportation to work (and also increase your health).
And if you do own a car, get a reasonably-sized one. SUVs are incredibly popular in Colorado, daily I see a single driver commuting to their job on paved and well-maintained roads. Most people would be better served by a sedan or hatchback and, on the few occasions you really need an SUV, rent one, you’ll come our way ahead financially (and, by the way, might help avert climate catastrophe). If you want to optimize even further, consider a nice used plug-in electric vehicle or fully electric vehicle (not a lot of good used fully electric yet, but there will be in the next few years). You’ll also save a ton on fuel and maintenance.
There has been a lot of discussion about Avocado Toast and the Latte Effect lately. While I think this has taken up way too much bandwidth, there are some ideas here worth considering. The key again is to be intentional about how you spend money on food and drink and to align it with your values. As a simple rule of thumb, the more you eat at home, the better off financially (and typically in terms of your health) you’ll be. As a teacher, you typically don’t have the opportunity to go out for lunch when you’re working, so you have an advantage over other working professionals that bringing your lunch is pretty typical (although some folks purchase a lunch in the cafeteria – you want to make that be a rare thing).
Going out for dinner is a wonderful thing, but should be done occasionally and not three to four times a week (that includes picking up fast food). Most folks, if they align their food habits with their values, will discover that eating a nice meal at home together is not only financially wise, but provides them greater happiness and fulfillment. If you want to get together with friends, consider hosting (or attending) a pot-luck. You’ll have more quality time with your friends, spend less money, and likely eat healthier.
The amount spent on food is the third “big rock” of spending, next to housing and transportation. If you can optimize all three of them, then you’re savings rate will increase and then you’ll have money to invest and be on the path to Financial Independence.
Many people are intimidated by investing and think they can’t possibly do it right, so therefore Financial Independence is out of their reach. It turns out that investing is really the easiest of the “big rocks” to do well. Your savings rate is more important than your investment returns, and your spending rate determines your saving rate, so you have a lot of control over two of the most important factors that affect your investing.
Because you are investing for the long-term, investing is really pretty easy. The specifics can vary significantly based on your situation and your risk tolerance, and you can perhaps achieve a slightly higher return by tweaking your investments and making them more complicated. But, in general, you should invest in a broadly diversified equity index fund and forget it. (See this and this for more, or get his book.)
Your biggest decisions revolve around which type of accounts to invest in (401k/403b/457/Roth IRA, regular taxable brokerage account, etc.). In part 4 of this series we’ll go into this more in-depth but, in general, you want to maximize the amount you can put into 401k/403b/457 type tax-advantaged accounts and, if you do want to retire early, also invest in some regular taxable brokerage accounts (so that you can draw on these funds when you retire earlier than is typical). As a Colorado teacher covered by PERA, you definitely have access to the PERA 401k program (which is a good one), but you likely also have access to a 403b or a 457 plan. If you do have access to a 457 plan, especially if it’s PERA’s, that’s the one you’ll want to invest in first because you can access that money more easily before age 59.5. (More on this in part 4.)
A key area related to investing (and, it turns out, related to how much you have to spend to live on) is to think more intentionally about your taxes. While we certainly utilized tax-advantaged accounts along the way, this is one of the areas where we could’ve improved the most. By learning the rules around taxes you can optimize the use of your income and tax-advantaged accounts available to you. Much more on this in part 4.
So, those are the big rocks. Be more intentional about the lifestyle that makes you happy and fulfilled. Make spending decisions that align with your values and your goals in order to increase your savings rate, including making better decisions around housing, transportation and food. Know the tax rules and utilize tax-advantaged accounts in a way that optimizes your savings, spending and investing, and invest in broadly diversified equity index fund(s).
Is it really that simple? Yes, and no. As we’ll see when we get to the case studies, long-term planning like this relies on many, many assumptions, and those assumptions will not always be spot on. In addition, some people will argue that some of the lifestyle decisions that are needed to live beneath your means are unrealistic. So, in part 3 of this series I’ll spend a bit of time discussing the “What ifs?” and the “Yeah, buts.”