This episode provides a mind blowing way of thinking about the true cost of your monthly expenses. If you are interested in achieving financial freedom, then it makes sense to look at each monthly recurring expense as really costing you 300 times more. For example, a gym membership that costs £80 per month really costs £24,000 (in dollars, a $120 monthly gym membership really costs $36,000). The episode explains this perspective in more detail. In summary:

- You have financial freedom when you don't have to work to support yourself. Therefore, if you want to be financially free, you have to think of paying for things from the interest on your passive investments.
- Although there is a lot of debate about the numbers, the most widely used assumption is that you can live from 4% of your portfolio (the so called 4% rule). This assumes that on average your portfolio will make enough to cover for both inflation and you drawing down 4% (I personally think it's better to use 3% to be on the safe side, but let's use the most commonly used assumption to illustrate the point).
- The 4% rule implies that you need a net worth that is 25 times your annual expenses to be financially free. To apply that to monthly expenses, simply multiply the 25 by 12 (for 12 months) and you need investments that are 300 times your recurring monthly expenses. So any monthly expense really requires 300 times more in capital to pay for it when financially free.
- This is why for the £80 per month gym membership, you need £24,000 in capital saved to pay that membership when financially free. That figure (£24,000) is more than the annul expenses of most people in the UK.
- This is why frugality and saving is so powerful as a way to get more financial freedom. It is more powerful to save expenses than to keep increasing your income because more income won't make you more free unless you control expenses.
- I'm not a financial advisor and as always, you need to do your own research. I think this perspective is useful and it has been very helpful to me.
- That's why I won't be getting a gym membership again anytime soon. There are plenty of free ways of getting good exercise!

Further Reading:

Mr Money Moustache article about the 4% Rule

Retiring Sooner: How to Accelerate Your Financial Independence by Darrow Kirkpatrick

The 4% Rule and Safe Withdrawal Rates In Retirement by Todd Tressider

Podcast Episode

Mr Money Moustache article about the 4% Rule

Retiring Sooner: How to Accelerate Your Financial Independence by Darrow Kirkpatrick

The 4% Rule and Safe Withdrawal Rates In Retirement by Todd Tressider

Podcast Episode

I look at this from the other direction. I add up my investments and divide by 300. That's how much I can spend every month, forever, if I stop working.

ReplyDeleteI use 4% as my safe annual withdrawal rate. Historical figures show that this is almost bulletproof. In the unlikely event that 4% turns out to be unsustainable, I would do a little part-time work to make up the difference, or reduce my expenditure for a while.

When building up the capital that is needed for retiring on a passive income, it's always better to reduce expenses by £100 than to increase income by £100. Increases in income are taxed at your marginal tax rate, which is higher than your average tax rate and may even take you into a higher tax bracket. Decreases in expenditure do not incur taxes.

Jake, generally you supply references with your podcasts. I don't see any this time, so I will suggest this excellent discussion of the 4% rule:

http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/

Adopting a "3% rule" would be even more secure, but it's problematic. The higher the hurdle to achieving financial freedom, the fewer people will achieve it. A 3% rule makes it much harder to achieve that freedom, than a 4% rule with some flexibility.

Great points, thanks Roger!

Deleteyou could also look at it the other way, meaning that your job, your monthly income, can be multiplied by 300 because that's how much money you would have to have to produce your monthly income. You do have to be frugal and spend as little as possible, but the concept has to make sense both ways, and somehow to me it doesn't work both ways because by this logic I should always be holding a job because of the amazing 300 multiplier that my monthly income would be subject to

ReplyDeleteInteresting criticism. I also like the 'invert' rule to check for truth. But I don't see how you succeeded in showing the invalidity of the statement by inverting it. Indeed it is correct that the monthly income you make can be multiplied by 300 to see how much capital you would need to have the same income from capital. And indeed you should hold your job if you don't want to lose that income, just like you should keep your capital if you don't want to lose that income. Am I missing your point?

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