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Minimum_Investment_Amount


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00:00:00.000 | Hello everybody, it's Sam from the Financial Samurai podcast and in this solo episode I
00:00:13.120 | want to talk about the minimum investment amount where work becomes optional.
00:00:18.660 | I started Financial Samurai in 2009 to make sense of the global financial crisis.
00:00:25.000 | And that was the time where I really wanted to start leaving work, getting out and doing
00:00:29.800 | my own thing or just retiring early.
00:00:31.480 | I didn't know exactly what I wanted to do, but I knew I didn't want to work in finance
00:00:35.640 | anymore.
00:00:36.640 | Ten years had passed and it was starting to feel like a big grind and it was no longer
00:00:41.620 | fun either.
00:00:42.620 | The correlation with performance and reward was going downhill because structurally the
00:00:48.240 | industry was in a decline, commission rates were coming down much like the real estate
00:00:53.160 | industry right now and it didn't feel good not to get rewarded based on merit anymore.
00:00:59.640 | As a result I decided to save and invest as much as possible to one day break free and
00:01:05.840 | break free I did in 2012.
00:01:08.580 | But back then I didn't have a simple formula to help guide me into how much I needed to
00:01:14.420 | accumulate in my investments in order to feel comfortable to break free from work.
00:01:19.960 | But now I have come up with a formula.
00:01:22.720 | And this is also a formula based off of my 12 years of experience not having a day job.
00:01:28.800 | I've gone through some ups and some downs, mostly ups because it's been a bull market,
00:01:33.400 | but of course I've gone through the market crash in March 2020 when COVID happened, the
00:01:39.560 | 2022 bear market, and then the growth of my household expenses due to the growth of my
00:01:45.100 | family.
00:01:46.320 | So it's been somewhat of a topsy-turvy ride, but in general it's been up and to the right
00:01:52.120 | again thanks to a strong economy and a strong market in the real estate market, stock market,
00:01:57.960 | and many other markets.
00:01:59.880 | So if you are tired of work, you don't like your job, you want to retire early, take a
00:02:05.320 | sabbatical, maybe go back to school or take care of your young ones until they go to school
00:02:10.360 | full time, I have come up with the minimum investment threshold formula where work starts
00:02:15.820 | to become optional.
00:02:18.040 | And that formula is taking the inverse of the historical return of the asset class you
00:02:23.000 | own and multiplying it by your gross annual income.
00:02:27.520 | When you reach this minimum investment threshold, the annual return from your investments has
00:02:33.500 | a high chance of equaling or exceeding your annual gross salary.
00:02:38.480 | Additionally, since long-term investment income and capital gains are generally taxed at a
00:02:43.520 | lower rate than your W-2 job income, you'll have an even larger after-tax cushion.
00:02:49.880 | And once your investments can regularly match or exceed your annual gross income, you're
00:02:55.800 | more free to do what you want.
00:02:57.400 | You don't have to work at a soul-sucking job anymore for big bucks or that healthcare.
00:03:02.260 | You can take things down.
00:03:03.520 | You can work at that job you've always wanted to work at, but that doesn't pay as well.
00:03:09.440 | I think about high school college applicants all the time where they write about how they
00:03:13.760 | start non-profits and they try to save the world, basically to be a better human being
00:03:19.280 | and help one's brothers and sisters.
00:03:22.240 | And then they go to college, they pay a lot of tuition, some get into a lot of debt, and
00:03:27.680 | then they see the typical industries, tech, consulting, finance, and they say, "You know
00:03:33.600 | what?
00:03:34.600 | I'm going to join these industries even though I don't like them because I need to make as
00:03:37.960 | much money as possible."
00:03:39.080 | You see that over and over again if you have that opportunity to take it and then you forsake
00:03:43.840 | the things that you really like to do.
00:03:46.000 | Well, once you achieve this investment threshold, you can actually go back to your roots to
00:03:52.040 | try to do what you really, really wanted to do in the first place, if it's not those high-paying
00:03:57.280 | industries.
