Financial independence, from a mathematical point of view, is pretty straightforward. You need an investment portfolio 25 times your annual expenses. With some basic assumptions, confirmed by historical market performance, if you withdraw no more than 4% of this portfolio each year, it will last indefinitely.
Financial independence is not absolute; it depends on how much money you need to cover your annual expenses. If you can live on $40,000 a year, you need a million dollars in your investment portfolio. If you spend $100,000 a year, you will need $2.5 million. That is a lot of money but actually getting to financial independence is easier than it might seem because you don’t have to save all of that money on your own. Once you start investing, the market helps you along.
Suppose you save and invest $20K per year. It may seem that it would take you 50 years to get to 1 million dollars. But if we assume that your investment grows at 11% annually (a reasonable assumption based on historical averages), it will take you only 17 years. In other words, you will only have to actually save $340,000, and the rest of the money will come from the growth of your stocks. In the table below, notice that after year 7, the market is actually contributing more towards your portfolio growth than you are. The rich get richer!
Surprisingly, how long it takes you to reach financial independence does not depend on how much you make but only on what percent of your income you save. If you make $200,000 and you save 50% of your income (therefore, you can live on $100,000 per year), it will take you exactly as long to accumulate the $2.5 million you need as someone who earns $80,000 and can save $40,000 of their income to reach their financial independence number of one million dollars. Of course, making more money helps – it is much easier to figure out how to live on 50% of a $200,000 income than to figure out how to live on 50% of a $20,000 income. Nevertheless, the table below will tell you how long it will take you to reach financial independence assuming today you have no assets and no debt based on various level of saving. You can get information based on your specific situation with this straightforward calculator.
Do you feel inspired? What percent of your income are you willing to save? The average US household saves about 7% of their income which translates to 58.8 years until financial independence. Can you do better?
I just finished eating a delicious “meat” and “cheese” sandwich on homemade bread and I thought I should share some amazingly easy recipes together with a comparison of the cost to make them at home verses buying equivalent products. Although the savings are significant, I mostly cook because I enjoy the magic of creating food (who knew you can make “meat” in your kitchen with just a few minutes of labor), and I like having control over the ingredients I use. Buying in bulk and cooking from scratch also reduces waste from packaging.
We are mostly vegan, hence the quotes above, but I am still pretty traditional and like a good “meat” and “cheese” sandwich once in a while. Bread is one of the easiest things to make and it is well worth making it at home to avoid all the preservatives added to store-bought breads. Plus it makes your house smell great.
I don’t remember where I got my bread recipe so I can’t give proper credit, sorry.
(This recipe is very forgiving. Even though I give exact measurements, I only measure the flour and the water and I am not very careful with those.)
Dry Ingredients 4 cups white flour (can replace 1 cup with whole wheat) 2.5 teaspoons yeast 1.5 teaspoons salt
Wet Ingredients 2 Tablespoons oil 1 3/4 cup warm water
In a big bowl mix together the dry ingredients. Then add the wet ingredients. Mix and knead for a couple of minutes. Add more flour if needed. Let the dough sit in the bowl covered with a damp towel for about 2 hours. It will double in size. I make two loaves out of it. After forming the loaves, give them another hour to raise and bake at 350 F until golden brown. Let cool before cutting.
Cost for two loaves using mostly organic ingredients with links to Amazon:
4 cups organic white flour = 18 oz =$1.62 2.5 teaspoons yeast = 0.25 oz = $0.20 2 Tablespoons oil = 1 fl oz = $0.05 Salt, water, and electricity for baking = a few cents TOTAL: Less than $1.00 per loaf
Comparable bread at the store is about $3.00-$4.00 per loaf. You can have added fun by putting rosemary, oregano, or suflower seeds in the dough. Unfortunately the child does not like anything added to her bread so we make it plain.
This recipe is a mild modification of Lessarella cheez by GoDairyFree. The original recipe is probably better but it requires lemons and I often don’t have those around. Prices quoted for mostly organic ingredients with links to Amazon.
Put all ingredients in a food processor (or use a submersible blender), blend until smooth (less than a minute) and then cook until thick (about 10 min). While cooking you really must stir THE WHOLE TIME. Freezes well. Great on sandwiches, pizza, quesadillas, and as dipping sauce for vegetables.
This “cheese” doesn’t really have a store bought equivalent but it fulfills all of our family’s cheese-needs for the week which used to take 3-4 packages of Dayia at $4.50 a bag and it is much less processed.
I don’t know why but it took me years to discover how easy it is to make seitan at home. This recipe is a modification of Seitan with Chickpea Flour from One Green Planet. Again, the original recipe is probably better but this has fewer ingredients so it is faster and cheaper.
