Is Financial Freedom a possibility for an average American? The short answer is – Yes.

Tony Robbins went on a mission in his latest book Money Master the Game: 7 simple steps to Financial Freedom to show how. Of course I wanted to read it! He interviewed 50 of the most successful investors in the world and compiled the best strategies for all to use. In addition to the technical strategies, Tony also addresses the psychological factors that influence our behavior. The book has close to 700 pages. Here, I would like to share with you my main lessons from the book.

Lesson #1 – Make the most important financial decision – Decide to pay yourself first.
Commit a percentage of your income to your Freedom Fund. Experts recommend saving at least 10% and many recommend 15%. The key to success here is to automate the process through a payroll deduction or automatic transfer to savings account. You can start with a smaller percentage and commit additional percentage when you get your next raise.

Lesson #2 – Determine how much money you need to achieve financial security and financial independence. Financial security means your savings can generate enough income to cover your most basic living expenses. Financial independence means you will have enough money to support you current lifestyle without working. The key to success is to resolve within yourself with the absolute certainty that “I’m going to do this”.

Tony provides an application which will ask you questions and calculate these amounts automatically at http://masterthegame.tonyrobbins.com/.

Easy way to calculate savings needed for financial independence, is to multiply your current annual income by 20 (that assumes 5% return on your savings). For example, if your current salary is $100,000 then savings needed for Financial Independence are $2 Million.  If you live on less than what you make than use that number for calculation.

To calculate your amount needed for Financial Security, first add up your monthly basic living expenses. Then, multiply by 12 to calculate your annual expense.  That amount is the total annual income needed after taxes. It is a little trickier to figure out the pre-tax amount. So it’s best to use a gross-up calculator (see link below) and then multiple that amount by 20.  In the example provided below, the monthly amount for basic living expenses is $5,190. The amount needed for Financial Security is $1,418,320.

If you are saving in a Roth IRA your gains are not taxed. In this case you don’t need to be concerned about taxes and pre-tax income and you will be able to reach your savings goals sooner. If your annual expenses are similar to the US average of $34,764, then you will only need to save $695,280 in Roth IRA to reach financial security.

*Based on Table 5. Size of consumer unit: Average annual expenditures and characteristics,
Consumer Expenditure Survey, 2013

Lesson #3 – Have an emergency fund to cover 6 -12 months of expenses.
This is your lifeline in case you get sick or lose your job. My personal preference is 12 months.

Lesson #4 – Make the most important investment decision of your life – Decide what percentage of your portfolio will be in the Security/Peace of Mind bucket and what percentage goes into the Risk/Growth bucket. The Security/Peace of Mind bucket holds money that you cannot lose. Many famous people made a lot of money and lost it all due to risky investments.

This decision is really about your risk tolerance and how much loss you can reasonably tolerate. You need to consider your future earnings potential, how easy it will be to replace the amount that it is lost and when do you need the money. In general, if you are younger and expect to make money for many years and don’t need the money for a long time, you can take a higher risk and invest more in stocks. The key is to remember that the pain of losing is far greater than the joy of winning. Read more about risk tolerance in my post  Surviving the Stock Market Crash in 2008.

Rutgers University has developed an online 20 question quiz to help identify your risk tolerance – http://njaes.rutgers.edu/money/riskquiz.

Investments that belong in the Security/Peace of Mind bucket include cash, cash equivalents (i.e. money market funds, bank money market deposit accounts, U.S. Treasury money market fund), bonds, CDs, annuities, structured notes and CDs that guarantee your principal.

I would exercise caution with bonds at this time due to rising interest rates. When interest rates rise, bond prices fall. If you hold an individual bond to maturity, interim changes in price will not affect the price at maturity and you will receive the principal back. In a bond fund, price of the fund will be impacted by rising interest rates and might result in a loss of principal.

Investments that belong in the Risk/Growth category include stocks, stock mutual funds, exchange-traded funds (ETFs), stock index funds, high yield bonds, real estate investments, commodities, currencies, structured notes and CDs that don’t guarantee your principal, and other high risk investments.

For the 20-year period from December 1993 to December 2013, the S&P 500 returned 9.2% annually, but the typical investor averaged just over 2.5%. This is because emotions get in a way and investors tend to sell when the market is low and buy when the market is high. You need to be really comfortable with your allocations for Security/Peace of Mind and Growth/Risk buckets. This way you can ride out major declines in your Growth/Risk bucket and avoid emotional selling.

Lesson #5 – Create a Dream bucket.
Make a list of your dreams. Put them in order of importance, big or small, short-term and long-term. Write down why you must achieve them. The Dream bucket meant to excite you and unleash your creativity. It helps you to find ways to earn more, save more and invest smarter. There are several ways to fund this bucket. You can allocate a portion of your profits in the Growth bucket, use a portion of your bonus, save a set percentage of your income or commit to a percentage of your next raise.

