Nine Traits That Got Me to Financial Independence at 41
A pervasive theme here at Trapped in Work is that behaviors and psychology matter more than your skills as a savvy investor. With that thesis in mind, I’ve endeavored to put together a list of my own behaviors and traits that allowed me to achieve FI at the ripe old age of 41. Here they are, in a very rough and un-scientific order of descending importance:
1. Long-term perspective: As a group we humans are remarkably awful at understanding the long-term consequences of our day-to-day decisions. As a result we most often choose options that maximize short-term benefits with little concern for long-term impact. For some reason I am largely immune to this affliction. In fact, I think I’m afflicted by the opposite effect: every decision, no matter how small, is assessed through the long-term benefit prism. If you’re wondering: yes, this makes me super-fun at parties. But it sure does help in accumulating financial resources and real wealth.
This mindset enables some of the other critical behaviors listed below. So you may think of it as something of a gateway drug (behavior) for FI.
Manifestation of this trait: Evaluating every purchase or consumption through a comparison of its current enjoyment/utility with its future value (a mathematical calculation of what the amount would be at a future point in time, say 15, 20, or 30 years, assuming a specified rate of annual compound growth, say 6%). Play around with the “FV” function in your spreadsheet app; you get to choose the number of periods (years or months) and the target return. Feeling particularly optimistic? Plug 9% in the annual return field. That $50,000 car just got a lot more expensive.
2. Patience (and time): I’m not a great investor. Not many of us are. But I spent the time doing the work necessary to understand various investing philosophies and to pick one that had a reasonable chance of success (defined as long-term, significantly positive returns). And then I stuck with it. And I’m going to continue to stick with it until compelling evidence establishes that it’s no longer likely to be effective over the long-term.
I can count on my fingers the number of times that I have sold a security for a reason other than annual re-balancing. I’m confident that my plain-vanilla index investing approach will achieve my objectives in the long run, and I’ve been patient during periods of time when short-term returns appeared to suggest otherwise. I have been able to overcome any emotional feelings of wanting to accelerate progress by chasing short-term performance. This is the mindset that leads to buying high and selling low, which, as you may know, does not lead to investing success.
Manifestation of this trait: Decide (thoughtfully) on your investing style and portfolio allocation, automate your contributions, and then leave it alone. For a very long time.
3. Social indifference: This is a term that psychologists use to refer to a lack of concern for what your peers think of you. And yes, it’s another one that will get you invited to all the best parties.
The effect here is easy to understand: if you are constantly evaluating your lifestyle and your purchases by reference to what those around you are doing, you will perpetually find yourself on the consumption treadmill. Our cohort group has different goals, resources, obligations, and time horizons, so how can it make sense to tailor our spending patterns and resource usage on the basis of someone else’s decisions and behavior patterns? Wouldn’t it make more sense to critically evaluate your own preferences regarding lifestyle, career longevity, future goals, etc., and then tailor our financial decisions to suit those unique personal preferences? If you want to get to a place of your own choosing—not your neighbor’s—then yes, this does make more sense.
Manifestation of the trait: Average age of automobiles in my neighborhood is, I’m guessing, 3.5 years. I’m at 15 and hope to get to 20-plus (on my oldest auto). I’ve actually received some snarky comments from some peers at neighborhood gatherings: “so what year is your car? Wow, that’s awesome. (Wink and smile).” Indeed, it is awesome.
4. Tax knowledge: The taxation of our earnings, wages, and investment returns presents a huge potential drag on wealth accumulation. Managing this obstacle to minimize the impact of the drag can have a significant impact on wealth over the short and long term. But far too many people make this element of financial planning more complex than it needs to be, and as a result either forego tax planning altogether, or over-do it and spend far too much (money and energy) seeking out exotic and complex tax shelters (I’m looking at you, physicians).
Yes, I spent the bulk of four years in college and three years in law school studying the complexities of the tax laws, but in reality I used very little of this complex and technical tax knowledge in my everyday personal financial planning. A couple of very basic principles will serve everyone well: A dollar of tax paid tomorrow is better than a dollar of tax paid today, and permanent avoidance of tax is best.
This doesn’t have to be rocket science. Instead, commit to taking advance of every single tax deferral/avoidance mechanism that is plainly set before you. There is no excuse for a high-income earner to not be maxing out a 401(k), an IRA, and an HSA. Every single year. Yes, it takes a moderately more advanced level of sophistication to know that as a high-earner you need to contribute to a non-deductible traditional IRA and convert to a (“back-door”) Roth IRA, but this is well documented now in how-to fashion on the Internets. (It wasn’t back in 2010 when this maneuver was first opened up by Congress, so I’ll cut you some slack if you’re only recently implementing this strategy.)