Wet Ingredients 1 tablespoon ketchup 1/3 cup soy sauce 1 1/2 cups hot water
Mix all dry ingredients in a bowl. Separately, mix all the wet ingredients. Add the wet to the dry, mix, and kneed for 3-4 min. Add extra wheat gluten if needed. Let rest for 15 min covered with a towel. I usually form two “loaves” and I like to make them kind of long and thin (helps with cutting later). Put in a pot mostly covered with water with some soy sauce and boil for 1.5 hours. They will at least double in size so make sure they have enough space to do that. You may have to top off the water occasionally and you might want to flip the loaves half way through but they will be fine if you forget. You can also boil them in vegetable broth but I never do.
Cost for two loaves of seitan using mostly organic ingredients with links to Amazon:
You can add seitan slices to any meal or salad. We also eat it just as a snack thinly sliced. Store-bought seitan in about $4.00 for an 8 oz package in my area. I don’t have a scale but I think the recipe above makes at least 2 lb so that is about $16 if you bought it pre-made. Plus, it is really fun to make!
I am taking an MBA class, and I was reminded of a lesson that we should all keep in mind when making money decisions. Here are three ways in which our mind can play tricks on us that lead us astray.
Suppose you are shopping for a big-screen TV. You are a smart shopper, so you compare prices and discover that your local Best Buy has the exact TV you want for $3,999.99. Walmart, which is 15 min away, also has the same TV but for $3,989.99. Do you drive for 30 minutes round trip to save $10 on a $4,000 TV?
Now suppose that a Dairy Queen, which is also 15 min away, has free ice cream cones for the whole family, which you know normally costs $10 at your local Dairy Queen. Would you drive 30 min to get free ice cream for everyone?
Most people will not drive extra to save $10 when they are already planning to spend $4,000 because $3,999.99 is “almost the same” as $3,989.99. But these same people will drive the same distance to get free ice cream that is worth $10.
The fundamental question is, is it worth driving 30 min for $10 so the answer should always be the same, it is either worth it, or it is not. But the human mind gets focused on the proportion, not the absolute amount. So, when making a decision about money, try to step out of the specific situation and think about the principle.
This can get complicated very quickly, and there can be good reasons why the answer might be different in the two situations. Making a big purchase can be anxiety-provoking, and many people just want to get it done. On the other hand, going for free ice cream can be a fun family outing, and the drive can be part of the experience. Making a different choice in the two situations is not necessarily illogical, but it is still important to watch out for proportional thinking.
Ignoring implicit costs:
We recently considered buying a treadmill to use during the cold winter months. A basic treadmill is about $300. We could afford it. But then I started considering all the other “costs”:
-It will take up space the whole year while we will probably only use it during the two very cold months.
-We will have to maintain it and potentially service it if it stops working (which is likely if we are buying the cheapest model).
-If we move (which is likely), we will have to move it or get rid of it.
-We hope to move to a smaller house at some point, which will probably not have space for a treadmill.
-Eventually, this machine will end up in a landfill someplace where it will be for millions of years.
After considering all these other “costs,” we have decided to at least try some alternatives. Doing online exercise videos comes at no cost, no environmental impact, and can be done on demand. Of course, staying healthy is priceless, so if other options don’t work, we will reconsider the treadmill, but we will try the other options first.
We often make different decisions about money based on how we obtained it. Let’s take the treadmill example from above. Suppose I win $300 and decide that I can have the treadmill for “free,” so I buy it. This is an example of coloring money. I think of the $300 I won as somehow different than the rest of my money. But it is not. I could have afforded the treadmill before, but I decided it is not worth it. Just because I now have a different $300, this doesn’t change any of the reasons I decided it wasn’t worth it. You should use the same logic in spending these $300 as you use for any other $300. All money that you have is the same, no matter how you obtained it.
The decision parameters change if I actually win a treadmill. In this case, I can’t choose to spend the money on something else. My choice is to take the free treadmill if I think that the rest of the implicit costs after removing the treadmill’s actual cost are worth it or decline it and get nothing. If I were offered a free treadmill, I would probably take it.
There is sometimes space to negotiate that should be explored. Imagine your child has just finished their undergrad degree, they are finding it difficult to get a job, and you want to help. You are sitting for dinner, and your kid starts talking about some certificate program that they read about that seems like the kind of thing employers are looking for. The program’s cost is $5,000, and you jump at the opportunity to help your kid and say that you will pay for the program.