Lesson #6 – Reduce taxes.
401K plans and IRAs allow you to defer tax paying on both contributions and earnings. In Roth IRA your contributions are taxable but your earnings are completely tax free forever.

In regular taxable accounts you can save on taxes by holding stocks for periods longer than 1 year to qualify for the reduced long-term capital gains tax rate. Index funds are also tax efficient because they don’t trade as much as active funds and therefore don’t generate as much capital gains.

Because of the amount of the information in the book, I had to divide this post into two parts. So stay tuned for part II where I write about asset allocation and investments.

USEFUL LINKS –

http://livingwage.mit.edu/counties/34003 – Living wage calculation for Bergen county, New Jersey.

http://www.bls.gov/cex/csxann13.pdf – Complete 2013 average expenditure per consumer unit from U.S. Department of Labor.

http://www.adp.com/tools-and-resources/calculators-and-tools/payroll-calculators/gross-pay-calculator.aspx – Gross up calculator.

As you get closer to 62, there is one important financial decision you will have to make. You can choose to collect Social Security benefits at age 62 or delay it until 70. The decision is personal and depends on your specific circumstances. However, there are several considerations that can help guide your decision.

1.  You will receive a higher Social Security benefit for every year you wait
Full retirement age is around 66 or 67 (if born after 1960). If you start collecting Social Security at 62, you will receive a 25%-30%(based on your full retirement age) lower payment than if you’ve waited until your full retirement age. In addition, if you wait until you are 70, you will receive 8% increase in benefits for every year you wait. For example, if your full retirement age is 67 and your full Social Security benefit is $1000, it will be reduced to $700 if you start collecting at 62 or increase to $1240 if you wait until 70. A simple break-even analysis for collecting at age 62 vs. 70, shows that the break-even age is around 80. You will receive more in total benefits if you will live longer than that. If you are in good health, have good genes and expect to live into your 80’s and 90’s, then maximizing your Social Security payment is a good strategy.

2. Your life expectancy
If you have health concerns and believe that your life expectancy is lower than average (see life expectancy calculator link below), then it might make sense to start collecting Social Security early.

3. You need money to cover your living expenses
If you need money to cover your living expenses now and there are no other options, then you have no choice but to apply for Social Security early and receive a smaller payment for life.

4. You plan to work after 62
If you work between age 62 and your full retirement age, Social Security will reduce your benefit $1 for each $2 earned above Social Security limit. In 2014 this limit was $15,480. So if you make more than the limit, it probably will not make sense to collect Social Security at 62.

5. Your social security benefit is higher than your spouse’s
Couples have an additional consideration. If your full Social Security benefit is higher than your spouse’s it might make sense to postpone collecting your benefit. Even if you have health concerns, you might want  to consider your spouse’s life expectancy as well. Your surviving spouse can collect Social Security benefits based on their own earnings or yours. It might make sense for you to wait to collect your benefits so that you and your spouse can collect a higher amount for the rest of your life.

6. You are more comfortable having the money sooner than later
If you worry about the future of Social Security or just more comfortable having the money early then collecting sooner might be the right option for you. You also need to be comfortable with having a lower benefit for life. It is true that Social Security has reserves to pay full benefits until 2037. After that, new revenues will be able to cover about 75% of scheduled benefits. However, with small changes the system can continue to pay full benefits. Because of political implications and how changes to the system were implemented in the past, it is unlikely, that any policy changes will impact current retirees or someone who is near retirement age.

I still have some time before I need to make this decision but my husband is getting closer to 62. He is in good health and hopes to work late into his 60’s. So for him it makes sense to delay collecting benefits for as long as possible. Actuarial life expectancy table from Social Security, shows the average life expectancy for a 62 year old man is around 81 and for a 62 year old woman is around 84 . So statistically speaking for most people, the longer they wait to apply for their Social Security benefits the higher the total benefit they will receive.

USEFUL LINKS  –

http://www.ssa.gov/OACT/STATS/table4c6.html – Social Security actuarial table for life expectancy

http://www.socialsecurity.gov/oact/population/longevity.html  – Quick life expectancy calculator

https://rslic.metlife.com/lic/corpLongevity.do?target=back  – Life expectancy calculator with basic health and lifestyle considerations

http://crr.bc.edu/special-projects/books/the-social-security-claiming-guide/ – Social Security guide from the Center for Retirement Research at Boston College

http://www.socialsecurity.gov/OACT/quickcalc/early_late.html – Early or late retirement calculations

http://www.socialsecurity.gov/retirement/1943.html – Shows how your benefit is reduced based on what age you start collecting benefits

http://www.socialsecurity.gov/retire2/agereduction.htm – Shows how your benefit is reduced based on your full retirement age

http://www.socialsecurity.gov/retire2/otherthings.htm – Full list of considerations from Social Security

http://www.socialsecuritysolutions.com/get-your-solution.php – Offers a Social Security calculator with different strategies for singles and married couples for a fee. Starting with a $20 personalized report.