Manifestation of this trait: I maxed out 401(k), IRA, and HSA contributions for me and Mrs. JF for every year that they have been available to us during our working lives. In some years that meant contributing 50% or more of Mrs. JF’s salary (in years when she was part-time because of maternity, etc.). Somewhere around year three as an associate attorney at the BSD law firm I was meeting with a senior partner in his office and he had left his 401(k) account statement on his desk. I couldn’t help but notice his balance. He was probably 55 and had been earning around $1 million a year for a number of years. I had more in my 401(k) than he did. He’s still there. Every day.
5. High Income From the Start: This isn’t a behavioral trait as much as it is an economic condition, but I was programmed from a very early age to seek out a high-remuneration career. Not by my parents, but through my own ambitions. I’m still not sure why. But I worked like a dog through college and law school to ensure that all options were open to me. So the work that led to the condition was behavioral based.
Let’s not pretend that your income level doesn’t matter in the trek toward achieving financial independence. That’s dumb. Of course it does. But it’s also true that you can achieve FI, I believe, irrespective of your income level. Some levels of income will make it harder, requiring more discipline and more time. My income level certainly made it easier, and required a shorter period of time. But I had to capitalize on that high income level by implementing a high savings rate. As I’ve said before: math is objective, and if you earn $1 million and consume $1 million plus $1, you’re broke.
I graduated law school at age 25 and started as a first-year associate at the law firm making $100k/year. That was before the bonus of $15k. Because I had attended public universities and accumulated no student debt, all of this money—after substantial taxes of course—was mine to do with as I chose. I had the frugal gene and I had grown up in a household that demonstrated prudent money management (even if it wasn’t necessarily explained in great detail), so consuming this windfall wasn’t an option.
My living expenses at the time were almost nothing. I lived in a house with two other guys for a year or so before Mrs. JF and I tied the knot, and then we moved into a modest apartment together. Other than rent we spent very little. I haven’t gone back through the Quicken data yet (I’ll save that for a future post), but as discussed above, I know that I maxed out my 401(k) contributions from day one, so that was roughly $15,000 a year in savings. I also immediately began putting around $2,000 per month into a taxable Vanguard mutual fund account. Eventually I would also max out a non-deductible traditional IRA for both me and Mrs. JF. (This would come in really handy in 2010 when the law changed to remove the income limitation on Roth conversions because I had a pile of high-basis traditional IRA money sitting there ready to go.) So I estimate that our savings rate in the earliest years of earning a salary was between 40-50% of pre-tax earnings.
My income would steadily increase over the next 13 years, ultimately topping out at around $350,000/year. Our lifestyle did increase, ultimately culminating in the purchase of our $600k-plus home in affluent suburbia, but we still managed to maintain a reasonably high savings rate as a result of increasing income levels.
So here are the takeaways: Yes, if you manage to generate a big income, you’ve got a leg up on everyone else that is trying to reach FI at a more modest income level. But if you blow it all on coke and hookers (or Range Rovers and ski-chalet vacations, same thing), it was all for naught. It won’t matter one bit. In fact, high-income earners can get themselves in more trouble than low-income earners because of their easy access to debt. A lot of people would be better off making $50k/year and spending it all instead of earning $400k and spending it all and then some.
Manifestation of this trait: Bringing home a fat-ass paycheck from day one of working, and immediately beginning the process of decades-long compounding by investing as much as possible in low-cost index equity funds.
6. Anti-action bias: I’ve talked before about the concept of an action bias. This is the psychological condition whereby we believe instinctively that doing something is preferable to doing nothing. I will concede that in many areas of professional and social life, this is often correct. But in the investing arena it is most typically counter-productive. Even deadly.
People that experience action bias are tempted daily to monitor their investments and take action. Do something, anything. Even the act of looking at your investment balances can be unhealthy since it alerts you to micro-movements in your wealth—often unfavorable when viewed day by day, minute by minute—and creates a sense of need to act to preserve your financial well being. This often leads to hyper-consumption of market news for the ostensible purpose of taking prudent action to preserve your position, but in reality the effect is to promote a short-term perspective. If you’re a long-term investor as you say you are, why do you care where the pharmaceuticals segment is headed in the next 3 months? Or 18 months?