This situation is kind of like winning a free treadmill. The parameters for the kid is that she can get this program for free or get nothing, so she will probably choose to do the program. But is this the optimal way for you to help your kid? Maybe there is a different and better certificate that she wants to do. Or maybe she would rather use the $5,000 to buy a car, which will allow her to look for jobs in a larger geographic area. Or maybe she needs the money to start a small business. Your money may be much more beneficial to your kid if, instead of promising to pay for the certificate, you decide how much money you want to give to your kid and then have a conversation with her to figure out the best way to help. Depending on the kid, you could be completely hands-off and give her the money and trust she will make a good decision. On the other extreme, you might want to discuss with the kid, and once a decision is made, use the money to pay directly for the item you agreed on. Either way, that will ensure that your money is spent in the most impactful way possible.
Remaining completely logical when making money decisions is hard, but it pays to think hard about your behavior and realize that emotions sometimes cloud our judgment.
Funky Wife is a special ed teacher. In normal times, she mostly works one-on-one with students, sitting right by them, sharing pencils, and exchanging pieces of paper. Many of her students also have behavior issues making them more likely to defy rules or engage in impulsive behavior. This trimester she is working online, but it looks like that might not be an option for the following trimester. We hope she can stay employed part-time and continue to work from home, but there is a chance she will have to take a leave without pay.
We briefly considered the possibility of her actually going back to the classroom. There haven’t been many cases at her school. On the other hand, the schools in my county have only been open for in-person learning for a few weeks, and cases both nationally and in our state are going up, so there is no reason to believe that cases at the schools won’t go up as well. So, I think we have decided that her going to work in-person is not a risk we want to take. The question of whether schools should be open for in-person learning is a thorny one. I fully realize that many kids do not learn nearly as much during online learning as they do in an actual classroom. Most of the learning The Child is doing happens with a parent sitting by her. I know there are many parents who either don’t have the time or the knowledge necessary to educate their kids. I also know that kids growing up in poverty are at a huge disadvantage, which compounds all the other disadvantages they have. And I know that most kids would be fine even if they get the virus.
On the other hand, both the students’ families and the teachers and their families may not be fine if they get the virus. And here again, poor students are at a disadvantage. They are more likely to live in multigenerational homes or to be cared for by grandparents, and their families are more likely to have preexisting conditions. Overall, I think a student is better off falling behind in math because they did online school for a year than losing their caregiver to the virus.
Teachers also didn’t sign up to be front line workers. A doctor or a policeman knows that they are embarking on a career that could put them in high-risk situations. A teacher doesn’t expect that to be part of their job. The same is true of paraeducators who often get paid just above minimum wage. Of course, this is also true of many other jobs which have suddenly become high-risk without a proportionate increase in pay.
So, back to our family. I don’t know what kind of choices we would have made if we didn’t have The Child, but at this time, I feel that our primary obligation is to her, and she needs her parents. Therefore, Funky Wife will not be returning to in-person work, and we will almost certainly experience a drop in income. Luckily, we already live on significantly less than we make, so our day-to-day life won’t have to change much. Also, we have enough savings that even if we have unexpected expenses during our single-income period, we should be able to manage.
Funky Wife enjoys her job, and I think she will be a little bit sad if she can’t work. For both of us, our jobs are much more than a source of income. Funky Wife loves to help students, especially the students that most people have given up on. She likes her colleagues, and she thrives on human interaction. She also knows that if she is not working, many household chores will fall on her, and she doesn’t like housework nearly as much as I like housework. So her not working is really not ideal, but at this point, we are grateful that we have this option. I feel terrible for people who feel that they need to go to work even though they are scared so they can pay their bills.
Money can seem really complicated. There are lots of books and blogs about investing, tax optimization, appropriate leveraging, etc. But there is actually only one lesson I want The Child to learn about money – live on less than you make! When you do that, you never go into debt, and your savings are always growing. When you are debt-free and have savings, you have many more choices about how you live your life, and that is much more valuable than anything money can buy.
I didn’t start investing for a long time because I found it scary. My family didn’t have investments and I didn’t know anyone I could talk to about investments. My first investments were rental houses – I could see them, touch them, knew I will get a rental check at the end of the month. The stock market on the other hand was a mystery to me. How do you pick stocks that will go up? Seems impossible.
It turns out picking winning stocks is indeed very hard, but fear not – there is no need for you to do that! This is why index funds were created! So, in this blog post, I will tell you everything you need to know to invest in the stock market. Please note that this is not advice about what you should do. I don’t know your personal financial situation and I am not a money manager. This is meant to be a basic introduction to the world of investing.