00:03:58.280 | And the beauty of my investment threshold formula is that it takes inflation into account
00:04:04.480 | because incomes are indexed towards inflation.
00:04:08.720 | So whatever income you're making is calculated based on some inflation index and whatever
00:04:14.520 | raise you're going to get next year is based on some inflation index.
00:04:19.160 | So every time you have an income change, hopefully a raise, you just recalculate the formula.
00:04:25.320 | In turn, the investment returns are also helped by inflation and historically have greater
00:04:31.480 | returns than the rate of inflation.
00:04:33.480 | So you don't have to calculate a real rate of return.
00:04:37.440 | All you have to do is run the numbers again, especially every time you get a raise.
00:04:43.680 | Other key assumptions for my investment threshold formula.
00:04:46.640 | Well, I assume the financial freedom seeker lives within their means, doesn't carry expensive
00:04:53.720 | revolving credit card debt, and saves at least 20% of their after-tax income every year.
00:04:59.240 | 20% folks is the bare minimum, especially if you're listening to this personal finance
00:05:04.000 | podcast or reading Financial Samurai.
00:05:06.680 | We've talked a lot about raising that saving rate to as high as possible.
00:05:09.960 | If you can get to 50% saving rate, well, that means every year you work and save is one
00:05:15.380 | year of freedom you buy.
00:05:17.200 | Another assumption is that the financial freedom seeker maintains their usual spending habits.
00:05:22.680 | We're not talking about living on delicious ramen noodles and water to cut expenses to
00:05:28.200 | the minimum so you can achieve financial freedom sooner or lower that investment threshold
00:05:33.960 | amount.
00:05:34.960 | No, we're talking about living your normal life, living a good life, living a rich life,
00:05:39.280 | not limiting yourself to living like a monk, shunning travel, renting a crappy studio apartment,
00:05:46.600 | or living on a boat or a van, avoiding having children, and forcing your partner and love
00:05:51.740 | of your life to work so that you can be free.
00:05:55.000 | That's suboptimal.
00:05:56.480 | Those are suboptimal decisions.
00:05:57.680 | Of course, anybody can do it and if you enjoy that, then more power to you.
00:06:02.720 | But I want you to live a comfortable life because I don't think there's a point to retiring
00:06:08.260 | early only to live near poverty and I also don't think it's ideal to live near poverty
00:06:13.360 | your entire career, your working career, just to retire early and continue to live in the
00:06:18.000 | same way.
00:06:19.000 | Instead, I think it would be much better to continue working or at least continue working
00:06:24.200 | in a job that you enjoy that might not pay as well.
00:06:27.200 | Alright, so the investment threshold formula in action, again, it's taking the inverse
00:06:32.640 | of the historical return of the asset class you own and multiplying it by your gross annual
00:06:37.920 | income.
00:06:38.920 | So let's use three examples that I wrote in my post.
00:06:42.600 | First example, say you are 38 years old, you work in the government, you have high risk
00:06:48.600 | tolerance and you're comfortable with 100% allocation in stocks.
00:06:52.200 | Well, we know that stocks historically have returned about 10% on average since 1926,
00:06:59.720 | therefore the inverse of 10% is 10.
00:07:02.120 | So you just take 1 divided by 0.10 and that equals 10.
00:07:10.760 | And then let's say your income is $100,000, so you take 10 times $100,000 equals $1,000,000.
00:07:18.120 | So as a $100,000 a year income earner, once you have achieved $1,000,000 invested in the
00:07:24.200 | S&P 500, you should feel free to explore other options if you no longer enjoy your job.
00:07:29.440 | So let's say you don't enjoy being a government worker with 2-3% raises and a lot of bureaucracy
00:07:36.000 | and you've always wanted to be an author or writer.
