Your Questions Answered: Volume 2

This week we’re taking another look at your specific questions. Today we examine the thorny subject of income and how much is needed to pursue financial independence, how we fund our lives without a job, the best option for medium-term saving goals, some discussion of real estate investing, and a requested expansion on last week’s post about emotional fragility, plus plenty more.

Here’s what you wanted to know…

How Much Income Do I Need for Financial Independence?

Reader: How much money do I need to make to pursue financial independence?

CC: This has so many knobs to turn. I want to first reiterate that financial independence is a spectrum. A three-month supply of living expenses might provide a hell of a lot of financial freedom. For this answer though, I’m going to assume we are talking about the level of financial independence that allows for an indefinite hiatus from traditional paid work.

Every town and every individual have different cost of living profiles, but I’ll take a stab:

Anyone serious about full financial independence should strive for a post-tax income of at least $50,000 (single) or about $75,000 (couple).

Key Assumptions on Income and Savings

• A single individual can live relatively comfortably on $25,000 in many but not all towns.
• A couple can live relatively comfortably on about $35,000 – $40,000 in many but not all towns.
• A post-tax income of $50,000 (single) and about $75,000 (couple) can allow for the folks to save 50% or more of their income. Retirement and HSA contributions count as savings. Here is how we calculate savings percentage.
• The individual is investing his or her savings in some sort of income-generating investment. In the simplest terms, this can be a stock and bond portfolio of 80/20 stocks/bonds. When we were saving, we were closer to 90/10 stocks/bonds. Here’s much more on our investing strategy.
• Said investment(s) will return at least 5% year-over-year (inflation-adjusted) over a duration of at least ten—but more like 40—years. This could be the stock market, real estate investments, etc.
• Current expenses = retirement expenses. You’d be a fool to believe this over the course of your life, but it’s a good starting point. Always plan for higher future spending (beyond inflationary growth).
• Net worth = $0. Carrying debt or starting at an already positive net worth will either lengthen or shorten this timeframe, respectively. Here’s how we calculate net worth.

The Importance of the Savings Rate

We saved about 70%+ of our income for the last five years of our corporate careers. With our natural frugality, we had already socked away about a quarter of our initial financial goal without really being very intentional in the first five years of our career. Largely uninvested, these assets sat in a savings account losing value to inflation. And yes, we paid down student loans in the early years (about $60k+).

Did having a high income help? Uhh….hell yes it did! That’s why I always encourage folks to reframe their mentality around the idea of making more money. Ask yourself: do you have problems with making money, or do you have problems with spending money?

“When a lot of people say they want to be a millionaire, what they actually mean is that [they] want to spend a million dollars.”

-Morgan Housel (source, give it a listen)

Self-Denial + Income = Power

Spending money has never been easier! Saving is hard, but good things come to people who take a stance of self-denial.

(Related Post: Do You Deserve a Life You Can’t Afford?)

So, perhaps now is not the time in your (presumably long) life for the low-paying job. An exception would be a less-than-desirable job that is a key stepping stone to a better opportunity. Those short-term sacrifices can pay big dividends, in more ways than one.

Might you first get yourself on solid financial footing and then pursue a more righteous or noble line of work that pays a lower wage? Here is more on the thorny subject of making more money.

(Related Post: Chasing Your Dreams is Probably a Bad Idea)

Do I need to save 50% of my income?

No, you don’t. Based on the 5% yearly growth assumption and a 50% savings rate, one could theoretically retire in 17 years.

If you save about 70% of your income, your entire career might only be 7-8 years.

I worked in the corporate world for 10 years, and while we were saving more than the typical American family all along, we only got very intentional with saving and investing in the last five years. If you want to save less than 50% of your income, financial independence will eventually come your way, but likely over a longer career duration. Look, here’s an easy chart!

And then there’s the entire issue of what number really means “financial independence.” If you love your job and just want security (or part-time work), I’d argue that the 4% Rule may not be particularly relevant to you. We wanted the full-frontal, so we saved much more. YMMV.

The math works, so make the math fit your life. Or perhaps find ways to make your life fit the math, because happiness = 7 either way.

So, you can certainly get more frugal, but frugality eventually has diminishing returns. Focus on mindful, value-based spending and try to break down those barriers on perhaps making more money.

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Saving for a Short (3-5 Year) Duration

Reader (paraphrasing): I’m looking at setting aside some money into a specific account to withdraw in 3-5 years to purchase a vehicle/slide-in camper. I’m trying to decide what type of account is going to be best for interest growth.

