Today’s guest post is brought to you by Doug Nordman, author of “The Military Guide to Financial Independence and Retirement.” All of the royalties are donated to military charities.
Military servicemembers should take advantage of powerful opportunities to pursue financial independence: pay raises, promotions, and bonuses.
Once you’ve paid off any consumer debt and built your “rainy day” fund for emergency expenses, then you’re ready to start investing. You’ll save a portion of your income every month and invest it for your transition to civilian life (and your eventual retirement).
The budgeting and savings skills that get you started can also grow your retirement portfolio even faster. You can accelerate your financial independence by contributing as much as possible to the Thrift Savings Plan, your IRA, and taxable accounts. There are two ways to speed up the process: spend less, or earn more!
The military’s annual pay tables generally rise at the rate of the national Employment Cost Index, but that won’t beat the rising budget expenses caused by inflation. Your military earnings will also rise with each new pay table, longevity raise, or promotion– but it’s all too easy to let lifestyle expansion suck away your hard-earned higher income. Just boosting your TSP contributions by the annual pay increase will not get you to retirement before your 60s. If you want to reach financial independence in your 50s (or even your 40s!) then you’ll need to save and invest more– and your higher earnings are the perfect place to start. It turns out that a higher savings rate is not as difficult as you’d expect, and compounding makes your investments grow even more quickly.
Aggressive savers should try to invest as much as possible of their pay raises and bonuses while holding down their spending. Financial independence would be easy if an E-7 could still keep their spending down at the level of an E-1, but this is unrealistic for all but the most hardcore frugal savers. (It’s deprivation, too!) A more achievable goal for an E-7 would be holding their spending at an E-6 level and investing the promotion pay difference. Every time you earn a promotion, try to hold your spending at the level of your old paygrade and invest most of the pay raise.
The same concept applies to bonuses. You’ve handled your lifestyle on your base pay and allowances, and a bonus should be an extra boost to your wealth! Sure, celebrate your bonus victory with a nice dinner or a spa day. Spend a little of that bonus money on an enjoyable experience that will generate even happier memories for a long time– but don’t blow it on a big shiny SUV. Before you start celebrating, try to save (and invest) at least 80% of that bonus.
Will this tactic of saving and investing make a difference? You bet: the results of the compounding are shocking– in a very good way!
I’ve graphed a spreadsheet that shows how quickly those little lifestyle changes will add up. If you can’t wait to see the picture, then scroll down to the end of this post and click on the link. In the meantime the next few paragraphs will lay out all the assumptions and the math behind the picture so that you can plot your own spreadsheet for your own career goals.
The spreadsheet starts with the 2009 pay tables and assumes that military pay keeps up with inflation over a 20-year career. It projects reasonable promotion gates for E-2 through E-7 and O-2 through O-5, although your service and your specialty may be a little faster. It also assumes that the servicemember saves (only!) 10% of their base pay at their lower rank, and 80% of their pay raise from their latest promotion.
Savings are invested and keep compounding at a conservative 3% over inflation in your TSP, IRA, and taxable accounts. 3% over inflation is a reasonable rate of return for an investment portfolio that’s concentrated 80% in the stock market. When you’re in the military, in your 20s or 30s with a steady paycheck and a “high probability of continued employment”, then you can afford to invest this aggressively.
The spreadsheet assumes typical promotion gates for enlisted and officer ranks. By the end of a four-year enlistment, an E-1 will earn three promotions and wear E-4 rank. By the end of 10 years of service they’ll reach E-6, and they’ll reach E-7 at 16 years. Officers follow a typical career path by promoting to O-2 at two years, O-3 at four years, O-4 at 10 years, and O-5 at 16 years.
Here’s an example of the spreadsheet’s savings goals for an E-5 in Year 9 of their career. Their promotion to that rank occurred back in Year 7, and they’re attempting to control their expenses during Years 7 through 9 as though they were still receiving E-4 pay. They’re saving 10% of their E-4 base pay and 80% of the pay raise (between E-5 and E-4 ranks) from the “over 8 years of service” column of the pay table.
Next year (Year 10) that E-5 promotes to E-6, but the spreadsheet conservatively assumes that the pay raise takes effect at the end of the year. Their longevity is the same because they’re still over eight years of service but not yet over 10. So the same “over 8” pay scales are in effect and the member is saving the same amount as in year 9.
Next year (Year 11) the recently promoted E-6 uses the “over 10” column. They’d save 10% of E-5 base pay and 80% of the pay raise (between E-6 and E-5 pay) from the “over 10 years of service” column of the pay tables.
Note that the spreadsheet is simplified with a conservative pay assumption. The military pay tables include longevity raises every 1-2 years, but the spreadsheet leaves them out. When you’re building your own plan, you can try to save longevity pay raises for even faster progress.
Other conservative simplifying assumptions include:
- No money is saved during the first year of a 20-year career. This really hurts the compounding but it’s a reasonable fact of life.
- Active-duty military savings and compounding rates occur at the end of each year instead of at biweekly paydays.
- Tax-free allowances like Basic Allowance for Housing are not included in the savings rate, allowing them to be used for higher housing and utility costs.
- Specialty pay and bonus pay are not included, although a frugal saver would invest both when possible.
The graph shows results for two different cases:
- Saving 10% of base pay and 80% of the promotion pay raise.
- Saving 20% of base pay and 100% of the promotion pay raise.
It may not seem like much of a difference from one year to the next. However the small boosts of saving each pay raise have nearly doubled the size of the final investment, even though the biggest raises occurred late in each career. By the end of 20 years you’ll be well on your way to financial independence– especially with a military pension. Even if you only completed one or two obligations, your additional savings will compound at a much higher rate while you pursue your own civilian career.
(If the graphic isn’t displaying correctly, here’s a permalink to a downloadable PDF:
Graph of Saving Base Pay and Promotions Raises )
Now that you’ve looked at the results, review your own assumptions to see where even more could be saved from longevity raises, housing allowances, cost-of-living allowances, specialty pay, and bonus pay. Lock in those numbers as soon as your paycheck goes up by automatically deducting the income and depositing it in your investment accounts. Your portfolio will grow even faster. In fact, if you can save and invest at least 40% of your gross income for 20 years then you’ll achieve financial independence even without a military pension!
Doug and his spouse both reached financial independence and retired from the military in their 40s. They’ve had a total of over 50 years of active-duty and Reserve service. Their daughter is a college senior (on a Navy ROTC scholarship) who will soon be an ensign on a destroyer. Doug answers lots of questions about the military and about reaching financial independence at The-Military-Guide.com.