Your retirement planning begins with tracking your financial data
Updated: Oct 26
No. I'm not talking about "big" data here. It is personal data that we have not been claiming enough ownership of. While it is important to protect it from its misuse, we don't want to miss opportunities to use it in our favor. Unknowingly, I hired my own data five years ago for the first time to improve my finance. It has become my life coach ever since.
Often, we underestimate how much we can accomplish with what we already have, especially when we don't see a clear path to get to where we want to be. I spent most of my career in academia, making less than the average income. Picturing my life that would not rely on salary seemed pointless five years ago. I have always been saving however little money I could spare in the certificate of deposit or savings accounts. But you won't see much growth in your savings at a 1% annual interest rate.
(Image source: Media Assets Repository System)
So, high paying jobs seemed like the only answer to my financial independence. But what if my dream job does not pay me much? Would I always remain poor? Even though I was trained to be a critical thinker as a scientist, I had never questioned this hypothesis until I learned about the compounding effect five years ago.
It turned out that I could have grown my savings at least 70% more if I had started investing just six years earlier when I finished my education, thanks to the compounding effect [1% (bank accounts) vs. 8% annual interest rate (investment return); see the graph below]. Historically, total stock market index funds have provided an 8% annual return, which is why I used an 8% annual interest rate as a benchmark for the investment return.
The compounding effect tells us that even small savings would end up making a big difference in the long run if we can secure a substantial interest rate. It was such a revelation that I decided to go over my expenses and savings, looking for ways to re-route as much spared money as possible to investment accounts.
That is when I realized the importance of tracking my expenses, savings, and investment. Being familiar with excel files, I created a spreadsheet that tracks my expenses and investment return (see the screenshot below). It took me some time to get used to recording daily transactions, which can be tedious at first. What I did not immediately realize then was the power of insights I could gain from analyzing these data.
(Personal finance tracker)
Once I had my finance data over two years, I could estimate my average living expenses with confidence. It enabled me to invest as much of my salary as possible while setting aside my living expenses in a checking account. Then, I could also use my average living expenses to estimate the size of my investment portfolio, which will sustain me during my retirement. After accumulating my finance data over five years, I was able to figure out the average rate of capital gains from my investment portfolio, which made it possible to estimate how long it would take me to reach my financial independence.
I use three tools to run this calculation: Simple Savings Calculator, Retirement Income Calculator, and Monte Carlo simulations. Vanguard's Retirement Income Calculator allows you to estimate your monthly income in retirement, based on how many years you have until you retire, your annual contributions to your retirement accounts, the size of your current investment portfolio, your expected living expenses during retirement, and investment return. But, you may get annoyed if you are a super saver because you cannot set your expected living expenses below 60% of your current income. Simple Savings Calculator breaks down your projected savings into the interest earned, your total contributions, and the initial deposit without any restrictions in your inputs.
(Simple Savings Calculator)
On the other hand, Vanguard's Retirement Nest Egg Calculator allows you to estimate how long your savings would last, based on how many years you have until you retire, the size of your current investment portfolio, and living expenses. This tool runs 5000 simulations, in each of which this algorithm randomly applies the investment return of a certain year in the database to your portfolio and repeats this process one year at a time for the duration of your retirement. If your investment portfolio survives 98% of 5000 simulations, that is the number you will get (see the screenshot below).
(Retirement Nest Egg Calculator)
From these analyses, you can get a clearer sense of how much savings you will need to retire and how long it would take you to get there in your situation. Even if your job is not paying you a lot, you won't need a million-dollar investment portfolio if your living expenses are low and your investment return is substantial. So, you can come up with plans that allow you to achieve financial independence in your term.
The benefits of tracking your data don't stop there. If you track the performance of your investment portfolio over time, you will see the compounding effect play out for you in real-time (see a plot below). My investment portfolio has gone through two corrections of the stock market in 2015-2016 and 2018 (you don't see the first correction in the plot shown below because I have been tracking my portfolio since 2017). When I first lost 10% of my investment during the first correction, I panicked and wondered whether I should sell all stocks before losing everything. Now that I have seen more ups and downs in the stock market, I know that my investment portfolio always recovers and gains faster, following corrections.
What I learned from the performance of my investment portfolio for the last five years is that the biggest growth driver for my savings is the size of my contributions to the retirement accounts and the generosity of my employer match. Although I said it before, it is worth repeating here: if you start to invest early in your life the same amount of money in index funds regularly for a long time, you will reach financial independence, regardless of your income. It is even better if you keep enough cash to invest more in deeply discounted, high-quality stocks during the market downturns, which will accelerate the recovery and growth of your investment portfolio after the market downturn.
Seeing is believing. Tracking is the key to our success because it gives us opportunities to course-correct when things go wrong, and to revise our goals by projecting our past performance into the future. Simply knowing that I will be able to retire in 5 years gives me peace of mind and freedom to pursue what I feel passionate about.
Every January, we promise ourselves to become "better" us. This time, why don't you give yourself permission to dream big, like the cat with a lion's shadow in the first picture above, by taking the first step to your financial independence? I can promise you that tracking your finance will help you come up with strategies that minimize your expenses while maximizing the growth of your assets.
Figure out your own living expenses, pay yourself first, and watch the exponential growth of your investment over time. You will be able to free yourself from mundane work while pursuing your dream...
(Image source: Media Assets Repository System)