Owning a stock means that you own a tiny little piece of the company. Not enough to be involved in any decisions that the company makes, but enough to get a little bit of their profits. You get money in two ways – dividends and increase in the stock value. Dividends are regular (often quarterly) payments to you because you hold stock in the company. They are kind of like the rent checks you get when you own a rental property. The increase in the stock value is like the increase of the value of your rental house. You only cash that in when you sell your stocks. Of course you can’t guarantee that your stock will grow, just like you cant’t guarantee that a rental’s house value will go up. The neighborhood your rental is in can go down in value and drag your rental’s value with it. But many stocks, given long enough time, will grow in value.
When you buy a rental house, you actually take quite a lot of risk. Crime could increase in your area and send the value of the house plummeting, a big employer in town can close making it impossible for you to find tenants, the city could redraw the lines of the school district sending your tenant’s kids from the best school in town to the worst. When you buy a single stock, very similar things can happen. Say you buy Apple stock. Seems like a great buy but what if Motorola comes up with a phone that can project a 3-D image of the speaker into the room of their conversation partner. Suddenly, everyone will stop buying the latest Apple phone because they will want a 3-D image projector and Apple stock will fall.
While if you want to own a physical rental, you have to actually buy a house and accept all the risks that come with it, when you buy stocks, you don’t have to buy just one. This is where index funds come in. And index fund is essentially a basket of stocks that represent the entire market the fund indexes. Most people like to buy index funds that index the S&P 500 or the Dow. Owning an index fund means that as long as most companies are doing OK, your investments will grow. Let’s say you get a fund that indexes the S&P. Both Apple and Motorola are components of the S&P so if Motorola comes up with a 3-D image projector, their stock price will sky-rocket. Apple’s stock will go down but because you own a little bit of both companies, you will probably make money overall.
If you believe that the U.S. economy is generally headed up, investing in an index fund is the easiest thing to do. You don’t have to pick stocks, read the Wall Street Journal, or be able to predict the future. Just buy a little bit of everything.
But wouldn’t it be better if you just bought a whole bunch of Motorola stock right before they unveiled their 3-D projector? Yes, it would be better. The problem is that that is impossible to do with any level of consistency. The market prices in new developments quickly and there are professionals whose entire job is to try to beat the market so your chances of accomplishing that are about the same as being the winner of the Boston marathon if your normal exercise routine is walking your dog around the block. You simply can’t expect to compete with the people who make marathon-training their full time job.
How about hiring one of those professional money managers to beat the stock-market for you? Well, it turns out statistically, they are actually not very good at beating the market either. I won’t go into the data on this here but you can read this article if you don’t want to take my word for it. Also, professionals will charge you a percent of your total investment (not just your profits) for their services so they have to beat the market by quite a lot to make up for their fee before you see actual gains.
So, you have decided that you do want to invest in an index fund. How do you actually do that? I recommend Vanguard (they have the lowest fees) where you can set up an account (takes just a couple of minutes) and buy their most popular index funds.
Remember that an index fund follows that market in whatever the market does. In early 2020, the stock market fell briefly by about 30% so investing has risks. Overall though, given a long enough period of time, the markets have always gone up. Past performance is not a guarantee for future returns but ultimately I have decided that investing in an index fund is safer and much easier than owning rental properties.
Disclaimer: Investing is a personal decision and your investment strategy should reflect your risk tolerance. This post is not professional advice and I am not a professional money manager (remember, I am a math professor). Talk to a financial advisor to discuss your personal situation. Any investment, including the ones mentioned in this post, can lose value.
For the novice, FIRE stands for Financial Independence Retire Early. Followers of this movement often save 50%-80% of their income to accumulate enough invested capital to be able to retire early (sometimes as early as in their 30s) and live entirely on passive income. If you hang out in the FIRE circles, you will hear about the 4% rule, which says that you can safely withdraw 4% per year of your investments and, assuming the market doesn’t do anything crazy, your money should last forever. If you don’t like percentages, this means that you need to have 25 times your annual spending in investment accounts to be able to quit your job and never need to earn money again.
There are, of course, variations on this theme. Some people go to great lengths to cut their budget to be able to retire as early as possible (lean Fire), some work longer in exchange for higher spending ability (fat FIRE), and some retire from stressful jobs but still work at some low-stress job they enjoy to supplement their investment income (barista FIRE). I am totally not interested in the RE (retire early) part of FIRE. I love my job and expect to continue working for many years, regardless of our net worth. I am, however, very interested in the FI (financial independence) part of FIRE.
