Housing, Transportation and Food are the big three categories to control in order to maintain a relatively high savings rate. To achieve financial independence (FI), the most important thing is your savings rate as I explained in a previous post here.
A lot of people try to find investments or other means with a high return rate. However, this may turn out futile if the necessary capital available to invest is not substantial. Good returns do not have a big impact if you intend to be financially free at a young age, considering that the stock market typically returns nominally 10% a year.
I am in the process of looking for a new place to live in January 2020 and this has made me to seriously consider my lifestyle costs in future. When I moved to new places previously, I did not do the math well, particularly for housing and transportation costs in relation to my new lifestyle. In a number of cases, this has resulted in me being worse of either financially, by quality of life or both.
For example, when I moved for my current job (from Cambridge to London outskirts) my salary went up by 13%. This seems great but I ended up living 11 miles from work compared to 4 miles previously. This seemingly innocuous change turned a simple 20 minute commute into a gruelling drive of over an hour in rush hour traffic.
The new job meant that I lost many hours a month plus cash due to the long commute and I was generally more tired. It felt like I had already been to work when I got to work.
Housing and Transportation
I see management of these two elements as being critical in propelling me towards financial independence at this stage. It is not wise to find a cheap place to live which is very far from work, costing time, an arm and a leg to get there. For this reason, I have decided to find a rental within walking distance of the office. Costs will be roughly the same as the previous place but the commute by car or train will be completely eliminated, resulting in cost savings and 7 hours a week freed each week. That would be effectively gaining an extra work week each month!
55% savings rate
To be financially free by my target date I have estimated that at least an average 55% savings rate will be required. This has been over 53% so far. I will also need to maintain the progress made by maintaining my core living expenses or even better by reducing them. To do this it is important to know current and expected expenses which will guide the search for new accommodation.
Housing and Transportation to gross income ratio
People often wonder how much they should spend on housing in relation to their income. It will depend on what you can afford and what you value in life. I was a bit shocked when the estate agent said that I could afford a place which is my gross salary divided by 30. This would mean that 53% of net pay would go towards housing which is ridiculously high. Admittedly I would get a nicer place but my financial independence progress would drop to only 29% and future savings to 35%. Achieving freedom would become practically impossible, leading to many more years in the cubicle.
With these facts in mind how much should one allocate towards housing and transport. I have been tracking how much I spend on these two since 2007 as shown the the graph above. When I started my first job in 2007 I lived in shared accommodation with very low costs and a 20% spend. However, within a year I got a small pay rise and had a huge bout of lifestyle inflation by moving to my own studio flat.
Now with a hefty 30% expenditure I managed to save absolutely nothing after a three year period and remained with even more credit card debt while having a negative net worth.
Over the next few years I moved locations for new jobs and back to shared accommodation. This enabled me to pay off the credit card and start the fi journey in 2012.
The housing and transport expenditure proportion has been steadily decreasing due to some some pay rises and is expected to get back to near 20% when I move to the new place. I find this to be an acceptable amount to pay. It may mean sacrificing a little luxury but will not derail progress towards financial independence within a few years.
*It is also important to stick to a budget while tracking your other expenses as these will affect the overall picture.
In summary, to maintain a 55% savings rate I would need to spend roughly 20% of my gross income to housing and transport to achieve financial freedom within 3 years. This is based on my current level (52%) of expenses covered by passive income.
I have found this to be the most comfortable scenario for me in relation to my goals. Everyone’s situation will be different.
As I am currently based in one of the most costly areas of the UK (South East), applying some Geographic Arbitrage almost anywhere would definitely have a positive impact. Quality of Life could be increased and Cost of Living reduced readily so this will definitely be on the cards soon. In fact I realise that I am already 70% FI for less costly parts of the country.
Also, renting a place rather than owning is beneficial as one would be far more flexible to take advantage of opportunities and overall expenditure on housing and transport would be far easier to limit.
Things look set to get more exciting in the next couple of years as the snowball keeps gathering speed and size, opening up more possibilities and options.