My investment philosophy is both simple and easy: the broad US and foreign equities markets, have the greatest potential to yield the highest return over my long-term time horizon. And to achieve that return—whatever it may be—all I have to do is invest and stay invested. And keep my hand out of the cookie jar, except for routinely scheduled re-balancing trades. To act any other way will undoubtedly lead to short-term performance chasing, and that ends badly (or sub-optimally).
Manifestation of this trait: As noted earlier, the number of trades over the course of an 18-year investing career is extremely small.
7. Humility: Okay, look, anyone that writes a blog and publishes to the world their thoughts on any topic—especially with a tone of moral superiority and self-confidence—may have a hard time asserting the trait of humility. Yes, in a lot of areas I know what I know and I firmly believe I’m right. But notwithstanding my writings and bravado here, I have always been comfortable assuming a very nondescript and unassuming persona.
My investing approach accepts average (i.e., market returns less marginal cost)—and thereby achieves above-average returns (because the rest of the active-trading world does not accept average, thereby ensuring below-average returns). Funny huh?
Humility has allowed me to accept, even to relish, the idea that people around us may think we’re poor because we don’t engage in ostentatious signs of wealth. We’re quite comfortable being nondescript. This also helps to insulate us from people that would otherwise want to serve us poison served in a gold cup.
Manifestation of this trait: When I started at the firm I bought two suits at the local discount men’s clothier (one black, one grey), and two pairs of Johnston & Murphy shoes (that were way more expensive than my taste, but I knew they would last). Over the next 16 years I would buy three more suits at that same discount clothier, and two more pairs of shoes (not because the first two wore out, but just for a wee bit of variety in the wardrobe). I kept this limited wardrobe in good shape and they lasted me my entire career. (Okay, it helped that after a couple of years we moved to “business casual”). I never looked to be at the forefront of fashion, but I always presented as conservatively well put together. Nothing flashy. Simple. Effective. Humble.
8. Waste aversion/optimizer mentality: I have always had the attitude that every dollar matters. Every one. Not because we can’t afford to waste a few dollars here and there—we can—but because of the potential effect of attitude creep. To adopt a mentality that some dollars don’t matter invites an attitude of pervasive wastefulness.
I recently read Jim Koch’s autobiography titled Quench Your Own Thirst. Jim was the founder of The Boston Beer Company, maker of the Sam Adams craft beer brand. (We can all debate later whether Sam Adams continues to be a “craft” beer or not.) It was a good read from start to finish, but it had one invaluable piece of learning. Jim tells a story about his time as an instructor for an Outward Bound course. During this time he developed something called his “string theory.” It goes like this: during outdoor training exercises that apparently involved multiple days camping in the woods with limited resources, the group of trainees would be given a length of string or rope at the start of the course. It appeared to be quite a good bit of rope, but Jim knew that the group would have multiple uses for it during the course. At first Jim would not give his trainees any particular instruction or guidance regarding the parceling out of the apparently abundant rope, and almost inevitably the group would waste it along the way and run out long before the mission was completed. So he changed his approach: he began telling his groups at the outset that they needed to be extremely conservative in their use of the rope or else they would run out. Not surprisingly this led to creative behaviors designed to re-use lengths of rope that may have otherwise been discarded. Groups that received this instruction almost uniformly had an abundant supply of string/rope throughout the duration of the course, and supplies left over at the end.
Wealth really is built $10 at a time. If you can adopt that view, then every dollar matters, and waste becomes offensive. Once again, that long-term perspective described in item 1 above really helps out. Even those of us that track every dollar spent in Quicken can have a hard time mentally understanding the cumulative effect of small episodes of wasteful consumption throughout the days that make up the months that make up the years. So instead I adopted a default attitude of fighting waste every time it was presented. This approach has the opposite and positive effect: instead of destroying wealth through the silent killer of $10 pissed away here, there, everywhere, you end up stealthily creating wealth by eliminating waste and adding bit by bit to your stash that is quietly leveraging the cosmically powerful force of compound growth.
Manifestation of the trait: For many years now I have tried to avoid cash transactions for a number of reasons. First, I can’t track it in Quicken (or I refuse to try), and therefore it is consumption that will be forever lost in time. If instead I put it on a credit card, it will show up in my spending reports categorized for what it really was. And if it was wasteful, I’ll have the opportunity to correct that error in the future by learning from the mistake. Second, every dollar on the credit cards earns us a return: either 2% cash back or a more lucrative rate of return in the form of travel-hacking dollars. Two percent may not seem like a lot, but 2% on all of your cash spending over the course of a lifetime will be significant. Remember string theory.
