How These 3 Key Principles Put You on the Path to Financial Success

On this episode of The Long View, author and blogger JL Collins breaks down the path to financial independence, what every investor needs in their portfolio, and key principles from the newly revised edition of his first book, The Simple Path to Wealth: Your road map to financial independence and a rich, free life.

Here are a few excerpts from Collins’ conversation with Morningstar’s Christine Benz.

How These 3 Key Principles Put You on the Path to Financial Success

Christine Benz: I wanted to talk about the key principles of the Simple Path, which are save as much as you can, ideally 50% of what you make. Avoid debt and invest in a basic index fund. As you reflect on those three key principles, which would you say has had the biggest impact in your own financial success?

JL Collins: Well, because for a large portion of my life, I made all kinds of financial mistakes, very clearly my savings rate is what saved me. And I, as you alluded to, when I came out of college and got my first professional job, which paid me the princely sum of $10,000 a year. Of course, back in those days, $10,000 a year bought a lot more stuff than it does today. But any event, I just randomly said, I want to begin building what I call the FU money. I had no concept of early retirement or financial independence then, but I knew I wanted to have a financial cushion. And I just arbitrarily said, you know what I can live on $5,000 a year. That’s a whole lot more than I was living on in college. So I’m going to live on that and I’m going to invest the other $5,000. And that’s what I did. So that is the thing that is probably the most powerful thing. Had I been smart enough and aware enough to embrace index funds earlier. Ironically, the first index fund that Jack Bogle created came out in 1975, which was the first year I ever bought stock. So theoretically, I could have been in in the beginning, but I didn’t know that.

And even 1985, when I was finally introduced to the concept of indexing and index funds and Vanguard, I still wasn’t smart enough to embrace it. It took me another 10, 15 years to get there. But that’s a problem with me. But for people today, especially young people like my daughter, who isn’t going to go through all the mistakes I went through and who started with, in her case, VTSAX

from the get-go, the path is going to be a lot smoother. And her savings rate, which has been aggressive, is just going to get her there faster.

Is a 50% Savings Rate Realistic?

Benz: So you referenced that 50% savings rate. I guess the question is how realistic it is, especially if you think about people who might be sole earners who are living in expensive metropolitan areas. Is it an unrealistic target, do you think, for many people?

Collins: You know, probably for some, but probably for far fewer than who think it is. And if you read Pathfinders, which is my third book, and it’s a collection of about 100 stories from all over the world, people who read the Simple Path to Wealth and embraced the principles in it. One of the things that’s a little bit stunning and very gratifying to me is how humble many of the beginnings for these people are, how little they had to start with when they started down this path. I mentioned that my first job paid me $10,000 a year and I lived on $5,000. I’m sure if I’d had the internet in my hand, which thankfully I didn’t, it would be filled with people telling me that I couldn’t possibly live on $5,000 a year. And frankly, by doing that, a lot of my peers were living a bigger lifestyle than I was because they weren’t doing that. But as somebody smarter than me once said, if you want extraordinary results, you’re going to have to do something different than the ordinary. And a high savings rate is one of those things.

What’s striking to me is I get a lot of pushback on 50% saying, oh, you know, that’s just unrealistic. And as Henry Ford would have said, if you believe you can, you’re right. If you believe you can’t, you’re right. And so for that person, it will always be unrealistic. But interestingly, I get push back from the other direction too, where people say 50%? I’m saving 60%, 70%, 80%. What kind of piker are you at only 50? So in the other point I would make about the 50% is a lot of people think that this approach is one of deprivation. I’ve never felt that way. And as my income expanded, I maintained that 50%. And what people somehow fail to notice is that, yes, my amount of dollars I had available to invest rose dramatically when I was making $20,000 a year. Well, I was now investing $10,000 but so did my lifestyle. Instead of living on $5,000, now I was living on $10,000. And I was making $100,000, well, now I’m living on $50,000 and investing the other $50,000. And of course, when you cross the Rubicon and you’re financially independent, well, then saving becomes optional. So, you get to a point where, as my friend Pete, Mr. Money Mustache, once told me everything’s free. And by that, what’s meant is that within reason at least almost no matter how much you’re spending, your investments are replacing it at a faster rate.

How Doing What You Love Can Help You Grow Income

Benz: Do you think growing income could have been another one of those key principles in Simple Path because it does seem like if you can concentrate on that, assuming you’re doing something that you enjoy, that is a really magical thing too, right?

Collins: You know, that’s a good point, Christine. And I’m kind of wishing that was part of the FAQ as you say it because that’s valid. And in fact, if you’re doing something you love or even that you’re just good at, which is the other way to approach your career is, there’s some pushback on this idea that you should find something to do that you love. And that’s great if you can. But that’s not necessarily available to a lot of people. I never particularly loved what I did, but I was good at it. And if you become good at something, then you tend to love it. But you also earn more money almost by default. So that’s a great point.

How to Pay Off Debt and Build Wealth

Benz: Debt paydown is in the book as well. You have some helpful breakpoints when people are trying to decide whether to prepay debt or more aggressively pay down debt. Can you walk us through those? And also talk about the impact of the prevailing interest-rate environment and how that might or might not change the calculus.

Collins: Right. So, my basic intention is that if you have debt, you are never going to be financially independent. So if you have debt, it’s an emergency. It’s what Mr. Money Mustache calls your hairs on fire. And I agree with that. So job one becomes getting rid of the debt. And there’s no easy way to do that. You simply have to organize your life in such a fashion that you would not only are no longer adding new debt, but that you are spending less than you earn, which of course is a basic principle to becoming wealthy. You’re spending less than you earn, and you’re taking that excess and applying it to the debt and paying it off. And of course, the bigger a chunk that you can divert to your debt, the better off you are. So again, going back to say 50%, if you can figure out how to live on 50% of your income. And you probably can for the vast majority of people listening to us. Then you’ve got the money to push toward the debt. And by the way, the great silver lining in that is once you’ve blown the debt out, you’ve already learned the habit of living on half of what you’re making. And now you simply take what you were paying off the debt with and begin investing. And then your wealth begins to build.

But before you can begin your wealth, you have to dig yourself out of the hole. Now, I think what you were referring to in terms of the interest rates is—there are one of the questions like it is, well, what if I have debt that is really low interest, wouldn’t I be better off investing the money, which will theoretically at least give me a larger return. So a good example of that is suppose you have a mortgage from a few years ago that’s 2%, 3%, even 4%. Well, in that case—and then I break it out by percentages—but I’d say, OK, if you’re carrying debt that’s less than 4% interest, maybe it’s not such a bad idea to keep that debt and invest the excess money instead. The key thing, of course, is organizing your life to have excess money. If you’re somewhere between 4% and in my mind, maybe 6%, that becomes more of a difficult question to answer. Theoretically, your investments will do better than 6% over time. But carrying debt should feel very uncomfortable to everybody listening. So personally, I’d be inclined to begin blowing off debt at that point. Anything above 6%, absolutely job one, blow off the debt before you do anything else.