CC: The low-interest environment these days is not very favorable to the short- to medium-term saver. For any expenditure beyond about five years (ish), I’d put it in the stock market*. Yeah, I know it’s risky but life is a highway and I want to ride it all night long.

For something on the horizon in 3-5 years, you have three primary options: a (high-yield) savings account, a money market account, or certificates of deposit (CDs).

Certificate of Deposit (CD)

If interest is the primary driver and you are certain you won’t want to withdraw this money for a specific duration of time, the CD might offer the highest interest rate. The downside is that penalties are applied if your money hasn’t seasoned like a fine Cotes du Rhone for the required term. 

Money Market Account

Coming in second on interest rates is likely to be your typical money market account. These are FDIC-insured up to $250,000 and you can withdraw cash immediately whenever needed. You can open an MMA with most banks or credit unions. I’d just shop around for the highest APY (annual percentage yield), knowing it could change any day.

High-Yield Savings Account

We still park a good chunk of cash in our high-yield savings account, but the interest rate is hot garbage. Why? Well, we’re lazy. It once had a great interest rate, and then this pesky bug showed up and the Fed dropped the rates like me pressing a kettlebell over my head. Our cash is still there. But it’s also less than a few percentage points of our total net worth, so I sleep soundly**.

Don’t Think About it Too Much

Either way, you aren’t going to get much in the way of a return on any of these options. I wouldn’t put days into researching these short- to medium-term savings accounts, because we are talking about very marginal optimizations.

*As with everything on this website, none of this is advice. It’s what we do, and we are but flawed creatures bumping around like a 1983 game of Rebound. Here is our Standard disclaimer.

**Except Tuesday, March 24th, when I accidentally made (and drank) green tea instead of chamomile tea at 9pm. Oops!

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More on Funding Early Retirement

Reader: Are you using a Roth IRA ladder to fund early retirement? 72t? Taxable brokerage? Rental income???

CC: Yes, no, yes, no.

For those of you new here, we fund a life without a job by selling shares of our investments (our savings, which is invested largely in index funds). Our savings creates its own income, which is more than ample to pay for our fairly minimal yearly expenses. But the devil is in the details, so let’s proceed.

Roth Conversions

We are starting Roth Conversions for the first time this year, aiming to make our first conversions at YE 2021. Check out this post and this post for much more detail on how we are trying to optimize Roth Conversions, manage healthcare spending, fund our expenses, and minimize our lifetime tax burden. No one talks about this stuff, and I’d argue optimally spending money in “early retirement” is way more complicated than saving to get there.

In year one, the early retiree can begin Roth Conversions. After five years, the Year 1 conversion has “seasoned” (makes sense to somebody) and can be spent without penalty. The cycle continues until all Traditional IRA funds have been converted to a Roth IRA. Funds in a Roth IRA can grow tax-free and all seasoned funds can be withdrawn without penalty. Boo-ya.

Rule 72(t)

Rule 72(t). You caught me. I admit: I had to look this up. That article kind of gave me a headache to read, and no, we’re not in the club. Moving on…

Taxable Brokerage Account

I think having a reasonably funded taxable brokerage account is key for at least the first five years of an “early retirement.” Why? If you’ve saved for an early retirement (< age 59 ½) exclusively through traditional (i.e., non-Roth) contributions to a 401(k), you are going to wake up from your crushing champagne hangover and realize you have no penalty-free liquid assets.

Any early retiree needs a five-year bridge of either previously invested Roth funds or, even better, a taxable brokerage account. The beauty of the brokerage account is that you’ve already paid taxes, so you can withdraw your original investment (cost basis) + capital gains and not pay any additional taxes, so long as you exist humbly in the large 0% LTCG habitat (see chart).

Rental Income

We don’t have any rental income.

And that makes a perfect segue!

Or is it Segway?

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Do We Invest in Real Estate?

Reader: Do you invest in real estate? If so, what market?

CC: No, we don’t invest in any real estate other than the house we own (and we believe the house you own is probably not a good investment).

We at one point were strongly considering purchasing a single-family home for rental and diversification, but the whole process felt way too un-passive to us. I’m a lazy investor, hence index funds. And then the pandemic really highlighted how the heavy leverage (debt) carried by real estate investors can be a real problem when tenants are unexpectedly forced to stop paying rent.