Sometimes I wonder why to me, FI is such an important goal. My wife thinks FI is a good idea, but she certainly doesn’t obsess about our FI number and how close we are to it. And people around me seem perfectly happy buying stuff they don’t need, so I am pretty sure they don’t even know there is such a thing as an FI number.
I am an immigrant from a relatively poor country. I came to the US for College with $500 and my tuition for the first semester covered. From there, I needed to figure it out on my own. Without even the ability to borrow money (foreigners can’t take out student loans), I was in a pretty tight spot.
At some point in College, maybe in my sophomore year, I got a terrible toothache. I didn’t have dental insurance, so I did the only thing I could – I took lots and lots of painkillers. It lasted for weeks. Much of the time, I was so drowsy from the pills I could barely function. I got a permanent case of an upset stomach. Eventually, I saved about $100 and went to the dentist. For me, at that time, $100 was a huge amount of money. The dentist looked at my tooth, took a couple of X-rays, gave me a proposed plan for how he can fix it, and charged me $100 for the consult and the X-rays. I still had a terrible toothache and no money.
Eventually, I learned about a free dental clinic. I found someone with a car who drove me there. They fixed that tooth and all the other teeth that were rotting in my mouth (I used to have a lot of tooth problems, probably due to very poor dental care in my home country), and I could get off the pain pills.
This is the sort of experience I never want to have again. And so when I have a choice between getting the newest iPhone or increasing our money stash, I opt to add to the stash. The stash is what keeps my family and me safe from at least some of the bad things that can happen in life. The iPhone can’t do that.
Take a minute and figure out your FI number. Imagine having that amount of money and the freedom that would give you. Now, look at the latest gadget you bought. What optimizes your happiness profits?
Life is a series of experiences. Some are trivial like brushing your teeth, others are memorable, like your wedding day, or that cruise you took to Alaska. Some experiences are fun (maybe your last vacation is on your list of fun experiences), some are neutral (your list depends on your personality, washing dishes is on my list), and some suck (like getting a root canal). The most awesome power of having discretionary income is that you can opt out of some of the things you hate doing and opt into some of the things you love.
When I was younger, I didn’t understand this super-power you gain as you develop a discretionary income. I thought of money as something your exchange for goods. Paying to opt out of an experience is a more abstract transaction – you give away money but you don’t get an object in return. Of course, when I was younger I also didn’t have discretionary income so it was hard for me to understand its power. Sadly, this super-power is somewhat limited — you will still have to get that root canal yourself, no matter how much discretionary income you have.
When the Child talks about money, she always talks about the things she wants to buy – a huge mansion with a pool, a fancier car, the latest cell phone. She doesn’t yet understand that this is not where the power of money lies. Lots of adults also either don’t know this super-power or just don’t agree that it is awesome–based on the choices they are making with their money. Maybe owning the newest cell phone does optimize their happiness profits but somehow I doubt it.
There are lots of things I enjoy doing that other people outsource. For awhile we had a person who cleaned the house and I hated it. I don’t like other people in the house, I don’t like the weird chemicals they use, and I always worry about the pets. That service wasn’t optimizing my happiness profits. On the other hand I will call a repair person for the simplest things. I don’t like fixing things. It makes me anxious, it always takes more time than I predicted, and much of the time I have to call the repair person anyway. Instead of spending 5 hours trying to fix a leaky faucet, I can have an expert fix it in 5 minutes and I can spend my time messing with the yard which I love.
Today, I decided that I will have someone else build the website for this blog. I feel slightly guilty about it because I know I am perfectly capable of figuring out how to do it myself. But I only have so much time, I have a full time job, a child I am homeschooling (schools are closed because of the pandemic), and I am taking classes to complete my Masters in Finance. I don’t want to give up any of these things and I want a nice blog so outsourcing is the logical move.
I am a big fan of Mr. Money Mustache. His followers would vehemently disagree with this post. Mr. Money Mustache lives on a ridiculously low budget and in part he achieves that by not approaching problems from the perspective that he can just spend money to fix the problem. I am pretty sure he repairs his leaky faucets himself. I admire that attitude and I agree – if you want to minimize your spending that is the way to go. But this blog is not about minimizing spending, it is about optimizing happiness profits so on this particular topic I will not follow his advice.
One important caveat to this post. Notice that the super-power of opting out of experiences exists only if you have discretionary income. When I was younger and didn’t have discretionary income, I did fix my own leaky faucets and much more. Those experiences weren’t fun but I don’t recommend buying yourself out of experiences if you don’t have enough money to meet the basic needs of your family.
Having super-powers is awesome and it is worth working hard to get them!