How long until you don’t have to work?

Usually the answer to this question is stated as “until your investment income exceeds your expenses”. That form of the answer makes me a little uncomfortable. It doesn’t really highlight the most lucrative place to make changes if not needing to work is your goal. I much prefer the answer “until your expenses are less than your investment income” because it highlights the fact that it’s your expenses that are keeping you from being financially independent. If you had zero expenses, then you wouldn’t need any income at all to maintain your standard of living and you’d already be financially independent.

Not needing to work to maintain your current standard of living is what I mean by the phrase financially independent.

Lately, I’ve been talking about happiness and how money is not really the answer. True, money can alleviate some unhappiness, but that really only happens up to the point where you have food and safety. Beyond that point money only provides increases in our standards of living, which we quickly get used to and soon return to our set point of happiness (although now dependent on and expecting the new standard of living). So as I suggested in the last article on maintaining control of your life, one very effective method to maintain control and happiness is to reduce your expenses.

But words only go so far and without numbers, they are only opinions. So lets get into some examples and see what we can find out.

Running the numbers

First let’s look at how long it would take a minimum wage earner (MWE) to become financially independent. In the article on who should be saving and investing, I laid out some expenses and income numbers for the MWE. Recapping the pertinent numbers, the MWE has $10,300 in gross annual income, $5,784 in annual expenses, and $9,012.50 in after tax income. So each year, after paying expenses, the MWE has the remaining $3,228.50 left as savings [1]. That’s a savings rate of 31.3%.

If we assume that the MWE can match the market, and generate 6% returns, and that inflation is 2%, then we can plot out a spreadsheet to show how long until the MWE makes it to financial independence. It turns out the MWE has to work 36 years to meet his current level of living standards. So if the MWE starts working at 18 right out of high school and never increases in skill to make any more money than the minimum wage at the time of that original article ($5.15), the MWE can stop working at 54 [2].

If you play with the numbers some more, it turns out that the amount of time it takes to get to where you can maintain a given living standard without working is a function of the savings rate. Someone who makes $100k per year and saves 50% of their income is going to be able to cover their expenses with their investments in the same amount of time as someone with $50k that saves 50% of their income. The $100k earner will be able to spend $50k (of today’s dollars), and the $50k earner will be able to spend $25k (of today’s dollars), but both will be used to living on that and will not need to have a job to cover their expenses.

Incidentally, the number of years to cover your expenses at a 50% savings rate is 20. So start working at 22 right out of college, save 50% of your income every year, and you’ll be able to stop working at 42 and maintain the same relative standard of living the entire time.

To calculate the savings rate, I’m taking the amount deposited into savings for the year divided by the gross income for the year. Gross income is the amount you get paid over the entire year before any taxes are taken out.

I’m assuming that anything that didn’t go into savings was spent on some kind of consumption and is in some way supporting your standard of living. So this is a conservative estimate, meaning that you might get there faster. For example, in retirement, you might have lower taxes on your income since currently investment income is taxed at a lower rate than earned income, and you wouldn’t be paying employment taxes like FICA on that income.

Here’s a rundown of the savings rates and the years to be financially independent:

So what is cable really costing you?

Now that we have that continuous graph, we can find our own savings rate and get a conservative estimate of how many years it will take us at that rate to be financially independent. We can also look at what changes in our spending can do to shorten the time to when we are financially independent.

So let’s say you look at your cable bill and figure out that you pay $100/month for cable. That’s $1200/year. Let’s also say that your income is $50k/year, and you’re currently saving 10% of your income, or $5k/year. Remember at 10% you have to work and save 61 years to match your relative standard of living.

So if you stopped paying for cable and started saving that $1200/year, you’d now be saving ($5000 + $1200) $6.2k/year total. So your savings rate is now 12.4%. The number of years to match your spending at 12.4% from the graph is 56. So if you’re only saving 10% now, and you can drop cable and save that money instead, it’s going to save you 5 years of working.