Our version of real estate investment will probably, if at all, take the form of occasionally renting out a room in our house, or renting the entire house when we travel. As nice as that sounds, I don’t really love the idea of my house being a hotel. Someone sleeping in my bed, peeing on my toilet seat, etc. We’ll see about that.

Properly Filling the Investment Buckets

Reader: If you’ve maxed out your IRA contributions, how would invest your next dollar?

CC: Good question, but I need more information. First, are we talking about a Traditional or Roth IRA? If traditional, you should then max out a Roth IRA using standard contributions. If your income is too high, use the Backdoor Roth method.

Let’s back up. Have you also maxed out a 401(k) (or similar) or an HSA (if available)? If not, do that. Here’s my 2021 Guide to Saving and Investing.

If you’ve already maxed out these three buckets, my next move is to open a taxable brokerage account. Here you can buy stocks and bonds with your post-tax dollars. About 50-60% of our savings ended up in a brokerage account, which gives us a lot of flexibility for doing Roth Conversions and still having living expenses in the precious early years of an “early retirement.” And let’s be clear: when I say early retirement, I mean someone who likes to work and find balance in life but not have traditional income or a boss for at least a while but might eventually. That seems like a succinct definition, right?

We really like Vanguard. Again, we have no affiliation with Vanguard—they’re just that great of a company. Open a brokerage account with vanguard here.

Here are a few key screenshots to get you going. I got as far as I could before having to put in personal information, so there’s that.

Expansion on Emotional Fragility

Below is a comment I received from last week’s post on emotional fragility:

“This is seriously the best f***ing post I’ve read in a while. FIRE blogs in general tend to get really redundant after you’ve sunk your teeth into it. A refreshing read to say the least.

Care to dive a little deeper into any one of the rabbit holes this post opens up? Particularly as it relates to the FI community?”

CC: First off, thank you very much. I enjoy a heartfelt, expletive-laden comment. It suits my grammar just fine.

I’ve given this a lot of thought. I recognize the extreme privilege I have to sit around and ponder how to maximize happiness. While this life is hardly the result of pure luck, I’d be remiss to shrug off our myriad opportunities of serendipity and good fortune.

Why

A fundamental discussion missing from the reason people pursue financial independence or (especially) early retirement is “why.”

Sure, plenty of people have spoken or written about “why” in a general sense—more time with family, more time to travel, less stress—but I always thought those reasons were superficial and lacking true depth and meaning. The “why” of almost anything in life is deeply rooted in our emotions and cut with our childhood.

An early retiree may have been great at being a left-brain saver and spreadsheet optimizer, but may have spent a lifetime avoiding painful emotions. And without the occasional confrontations with what hurts the most, we will never find happiness. We’ll hop the fence, eat all the new green grass, and then plop down and mope amongst all the chewed blades. Soon, we’ll be back on the same treadmill, in search of the next green pasture.

So many people seem to think that leaving a job that kind of sucks will bring true joy. And it does, for about a month (in my experience). And then a pandemic starts and things get weird. Perhaps we need to face the reality that the job, the boss, or even the routine may not be the problem.

The problem might be…us.

Chasing Greener Grass

I’ve been chasing greener grass my entire life, and I finally feel I’m understanding my own motivations. Some of them are complex and personal (you don’t get to know everything, folks!). I will say this though: having financial security and not spending 40-60 hours a week at a job (or preparing for the job) frees up a lot of time to either make it right or flounder. We get to choose, but the correct path is a difficult one. If the path feels easy—continuing to side-step emotions—even greater difficulty will find us eventually.

I’m loving my life without a paid job lately, but it’s because I’m now better balancing work (this website) and play (climbing, outdoors, etc.,) than I was on our road trip. I think it’s also key that I’m keeping climbing far more in the “play” camp than “work” camp. Too many climbers—and I’ve certainly been guilty—turn climbing into work, which I’d also argue has a root in our psychology.

Balancing Logic and Emotion

So, in summary: we can do everything correctly with the logic- and reason-based part of our brains to optimize our finances and achieve financial independence. For those strongly driven with their Thinking Brain—my wife and I—saving, investing, and achieving financial independence is almost natural. What’s hard for us is settling into a better balance with our Feeling Brain, and leveling up to why we are even doing this in the first place.

Alternatively, the impulse-driven Feeling Brain types are always going to struggle to even get started with something left-brain heavy like financial independence. But get them a cocktail, a rhythmic beat, a dance floor, and…

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Remember, the best laid plans mean nothing if you can’t take action today. Have questions? Need some feedback? Hit us up on the contact page.

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Thanks guys, see you next week.