IMPORTANT NOTE: This is written with my sons JC and Timmy as the intended readers.
First, before we look at the core assumptions for achieving financial independence and retiring early, I need to tell you both: I love you… a lot. And, my love for you is unconditional.
Some of what I am going to say can, when read in a certain mood, feel condescending and judgmental. That is not my intent, but I feel it will be negligent of me not to comment where I do have an opinion and, in some cases, very strong opinions about certain things. I will also point out that sometimes I have strong opinions about something and even I choose to ignore my own advice. I will try to point out examples as they arise.
Human Capital and Financial Capital
When I think about achieving financial independence I like to think of it in terms of human capital and financial capital.
Human capital is being able to work to generate income. I think it is great that you were willing and able to get a job in the same field that you got your degree in from Arizona State University. I’m proud of the hard work you put in to get that done. The income you earn from the work you do will provide you with the resources you need to both support yourself in the short-term and also buy back your time. You buy back your time by investing the fruits of your human capital, income, into financial capital.
Here’s how I actually think about it. How much would you need to have invested to be able to generate the $70,000 or so per year that you’re earning from your job? We will be discussing what a safe withdrawal rate is in a bit, but if you assume that you’re able to pull out 3.25% of your investments each year to live on, you’d need to have:
Amount Invested × .0325 = $70,0000
Amount Invested = $70,000/.0325 = $2,152,846.15Congratulations… for the hard work you did in college and getting a good job, just out of college you essentially have the equivalent of over $2 million in net worth. Another way I’d describe this is: you are a $2 million dollar asset that when put to work daily in a job, earns $70,000 per year.
Remember though: to achieve financial independence, we want to convert the fruits of your human capital (your income) to financial capital to buy back your time.
If you assume that you need to work 40 hours a week for 50 weeks a year, that means that you work about 2,000 hours per year to generate $70,000 per year. That’s:
Income Per Hour = $70,0000/2,000
Income Per Hour = $35If you wanted to buy back an hour of your time per year (at your current earning power/human capital rate), you’d need to have investments in financial capital that generate a return of $35 per year. How much would you need to have invested at a 3.25% safe withdrawal rate (which we will go over in detail shortly) to earn $35 per year to buy back an hour of your time?
Amount Invested × .0325 = $35
Amount Invested = $35/.0325 = $1,076.92What that means is each time you save $1,076.92 in your financial capital account, you buy back an hour of your time per year. I know you’re the “undisputed king of computation” (according to your grade school teacher), so I am sure you can see that if you multiply that by twelve to find out how much you would need to have invested to earn back an hour per month. Or, multiply it by 50 to find out what the “cost”/investment is to buy back an hour per week of your time. In your case, you’d need to have $12,923.07 invested to buy back an hour per month of your time or $53,846.15 invested to buy back an hour per week.
I will be going into a ton more detail about how to accumulate the money to buy back your time, but I believe it is important to realize the relationship of human capital and financial capital. And, in my opinion, a key concept of financial independence and retiring early is that you’re trying to convert human capital (time) to financial capital (money) that produces more passive income (the fruits of your financial capital) so you no longer have to invest your human capital in work you deem undesirable (more on desirability of work later as well).
Keeping Expenses Low and the Obvious Relationship Between Income and Financial Capital
I will direct your attention to the obvious relationship between your income and financial capital invested. If you need more income to support your expenses, you will need more financial capital to support those expenses.
This raises an important early discussion about your expenses.
You’re lucky. You’re just out of college and still have the standard of living expectations of a young adult in college. Beware of standard of living creep. You don’t need to live in a house like you grew up in. You don’t need to buy a car like your mom or I drives. You don’t need to eat a burrito at Qdoba everyday like I do. You don’t need to buy every Hearthstone card like I do. You don’t need to have the fastest high-speed internet in your house like we had when you were growing up; well… maybe that one.
And, that snarky comment about high speed internet… is actually another point. You get to choose what is important to you and what you’re willing to splurge on. I would strongly recommend you pause to consider what you’re spending your money on though.
I have a couple rules of thumb that complement the discussion above on human capital and financial capital. I call it my “Qdoba burrito rule” or my “Netflix rule”. Same rule, different names. Here’s how it works: if you want to eat out and get a burrito at Qdoba once a month or subscribe to a service like Netflix, you will need to have about $3,692.31 invested to afford that in retirement. I am assuming the burrito or Netflix is about $10 per month and the same safe withdrawal rate, but here’s the math:
Amount Invested × .0325 = $10/month × 12 months
Amount Invested = $120/.0325 = $3,692.31How long will you need to work at $35 per hour (fruits of your human capital), to save up $3,692.31? That’s 105.49 hours. Ignoring taxes, you’re at almost three weeks. If you take into account income taxes to net $3,692.31, you are probably above 3 weeks. Ultimately, it is up to you to decide whether you do want the monthly burrito or Netflix service. As you well know, I’d need to have about $110,769.23 invested to support my daily Qdoba habit (estimated at $300 per month) and I may be OK with that while you may not be. If you do decide you want Netflix or a burrito every month, it will extend how long it will take for you to achieve financial independence and be able to retire early (“FIRE date” from here on) by about 3 weeks.
Every additional expense you have means two things that will slow down your ability to achieve financial independence and retire early. First, it means you need to save more to keep that expense in retirement since you’ll need more money invested to generate income to continue it. And secondly, it takes dollars away from you that you could be using to buy back your time by investing them.
That’s a pretty important concept. Probably worth highlighting actually. It raises an interesting way of looking at your income and expenses when thinking about retirement and I will go over it in detail in the next post.