I’ve been thinking a lot about early retirement lately and what exactly would be required to walk away from the day job and live completely off my portfolio.  As I was pondering this, I started to question whether or not I was saving enough money to realize my goal of becoming financially independent.

With that, I broke open a spreadsheet to come to some conclusions as to the percentage of savings required to have in a portfolio that would cover my expenses at a particular date in the future.

The Numbers

Assumptions:

• Combined Household Before Tax Salary: $100,000 (after inflation – assume grows with inflation)
• Average Tax Rate: 30%
• Expenses = 100% – Average Tax Rate – Savings Rate
• Market Growth: 4% (after inflation)
• Withdrawal Rate: 4% (assume only dividends are withdrawn, thus highly efficient taxation ~0%)
• Assume invested in a non-reg portfolio with no capital gains tax.

I created a spreadsheet to go through the various scenarios at increasing savings rates.  Instead of displaying all the numbers, here is the spreadsheet so that you can do similar calculations of your own.

After running through the scenarios, I came to the following conclusions on the years to financial independence (fi) based on savings rates.

Based on my assumptions, it’s apparent how guys like QCash were able to retire so early (in his 30’s).  QCash has indicated that during their working years, they saved approximately 50% of their income.

If you have a two income household, with roughly equivalent salaries, then perhaps a strategy that you can try is to live on one income.  As you can see from the table, saving 50% of your household income puts you on the fast track to financial independence.

Conclusions:

It’s pretty obvious that the higher percentage of income that you save, the closer financial independence becomes.  However, what this article shows is how powerful aggressive saving can be.

If you only save a small portion of your income, don’t be discouraged by the large number of years before financial independence.  My calculations did not account for Canada Pension Plan or Old Age Security. Both of which could provide a family with up to $32,000/year providing both spouses qualify for maximum benefits (at age 65).

Looking for some frugal tips? Here are 25 Ways I Save Money.

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I came by an eye opening article by Vanier Institute of The Family (via The Wealthy Baker) that explains the current financial state of Canadian families (2008).

Here are some of the highlights:

Savings

We look south of the border and see the abysmal savings rates of the typical American family.  You may assume that Canadians save much more than our U.S friends, however, that is not true.  Our savings rates are almost as low as in the U.S!

Back in 1990, Canadians had a healthy savings rate of 13% compared to the U.S 7%.  However, the gap has dwindled significantly over the years where in 2008, Canadians save about 3% of their income and Americans 1%.

These recent numbers are relatively poor if you look at the savings rates from other countries:

Canada has a relatively low savings rate among industrial countries. For the latest year available, the savings rate was highest in France (12%), Russian Federation (11%), Germany (11%), Austria (10%), Italy (9%) and Belgium (8%) … all much higher than for Canadian and US households.

RRSP Contributions and Charitable Donations

In 1990, 30% of tax filers made a charitable donation.  What do you think the number was in 2007?  I would think higher, but in fact, in 2007 only 24% of all tax filers made a charitable donation.  Note though that the only donations counted in this article are the tax deductible (traceable) kind.  Volunteer work, church donations etc aren’t considered.

RRSP contributions peaked in 1997 with 30% of tax filers contributing.  In 2007, only 27% of tax filers made an RRSP contribution with an average amount of $2,800.

Debt

Household debt (including mortgage) in Canada seems to be exponentially increasing with time.  Since 1990, Canadian household debt has increased over 71% with a strong uptrend intact.  What’s more concerning is the debt to income ratio or debt service ratio (DSR).

In 2004, about 6.3% of US households had a dangerous DSR above 40% compared to 4.4% in the same situation in Canada. While this is a hopeful sign for Canada, the 4.4% still represents over 600,000 households with dangerously high DSRs. Within Canada, the percentage of households, in the lowest third in terms of income, who had a dangerously high DSR above 40% rose from 6.6% in 2004 to 7.8% in 2007. The recession will make it even more diffi cult for the less well-off

Our total debt relative to net worth is the highest in 44 years at 23%.

Net Worth

The average net worth of Canadians has been on an uptrend since 1990 (finally some good news) with most of the assets in shares, pensions and real estate.

Average Incomes

They have a nifty table with average income of families and individuals.  Here are some of them from 2006:

• Senior Couples: $48,300
• Couples without Children: $65,800, One Earner: $52,600  Two Earners: $73,700
• Couples with Children: $76,400, One Earner: $54,900, Two Earners: $75,800
• Female lone-parent: $37,000
• Male lone-parent: $54,500

Conclusions

I always knew that the “typical” Canadian family had a lot of debt and perhaps not the most financially responsible, however, I did not realize the extent of the problem.  Some of the numbers highlighted are staggering.  If you get the chance to go through the report, what stood out for you?

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