00:07:39.040 | It doesn't pay very well, folks, I know, but you've wanted to pursue this dream since you
00:07:43.960 | were a child.
00:07:45.400 | So you try your hand at writing and you earn $40,000 a year, which frankly is not that
00:07:51.960 | much money.
00:07:52.960 | But guess what?
00:07:53.960 | You can live off that.
00:07:54.960 | You're happy because you're doing what you want and you have a $1.1 million stock portfolio
00:08:01.240 | after 15 years of working, saving, investing aggressively without fail.
00:08:05.920 | So if you're able to survive off a $40,000 a year salary and not touch principal, you
00:08:12.720 | actually only need $400,000 invested in stocks using my investment threshold formula.
00:08:19.960 | And since you decided to switch your career at 38 years old with $1.1 million in stocks,
00:08:24.760 | you actually have a $700,000 investment buffer.
00:08:28.560 | So this is the example that I'm talking about where you can work at your higher paying job
00:08:33.360 | that you don't like, you gut it out for 10, 15, 20 years, but if you save and invest diligently,
00:08:39.260 | you can transition, you can quit the money and step away and do something you really
00:08:43.280 | enjoy that's going to nurture your soul instead of suck it dry.
00:08:47.480 | Here's a second example of how you can use my income threshold formula to figure out
00:08:52.280 | when to retire.
00:08:54.320 | Let's say you've worked for 23 years post-college and you're 45 years old.
00:08:59.380 | You earn $300,000 a year in tech, a notoriously volatile industry.
00:09:04.920 | So instead of being comfortable with 100% allocation of your retirement portfolio in
00:09:09.160 | stocks, you'd rather have a 60/40 stock/bond portfolio.
00:09:14.480 | When can you comfortably retire?
00:09:16.880 | Well, given that bonds historically have returned about 5%, the historical return of a 60/40
00:09:24.000 | portfolio is around 8%.
00:09:26.960 | Now the inverse of 8% is 12.5.
00:09:31.000 | To find your investment threshold, multiply your gross annual income of $300,000 by 12.5
00:09:38.000 | which equals $3.75 million.
00:09:41.500 | So if you have $3.75 million in a 60/40 stock/bond portfolio, that is when you can consider retiring
00:09:50.120 | early or doing something else.
00:09:52.640 | Unfortunately in this example, you only have $2.5 million invested in stocks and bonds
00:09:58.240 | with no other assets for simplification purposes given this example.
00:10:03.360 | Given that you can save $100,000 a year after taxes, a compound return calculator estimates
00:10:08.720 | your $2.5 million portfolio will reach over $3.75 million in about 3 years and 10 months,
00:10:17.440 | assuming an 8% annual return.
00:10:20.360 | Of course, a bear market could extend your timeline and that's why you're dynamic.
00:10:25.160 | You're going to change as the conditions change.
00:10:29.140 | But overall, you feel great knowing that after using my investment threshold formula, you
00:10:34.720 | have a high probability of retiring in the next 5 years and no later than 6 or 7 years.
00:10:42.160 | And once you have that target date in mind, I'm telling you folks, work becomes more bearable.
00:10:49.560 | You don't have to fret about all those meetings and the performance as much.
00:10:53.720 | You see the light at the end of the tunnel.
00:10:55.980 | And when you see that light, you just get motivated to keep on going, to break free.
00:11:01.680 | Alright, here's the final example of how using my income threshold formula can help you decide
00:11:07.240 | to take it down a notch at work or do something different.
00:11:11.360 | Let's say you're 26 years old and an associate in investment banking.
00:11:16.040 | You're already kind of burned out, kind of hate your lifestyle, but you're making $200,000
00:11:21.280 | a year, which is great money for a 26-year-old.
00:11:24.640 | And let's say you also grew up in a culture that values real estate more than stocks.
00:11:29.040 | Real estate is a tangible asset.
00:11:31.120 | It doesn't just go poof overnight like stocks.
