ASX Dividend Aristocrats

Hi there, welcome to the latest blog post.

The purpose of investing is to build wealth.  For nearly everyone, wealth is not the goal in and of itself.  Financial freedom is.

By financial freedom I mean the ability to indefinitely live off of your savings and do what you want, when you want.  For investors, this happens when your portfolio’s income stream (plus any other sources of passive income) exceeds your expenses.

There are 3 factors that determine how quickly you will reach financial freedom:

1. Income – How much money you make annually
2. Expenses – How much you spend annually
3. Compound Annual Groth Rate (CAGR)– The annualized return you realize on your savings

Most people who are interested in money and investing often focus most of their attention on #3, CAGR. Where to buy an investment property, which stock to buy, how much to invest in bitcoin or what superfund is performing best. Although these types of topics are interesting and get a lot of attention in the news, they are essentially noise to your ultimate goal of financial freedom.

Factors #1 and #2 are probably more important as they are typically far more in your control than returns on your investments. Income and expenses largely relate to your psychological behavior towards spending and saving. If you cannot get a handle on your income and expenses it wont matter how good your CAGR is – you will never get ahead of your bills and debts.

To reach financial freedom as quickly as possible you should seek to improve all 3 factors, not just one. Lets have a look how small changes to the ‘typical’ Australian family might be able to fast track their savings.

The median Australian household income is ~$75,000 per year.  Imagine a family has the following financial profile:

• Makes $75,000/year
• Spends $69,000/year
• CAGR of 7% per year

If the family were to follow the ‘4% rule’ of retirement (i.e. only spend 4% of savings annually in retirement), they would need 25x their annual expenses as savings before retiring.  It would take 45 years to reach their retirement goal.

$1,725,000 X 4% = $69,000

$69,000 X 25 = $1,725,000

Now imagine this family were to have a 10% increase in one of the 3 factors.  The number of years it takes to reach retirement are below, assuming no change in the other factors:

• Income increases 10% to $82,500:  34 Years until retirement
• Expenses decrease 10% to $62,100:  35 Years until retirement
• CAGR increases 10% to 7.7%:  42 years until retirement

Cutting expenses 10% saves a full decade in the time it takes this family to retire.  Increasing income 10% saves 10 years as well.  Finally, a 10% increase in CAGR saves (only) three years.

Here’s what happens when all 3 factors are improved 10% ($82,500 income, $62,100 expenses, 7.7% CAGR)…  18 years are saved, and retirement is reached in just 27 years starting from 0.

Expenses are most within your control.  They also provide the most ‘bang for the buck’ as far as reaching financial independence.  Increasing income without increasing expenses is also very powerful in reaching early retirement.

Of the 3 factors, CAGR gains are probably the easiest to improve if you are invested in high fee managed funds and/or a high fee superfund.  That’s because there are numerous low cost Exchange traded funds (ETFs), listed investment companies (LICS) and low fee superfunds that will meet your needs AND provide an adequate investment return. We have profiled quite a few here at ASX Dividend Aristocrats.

Key takeaways

1. Focusing on income and expenses has the greatest impact on savings
2. Even a small increase in CAGR of 1-2% can result in large long term gain
3. Financial Freedom is obtainable with planning and preparation

Please share with anyone you may think will benefit from this information!