This was where I thought this blog would start. In fact, prior to writing this blog, I spent the vast majority of my time concerned about Wealth, and whether or not I was on track to retire with the ability to enjoy my life. In the book, Rich Dad, Poor Dad, Robert Kiyosaki defines wealth as a TIME FUNCTION (side note: I’ve read many of his other books, the first one is all you need to get started). Interestingly enough, he defines wealth a the amount of time an individual can maintain their current lifestyle if they stopped working completely. So for instance, if an individual spends $3000 a month, and they have $60,000 in the bank, they can live for 20 months while maintaining the same lifestyle. This assumes no interest on the principal amount of $60,000. For example, perhaps that money is just sitting in a checking account.
Now, if the money is sitting in an investment that earns returns, the math changes a bit – say that same $60,000 earned 10% interest annually, then there is a little more money to go around, as shown in the table below:
As you can see from the chart above, $60,000 at 10% interest doesn’t make much of a difference – a little more than a month. But what if you had $600,000? The chart ends up being too big to paste in here, but the 0% interest lasts 200 months (about 16.7 years)… and the $600,000? Well, it basically lasts forever, because 10% of $600,000 annually is $60,000 and since this person only spends $3000 a month – $36,000 a year… well the value of the principal goes up year after year. So in this scenario, this individual is quite wealthy with $600,000 in an investment which returns 10% annually.
Of course, in the real world there are taxes, and unforeseen expenses, and all sort of other variables which I will get into later, and hopefully show where I made some errors early in my life and you can avoid those.
Ok, time to see how I’m doing. Break out the trusty HP-12C Financial Calculator and start punching some buttons. Seriously, I have one of these things, and I still do not understand the appeal. I guess it’s kind of retro. I’m sure all see all the hipsters in Brooklyn tapping away on these soon enough.
Alright then. I have roughly 50 months of current lifestyle in investments. And I’m 40. This is a whole lot of not good. Here is a tip for you kids out there: do not compare yourself to the ‘average’ American. When it comes to planning your finances (well, planning anything for that matter) you want to be well above average. I think in my 20s I managed to trick myself into thinking that I was doing more for myself financially than I really was. Now, some of this was somewhat understandable – for instance, I bought a house and was paying the mortgage and making improvements. So that was good. The Boat was not. If you don’t understand that, go back and read that post. Laugh at me. Then please avoid that mistake for yourself.
Critically I did not set up a Thrift Savings Plan when offered by the Government. Now, again, this is an area where I wasn’t completely doing the wrong thing. In fact, I actually tried to do the right thing for a while, which will be the subject of another post. But the point being… Sign up for your 401K or whatever version of it that your company offers. That money gets deleted from your paycheck and put into investments before you even see it. Some people are reading this and saying ‘Well, the tax advantage of a 401K is mitigated by the fact that an individual eventually pays income taxes on that money, so is it really worth it?’ If you are one of those people, congratulations! I’m being really serious here – if you are at the level where you are calculating the relative tax advantage of investing in your 401K now vs when and where you plan to retire… well, you are further ahead than I was until age 40. So hopefully you’re reading that at like age 23.
I think a really great guide is put out by Financial Samurai. I really like Financial Samurai, and it sounds like he and his family have their stuff together. Suffice it to say, I am at the ‘Low End’ range of his chart for my age.
So what now? What is the next step? Well, to be completely honest with my readers, at first I just gave up for a couple of days. I kept spending my normal amounts, and just pretended that I hadn’t run the numbers. Then I came back a couple days later, logged into all my accounts, and ran the numbers again.
Turns out I was right the first time. Now, again, there are people that are really struggling day-to-day, and that is not me by any stretch. So I do want to first say that I’m thankful for my health (although not as good as I thought!) and I am also thankful that my mother and father were great people who ensured that I not only went to college but took a degree which would benefit me down the line. In truth that was more on my father’s side – he was an engineer by training and was quite adamant that I take a major which had tangible skills associated with it. Engineering it was.
So, yes, I am doing pretty well. In fact, I just looked up Income Quartiles in the United States. This one has my metro area included, which is great. Turns out I’m in the top 25%. Yay me!
If you remember from earlier, I mentioned not comparing against the average. That’s why I like using quartiles or percentages. For example, if you remember a few years back there were many protests against the ‘2%’ of the country that has the majority of the wealth. You can certainly protest it, but until the fundamental system changes, I believe there is more benefit from working within the system for your own benefit.
…So back to my numbers and spreadsheets. At present, I am behind the power curve (near the bottom of the low-end range of the FS chart). Assuming that I can:
- Put 25% of my earnings into my investments
- Average a 7.5% rate of return every year
…I will be on track to hit the ‘Mid Range’ by 50.
Please think about that for a second. If you are in your 20s, or 30s… please think about this: I am now seriously considering becoming an Uber driver as a ‘side hustle’ to augment my earnings in my 40s to try and get to the middle of the road. In that regard, I’m somewhat lucky in that I do not have a wife or kids, so I do have the ability to basically work nonstop through my entire 40s… to get to average.
Now, looking at the chart the middle of the road FS lists $1,000,000 at age 50. Most planners use an estimate of 4% return on invests as a conservative estimate to maintain the principal value of the investment (remember the $60,000 from earlier? Well, in this case, the target is $1M even, and a rate of return of 4%). So at a 4% rate of return that level of investments nets $40,000 in returns. That means that I could spend $40,000 per year essentially forever. Remember the chart showing the income quartiles for the US? Turns out $40,000 per year is in the roughly the 40th percentile of income. And that’s doing exactly zero to earn additional income.
What would I do? Would I just sit there doing nothing for a year? Well, no. I might get a job as a ski lift operator, and get to ski in my downtime. That actually sounds like a lot of fun! Now, no one gets rich being a ski lift operator but at that point, I wouldn’t need to.
As it stands right now, I’m not driving for Uber. Is that the best use of my time? Those are the questions that I hope to answer through this blog, as I track the things I do and their results.
Conclusion: Start putting some money into your 401K, or your IRA, or whatever you’re going to use. But start putting it away NOW. Don’t wait. Future blog posts will have some of the other mistakes I’ve made and things that I’ve fallen for over the years, so you can avoid those too. But if you’re young, there is zero substitute for starting early, as you can see from where I am right now.