00:11:34.600 | Real estate provides shelter, generates income, and is less volatile in general than stocks.
00:11:39.920 | So, you invest all your money outside of banking into residential real estate for retirement.
00:11:46.200 | Bonds, simply a little too boring.
00:11:48.600 | Real estate is like bonds plus, right?
00:11:50.880 | Higher upside and similar amount of downside.
00:11:54.640 | Not the same, but similar.
00:11:56.520 | When the economy is going down, rates are going down, demand for real estate tends to
00:12:00.480 | get betrayed because affordability increases.
00:12:04.040 | Now, historically, real estate has returned about 4% on average, 2% above the long-term
00:12:10.680 | inflation rate.
00:12:11.680 | When inflation is up, real estate returns tend to go higher as well, as we saw in 2020,
00:12:17.120 | 2021.
00:12:18.120 | Now, interestingly, I have looked around the internet, research papers, and some publications
00:12:23.840 | such as the San Francisco Fed suggest that real estate has historically returned 7% annually
00:12:29.280 | since 1850s.
00:12:30.640 | So, real estate is local, but overall, let's say 4% annual rate of return for the country.
00:12:37.240 | To figure out how much real estate you need in order to make work optional, you do the
00:12:42.400 | same formula.
00:12:43.920 | You take the inverse of the historical rate of return and multiply it by your gross annual
00:12:48.440 | income.
00:12:49.440 | So, in this case, the inverse of 4% is 25, and you multiply 25 by 200,000, your gross
00:12:56.840 | annual income, to get $5,000,000.
00:13:00.520 | Now you must do your best to live off of $200,000 or less as your income grows and save and
00:13:05.740 | invest as much as possible on any income above $200,000.
00:13:10.240 | $5,000,000 in real estate sounds like a lot, and it is a lot.
00:13:14.760 | But in our system today, people with good credit and stable income are able to acquire
00:13:20.320 | real estate using a 20% down payment.
00:13:22.640 | So, you really only need $1,000,000 to buy $5,000,000 worth of real estate over time.
00:13:28.040 | I'm not talking immediately, I'm talking about over time where you're building your residential
00:13:31.880 | real estate portfolio.
00:13:33.140 | Now, $1,000,000 down payment is $1,000,000 less or 50% less than you would need if you
00:13:39.280 | preferred to have 100% of your portfolio in the S&P 500.
00:13:44.640 | Because if you were making $200,000 and you preferred 100% in stocks, you would take the
00:13:49.720 | inverse of 10%, which is the historical rate of return for stocks, and you'd get 10, and
00:13:54.720 | 10 times 200,000 is $2,000,000.
00:13:57.240 | So, with real estate, you only need $1,000,000 in down payment to command $5,000,000 in value.
00:14:03.840 | Now, of course, if you own residential real estate and are a landlord, you're going to
00:14:08.440 | have to spend time and money managing your properties and tenants.
00:14:11.840 | Additionally, with significant debt, your real estate equity could fluctuate much more
00:14:16.600 | dramatically.
00:14:17.600 | But the thing is, you're 26 years old, so in your 20s and 30s, you have a lot more energy
00:14:23.240 | and time and desire to make more money, so you are comfortable managing people and trying
00:14:29.800 | to gain sweat equity by remodeling and expanding your property.
00:14:34.720 | The key is to own rental properties that generate strong cash flow, which you can live off of.
00:14:39.720 | And fortunately, as we read in a previous post, rental property income yields are higher
00:14:46.400 | than stock dividend yields in general.
00:14:49.720 | And also, the power of rental property income is greater because to generate that rental
00:14:54.360 | property income doesn't require the same amount of degradation in the asset as stocks.
00:14:59.600 | When you're paying a dividend from the company's balance sheet, let's say it's a $100 dividend,
00:15:04.640 | your balance sheet, the cash balance goes down by exactly $100 as well.
00:15:09.200 | It's not free money dividends.
