The Formulas to Achieve Economic Freedom


Three scientific formulas are the foundation. They’re easy to use, but the difficulty comes from knowing just how to apply them.

 

Podcast Transcript Episode 3

Doug Fabian: The achievement of economic freedom requires the use of science. Today, we talk about the formulas to achieve financial success, and there are only three.

Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio. This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services.

Doug Fabian: Welcome to the Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is all about helping you achieve your financial dreams. We call that economic freedom. This program is about your journey to achieve or maintain economic freedom for yourself or your loved ones.

Today, we want to help you find your next step on that journey. This is Episode 3, The Formulas to Achieving Economic Freedom.

We chose the name for this podcast, The Science of Economic Freedom, very carefully. Here at Mercer Advisors, we own the trademark for Economic Freedom. We’ve been using this term for more than 25 years. We know what it means, and it is our mission to help our clients achieve it. Here is the mission of this podcast: to bring the achievement of economic freedom to everyone who chooses to set this as their goal.

Now let’s also remind ourselves why we use the word “science”. The dictionary definition of science is this: “the study dealing with a body of facts or truths systematically arranged showing the operation of general laws and truths about money and finance.”

We must reiterate this fact—70% of Americans are financially illiterate. Seventy percent! This means most people never learn this stuff. Even if you think you know it, bear with us as we go through some basics today. Realize that we’re building a foundation of knowledge that will come to serve you over and over again in the years ahead. The path to economic freedom is a journey through time and it never ends. Once you achieve economic freedom, you must continue down the path so you don’t lose it.

Now, today, we’re going to introduce you to the basic formulas to achieving economic freedom. These may seem elementary, but they are the foundation of our collective goal. We are also going to talk terminology. Language is important. The definition and understanding of the terms of our financial science are essential.

Let’s review some terminology of economic freedom.

Spending plan: This is a tool and exercise, a habit that allows the tracking of your income and expenses. This is a universal truth. Everyone has income and expenses.

Balance sheet: This tool is a summary of your assets and liabilities. Again, another universal truth. Everyone has a balance sheet.

Assets: Items of ownership that have exchange value, items listed on your balance sheet.

Liabilities: Debts that are owed by you, also listed on your balance sheet.

Asset allocation: A summary in percentage terms of your investment diversification. Universal truth. Everyone has an asset allocation.

And lastly, compounded growth: The geometric formula that grows money over time.

Now that we understand these terms, let’s move on to The Formulas of Economic Freedom. These formulas are not tied to the financial markets. They are about your financial activities: saving money, spending money, investing money to accumulate wealth. Nothing about investing itself. We will get to that, but we are still laying the foundations of achieving economic freedom. These concepts and formulas are all mathematical and there are only three. Here they are:

Number one, your income minus expenses equals your savings. We call the management of your income and expenses your spending plan. It is simple arithmetic to track your spending. Everyone has a spending plan, whether you’re tracking it or not.

Number two, time plus money times compounded growth equals your future wealth. Your rate of return compounded year after year, getting your growth on growth equals your future wealth.

Number three, your allocation to stocks, bonds, cash, and alternative investments is the single determining factor of your investment performance. Asset allocation is stated in percentage terms. Everyone has an asset allocation, some by choice, some by default.

That’s it! Now let’s take these one at a time.

Your Spending Plan: Income minus expenses equals your savings or surplus capital. This is where the rubber meets the road. This is the place where most millionaires get started. Be good at saving money and/or be good at making money and put it away so you don’t blow it. Force yourself to save. Measure how much you’re saving.

Pay yourself first. Fund your retirement accounts, your IRA, your Roth IRAs, your 401(k), your 403(b). Saving money is the foundation of Economic Freedom.

The second formula: Time plus money times compounding equals your future wealth.

Time is going to pass by anyway. Add your savings and then compound your nest egg, and you will have your future wealth. This is the greatest factor to achieving wealth. Compounded growth is growth on your growth. Compounding is a geometric progression, a sequence of numbers that compound on the previous value.

Compounded growth of 5% might not seem like much, but compound 5% for 30 years, and it’s huge! We tell people to set a rate of return goal. This is a compounded growth number you want to achieve over the next 10 years. Now, most times people tell us a reasonable number, 4%, 6%, 7%, sometimes 10%. You may not get that exact number each year, but setting the goal does three things for you.

Number one, it helps you determine an investment strategy for your money. Number two, it motivates you to get out of zero return accounts, and number three, it gives you a tool to measure your results.

Now we must mention inflation here as well. Historically, inflation has compounded at 3.2%. This is a big deal and a big number working against you. This single fact should drive you out of cash alone. The value of $100,000 after 30 years of inflation? A hundred thousand dollars under the mattress for 30 years is equal to $37,693 today, more than a 60% loss.

Lastly, your asset allocation: stocks, bonds, cash, and alternatives. Your asset allocation is the single biggest determining factor of your investment returns. It manages your risks while placing your assets at risk. Without risk, there is no return. Stocks are your growth engine, bonds your income and safety sleeve. Cash is a temporary parking place and alternatives are non-correlated investments to the other three classes.

Now we’ll get into all four classes when we start talking about investing in future episodes, but asset allocation is reflected in percentage terms. For example, 60% stocks, 30% bonds, 5% cash, and 5% in alternatives. Or, another allocation could be 60% stocks, 40% bonds, no cash, no alternatives. Here’s a universal truth: Everyone has an asset allocation.

Now, let me summarize today’s show. There are only three scientific formulas for the achievement of Economic Freedom: your spending plan, your compounded growth, and your asset allocation.

Now, here are the action steps from today’s program. Answer these questions:

How much money are you saving right now in percentage terms? What is your compounded growth goal? What rate of return would you be satisfied with? Lastly. What is your current asset allocation?

Remember, you can write me an email. Ask me a question, comment on the show, or give me a subject. My email address is [email protected]

Next up, what does economic freedom mean to you? Setting your financial goals.

Thanks for listening.

Announcer: The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio. This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services.

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