9. Frugality: I saved this one to the end because it is boring and predictable. For some it’s even offensive; a word that demands an immediate change of the channel. So I put it here not because it’s the least important—I would actually put it at #2 or maybe #1b right behind long-term perspective—but for editorial purposes.
The argument could be made that this is the same concept as the waste aversion/optimizer mentality discussed in Item 8 above. True enough, there is a lot of conceptual overlap between the two. But there are important conceptual differences. Waste aversion, for example, might compel you to research a bit longer before you buy the $10 item just to make sure that you don’t miss an opportunity to buy it for $8. Frugality, on the other hand, might lead you to conclude that you don’t really need or want the item in the first place.
A frugal mindset allowed me to shape my perspective to one that focused on the critical things in life that are truly important, eliminating everything else. When your needs and wants are stripped down to only the most meaningful things, you find that you have dramatically accelerated your trip to financial independence simply by reducing the definition of what you have to have. And if you have successfully cultivated a genuine perspective of frugality, this isn’t an exercise in managing self-denial. You will genuinely appreciate and prefer a simplified lifestyle, where all of your needs and wants are perfectly and sustainably met.
Manifestation of the trait: It’s an ordinary Friday in June at 1:30 pm, and I’m not sitting at my mahogany desk on the 50th floor of the downtown skyscraper, or in the drab confines of the entrapment chamber that I inhabited at the corporate employer. I’m sitting in my living room at home, leisurely writing these words while looking out the window at the green grass of my front yard. I guess I’ll go start the weekend now. No one to tell me I can’t.
Great article. How do I sign up for email updates when you have new articles out?
Can’t find a link to that..
Thanks Bo. The email widget was not on. It is now, so you should see the email entry on the home page.
–Joe
“I can count on my fingers the number of times that I have sold a security for a reason other than annual re-balancing.”
Curious, how do you account for taxes when re-balancing inside a standard brokerage account? Selling stock and buying bonds to ‘re-balance’ leads to a tax-event, so how did you go about accounting for that during your 18 years?
Simple: avoid rebalancing in taxable accounts. All of my rebalancing transactions are done in tax deferred accounts, so no tax impact. In the very limited situations where I have had to trade inside of a taxable account, I have tried to time gains and losses to coincide in order to minimize or negate any tax impact. And if you are good (or lucky), you can use movements inside taxable accounts to your advantage. Back in 2008/2009 when the markets had cratered, I wanted to move all of my international fund/ETF holdings to my tax deferred accounts (at the time they were much less tax efficient that US funds), but I held a good bit in the taxable accounts. I used to market meltdown to sell at a big capital loss while simultaneously shifting amounts in the tax deferred accounts to international funds to keep the same allocation across the portfolio (mindful of course of the wash-sale rule which does apply to purchases in tax-deferred accounts). So I kept the same target portfolio allocation, moved all the international to tax deferred, and generated a big capital loss for tax purposes that I carried forward and used in a number of future years.
So while you may not always have the option, if you do, I would say that you do all that you can to avoid creating tax drag on investment performance by creating taxable gains in taxable accounts. But of course, if you’re invested incorrectly or otherwise have no rebalancing option, then you have to do what you have to do (and look for other tax-mitigating strategies like ensuring you get long-term cap gain treatment, etc.).
I too, have a huge aversion to selling in taxable accounts and absolutely refuse to incur capital gains. This has done two things for me–
1) It has made me more conscience of what am buying, knowing that my holding period is “forever” in those taxable accounts. Index funds are clearly the way to go.
2) I’ve used incurred capital losses to offset income ($3k/yr). I rotated my mutual funds like you did in early 2009 (not the exact bottom, but close enough) and have had enough losses for the last 10 years, and will have a few more. Offsetting that income is saving me $1k/year in taxes.
That said, I am periodically re-balancing towards my asset allocation in the retirement accounts.
I enjoyed the article, especially the idea of social indifference. I work in an engineering environment, and one of the many things that is nice about it is that there is not much bragging about brands or purchases. I’m convinced nobody knows what brands of watch, clothes, or shoes people wear, or more importantly, cares.
Thanks M. I particularly enjoy the social indifference topic too. I’ve read a bit of the scientific/academic research in this field and it’s fascinating. And of course you know that engineers seem to have an unfair advantage over everyone else when it comes to building wealth. That is supported anecdotally by their disproportionately large representation in the FI community (MMM, Mad Fientist, Mr. 1500 come to mind just for starters) in addition to being documented as wealth-over-achievers in the research data contained in The Millionaire Next Door. Lawyers and doctors on the other hand are on the opposite end of the scale!