It’s important to note that only the person saving only 10% per year is going to see a 5-year benefit from dropping cable. And the reason is because that person is already saving so little. Even small changes in savings will make large differences to this person. But if you’re making $50k and saving 50%, or $25k/year, then an extra $1200/year is only going to shave 2 years of working, 18 years instead of 20 years. Maybe you’re willing to work a couple more years to watch The Daily Show? Maybe you’re not. But the point is you can now figure out how many years a monthly expense is really costing you and determine if it’s really worth those extra years of work.

Does it make sense to work harder?

So you can see that someone who’s a diligent saver gains less from cutting expenses than someone who is less diligent of a saver. But let’s take a look at what the diligent saver might get from working harder and adding some extra income. If you’re the 50% guy, and you add an extra $10k of income (without adding any new expenditures), your new savings rate would be 58.3%. So instead of the 20 years, you’ll be able to quit working after 16 years, or 4 years earlier. Assuming you started at 22, that’d be financial independence by 38. Again, maybe that’s worth the extra work, and maybe it’s not. That’s a decision for you to make, but consider taking a dry run at it to make sure it’s worth the extra work.

Forward looking statements

Now there are lots of caveats here and we can only make guesses about the future, so all of this is subject to those limitations.

For example, the above assumes that when you do quit working that you will have the same level of expenses as when you were working. That may not be the case for you. Maybe you expect your kids to be living on their own at that point. Maybe you will have paid off your mortgage and only owe taxes and insurance each year. Maybe you don’t have to maintain a work wardrobe and can wear Bermuda shorts, sandals, and Hawaiian shirts all the time. Maybe you don’t buy lunches out any more. But consider that you’ll also have extra expenses, like needing to maintain your own health insurance.

Or you may plan to move to somewhere much less expensive than your working environment. If that’s the case, again I encourage you to do a dry run now. You don’t want to save less now assuming you’ll be happy living some where cheaper, and then find out you were wrong, but don’t have the money to live where you wanted to.

A few times in this article I referred to maintaining your “relative” standard of living. What I mean by this is your standard of living relative to the rest of society. The benefits and opportunities that a middle class family has now were not even available to the richest families even 50 years ago. And it can be inferred that as time passes more advances will be made.

But if the benefits and opportunities currently available are good enough and you don’t feel a need to increase with the times, you might be able to be financially independent even faster. You would be trying to maintain an “absolute” standard of living, rather than a “relative” one. So you could probably ignore the affects of inflation on the amount that you needed to spend to maintain your standard of living, but still benefit from the affects of inflation on your income [2].

Consider though that you will be like the older person now that doesn’t have or want a microwave, a computer, a cell phone, cable, Internet access, or any of the other advances that have been made in the last 50 years. It’s certainly possible to live without these things, but you need to know yourself and whether or not you can handle seeing other people having these things and you not being able to afford them. If medical science comes up with a procedure to reverse the aging process are you going to be happy continuing to age while everyone else stops aging?

Also when playing with the numbers, don’t get fancy with the earnings percentage. 6% is about the most that you should expect to make long-term. You don’t want to be stretching to make more gains on your money when investment income is the only income you have. That will just lead to taking risks that are less likely to pan out and more like to end up with you poorer, and possibly having to go back to work.

And lastly, the calculations above assume that you have zero savings to start with. If you have more than zero, then you’ll want to add that in to your own spreadsheet to see where you stand.

Summing up

So if you’re considering adding a new monthly expense, like a mortgage payment, car payment, or some other loan or service payment, take a few minutes to figure out how many more years of work you’ll have to endure to fund that new expense. Is it really worth it?

[1] The MWE would have about 10% more savings if they were saving the money in an IRA, but I’m going to ignore that option to keep it simple.

[2] In the calculations above I’m assuming you’ll get regular cost of living (inflation) increases in your income and will continue to save the same percentage of that new pay level.


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