00:15:10.940 | But when your rental property generates $100 in income, it's not like $100 worth of damage
00:15:16.240 | and property taxes and so forth occurs.
00:15:19.040 | I hope these three examples help elucidate how you can use my investment minimum threshold
00:15:25.000 | to make work optional.
00:15:27.080 | The key here is to actually make a change, to have a courage to change your life for
00:15:32.200 | the better.
00:15:33.200 | I know quitting the money is hard, it can be scary, but if you've reached that investment
00:15:38.000 | threshold and you're not happy with your life, you have to make that change because when
00:15:42.560 | you get older and look back on your life, you're going to feel regret.
00:15:47.400 | And as I've learned and experienced over time, regret really starts eating you up inside
00:15:54.120 | and it actually grows.
00:15:55.720 | But the good thing about this uncomfortable feeling of regret is that it propels you to
00:15:59.800 | make a change right now and propels you to think more analytically and take more risks
00:16:05.320 | so you don't have as many future regrets.
00:16:08.480 | I want to make it clear that my investment threshold formula represents the minimum amount
00:16:12.480 | you need before feeling comfortable transitioning out of your current job.
00:16:17.740 | It's the practical and responsible minimum amount you need to change your life.
00:16:22.320 | Obviously, you can change your life much sooner than before you hit the minimum investment
00:16:27.160 | threshold, but it's a little bit more risky.
00:16:30.760 | Also, once you achieve this minimum investment threshold, it's unlikely you're going to be
00:16:36.360 | able to or feel confident enough to retire early.
00:16:39.780 | And that's not the point of this threshold.
00:16:41.520 | This threshold is to help you figure out when is that time where you can start taking it
00:16:47.600 | down a notch, but not fully take it down a notch.
00:16:50.800 | After all, if there's a 70+% chance of your investments making money any given year, there's
00:16:55.760 | a 30% chance of your investments losing money in any given year.
00:17:00.240 | Therefore, you're likely to aim to accumulate more investments or continue working even
00:17:04.960 | after reaching this investment threshold.
00:17:06.760 | It's very logical and I've gone through this experience since 2012.
00:17:11.200 | So let's say you expect a bear market to happen and your investments to decline by 30% one
00:17:16.700 | year.
00:17:17.700 | Well, to give yourself a buffer, aim to achieve 142% of the minimum investment threshold amount
00:17:23.800 | that comes out from the calculation.
00:17:26.620 | That way, you have a 30% downside buffer.
00:17:28.680 | And let's say you think there's going to be back-to-back years of 30% declines, which
00:17:33.160 | is extremely rare, then mathematically speaking, you just need to accumulate 204% of the minimum
00:17:41.480 | investment threshold and then you're protected.
00:17:44.800 | Pretty cool how there's a simple mathematical calculation for anything.
00:17:50.040 | The hard part, the trick is figuring out how much is enough that corresponds with your
00:17:55.480 | risk tolerance, your hopes, your dreams, and your goals.
00:17:58.880 | I really want everyone to take action once you achieve this investment threshold.
00:18:04.440 | Not only calculate it, but be methodical and then take action to change your life for the
00:18:09.060 | better once this threshold is reached.
00:18:11.920 | This means not wasting another minute at a job you dislike, hopefully you negotiate a
00:18:15.920 | severance package.
00:18:17.480 | This means leaving a terrible relationship behind because you're no longer financially
00:18:21.660 | dependent on someone, but you're independent and you can do whatever you want.
00:18:26.520 | Changing your life for the better also means doing the things you've always been afraid
00:18:30.620 | to do because money has held you back.
00:18:33.680 | Finally, I suggest everyone stay dynamic.
00:18:37.000 | Stay on their toes and calculate this formula every single year.
00:18:41.320 | And just do a gut check to see where you are progressing, how far you have to go, what's
00:18:45.980 | the latest income figure you have, and whether this is enough to make you happy and live
00:18:50.700 | the life that you want.
00:18:52.560 | Because life is always changing, always.
00:18:55.880 | On your financial journey, you're undoubtedly going to experience fear and doubt as economic
00:19:01.080 | and personal circumstances evolve.
00:19:03.560 | The key is to remain flexible with your financial goals and adapt to the changing conditions.
00:19:09.720 | For example, when my wife left her corporate job at age 35 in 2015, I thought we'd be
00:19:15.800 | very happy, very comfortable living on $10,000 a month, right?
00:19:19.640 | Sounds pretty good in less expensive Honolulu, Hawaii.
00:19:23.440 | Based on my conservative investment return target of 2-3 times the 10-year treasury bond
00:19:28.160 | yield, retiring early with $3-4 million invested seemed like enough.
00:19:34.520 | But the problem is this was a static number and it was just a number.
00:19:39.400 | I hadn't lived this.
00:19:40.640 | I was just imagining this.
00:19:42.640 | Then in 2017, our son was born, followed by our daughter in December 2019.
00:19:48.480 | And then a year later, the pandemic hit, prompting the government to inject trillions of dollars
00:19:53.020 | into the economy, which fueled inflation for two years.
00:19:57.520 | It's kind of unpredictable, scary times.
00:20:00.800 | So relatively quickly, the $120,000 was no longer enough to raise two kids in San Francisco.
00:20:06.520 | It's funny because to qualify for affordable housing in San Francisco, you have to make
00:20:12.720 | around $120,000 or less.
00:20:15.800 | So now, in order to live the lifestyle that we want, which I think is a relatively middle-class
00:20:20.400 | lifestyle, a house, a car, 2-3 weeks of vacation a year, requires about $300,000 to $350,000
00:20:28.440 | a year in annual household income.
00:20:31.320 | And I know some of you folks living in lower cost areas of the country or the world will
00:20:35.760 | think that's ridiculous, but those are the numbers.
00:20:40.040 | And so using a 5% rate of return on our investments, that means needing at least $7 million invested
00:20:45.560 | where work becomes optional.
00:20:47.800 | And even if work isn't optional for some reason, for those of you just wondering when, how
00:20:53.760 | much money will I have where I will finally feel settled and comfortable and financially
00:20:58.760 | free?
00:20:59.760 | Well, based on this example and calculation, that number is $7 million.
00:21:04.160 | Now it's not all going to be the same for everyone, but using my investment threshold
00:21:08.160 | formula gives you an idea of when you can feel that mental reprieve where you don't
00:21:15.000 | have to grind forever, for so long and so hard anymore.
00:21:20.040 | So there you have it folks.
00:21:21.040 | I hope you use my investment threshold formula to your advantage.
00:21:25.240 | Back in 2009 and 2010, I didn't have this formula, this clear guide to help me shoot
00:21:31.800 | for what to save and invest in and how much.
00:21:35.520 | And so now we do.
00:21:36.960 | And I've gone through the past 12 years without full-time employment and therefore I really
00:21:42.720 | believe this investment threshold formula will help you achieve the life that you want
00:21:48.040 | in a responsible manner.
00:21:49.920 | Thanks so much everyone.
00:21:50.920 | If you enjoyed this podcast, I'd love a share and a positive review.
00:21:54.720 | It keeps me going.
00:21:56.320 | And also please share this idea, this concept of the investment threshold formula to as
00:22:00.640 | many people as possible and run your own numbers.
00:22:03.920 | I haven't seen this type of formula anywhere, but it's clear and it's actionable and
00:22:08.600 | it's something that I love to come up with to help you achieve financial freedom sooner
00:22:13.020 | rather than later.
00:22:14.020 | If you'd like to keep in touch, please subscribe to my free weekly Financial Samurai
00:22:18.840 | newsletter at FinancialSamurai.com/news.
00:22:22.080 | [Music]
00:22:23.080 | [Music]
00:22:28.080 | (gunshot)