The_Investment_Returns_Crossover_Point_Where_Work_No_Longer_Matters
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai.
00:00:02.440 | And in this episode, we're going to talk about investment returns versus active income.
00:00:07.700 | And what happens when investment returns beat your active income every year.
00:00:13.080 | So I don't know about you folks, but I'm pretty tired.
00:00:16.280 | And I know a lot of people who are growing more and more apathetic to work, because they're
00:00:21.960 | tired, but also because their investment returns have been so good.
00:00:26.320 | We've been in a bull market technically since 2009.
00:00:29.600 | So that's about 12 years of generally upward momentum, except for what 2018, maybe one
00:00:37.040 | more year, not so good.
00:00:38.520 | But in general, we've been making money every single year.
00:00:43.020 | And you might find that one day, your investment returns are greater than your annual active
00:00:48.360 | income.
00:00:49.400 | And you're going to feel giddy and excited.
00:00:51.960 | But you're probably not going to quit your job just yet, just in case it was a fluke.
00:00:55.520 | However, after several years of investment returns surpassing your active income, you'll
00:01:00.680 | develop a lot more courage to do something new.
00:01:03.640 | You might finally ask for that well-deserved sabbatical without fear of your year-end bonus
00:01:07.780 | getting slashed.
00:01:09.220 | You won't fear as much not getting that promotion because you got the investment returns.
00:01:15.120 | So who cares if the company screws you?
00:01:17.400 | Well, of course you will care because you obviously want to get what you deserve.
00:01:21.880 | But once those investment returns surpass your active income, it becomes harder and
00:01:27.160 | harder to care as much about your career.
00:01:30.600 | And it becomes harder and harder to get as motivated.
00:01:33.320 | So that's where I find myself, folks, as I transition back to retirement by 2022, when
00:01:38.040 | there's hopefully herd immunity, although who knows, I've been trying to justify my
00:01:42.760 | decision to no longer work so much, you know, no longer write as much do business development
00:01:48.640 | deals, all that stuff that I promised I would do once the lockdowns began because, hey,
00:01:53.520 | you're stuck at home, I'm stuck at home, why not try to make some money?
00:01:57.640 | As a father of two young children, not working feels like a sin.
00:02:01.600 | It really does.
00:02:02.600 | It is very hard not to feel responsible for your family.
00:02:07.840 | You know, if you're a parent, work is part of what you need to do.
00:02:11.760 | You need to make money, you need to stay healthy so you can live a long enough time before
00:02:15.940 | your kids become adults, and so forth.
00:02:19.160 | However, my investment returns have been greater than my active income returns for the majority
00:02:25.040 | of years since 2012.
00:02:27.240 | Now that's relatively easy to do when you don't have a day job.
00:02:30.520 | But of course, I've got financial samurai revenue coming in, and the site has grown
00:02:34.400 | over time.
00:02:35.880 | But I will say that since 2012, the majority of the years, my investment returns have been
00:02:42.240 | greater than my last year of working in finance.
00:02:45.920 | As a result, I've really begun to question whether it's worth spending any time to make
00:02:51.000 | any active income.
00:02:52.760 | I've spoken to friends who make from $50,000 to 10 plus million dollars a year, and a lot
00:02:58.600 | of them are becoming more and more apathetic to work, partly because their investment returns
00:03:04.080 | are grading a greater and greater amount.
00:03:07.280 | And so they're also thinking to themselves, why bother working so hard?
00:03:11.860 | In addition, the active income I do make doesn't do much to stem any losses.
00:03:16.860 | For example, let's say I lose 10% on a $5 million portfolio.
00:03:21.040 | That's a $500,000 loss.
00:03:23.200 | Ouch.
00:03:24.200 | Yikes.
00:03:25.200 | Even if I worked really, really hard, however, for the next several months to make, let's
00:03:28.840 | say $50,000 online, I'd still be down $450,000.
00:03:34.240 | Losing $450,000, at least on paper, feels the exact same as losing $500,000.
00:03:41.600 | It's a terrible feeling.
00:03:43.520 | I would say the breakpoint would be maybe around, I think losing $200,000 would feel
00:03:50.040 | better than losing $500,000.
00:03:52.680 | But anything after $200,000, it just feels bad.
00:03:56.540 | It's about the same.
00:03:57.540 | Therefore, if I spend any time trying to make money, that precious time to make the extra
00:04:03.000 | $50,000 online, I think it would make the situation worse because I would still feel
00:04:07.720 | bad about losing $450,000, and yet I would also have spent precious time trying to make
00:04:14.200 | that $50,000, which I could have used to do something more enjoyable with my life or spend
00:04:18.960 | time with my family.
00:04:20.340 | And then on the flip side, let's say I return 20% on a $5 million portfolio in one year.
00:04:25.600 | It's feasible because in 2020, that's almost what happened.
00:04:28.800 | And in 2021, the markets are up about 20% and it's only September 1st about.
00:04:35.260 | So that's a $1 million gain, which is amazing.
00:04:38.880 | Now even if I take on some consulting projects to make, let's say $100,000 over the next
00:04:43.760 | several months, a $1.1 million gain doesn't do anything to change our happiness or our
00:04:50.520 | lifestyle one bit.
00:04:52.600 | And the reason is we comfortably live on much less each year.
00:04:57.080 | I don't know what to do with that extra money if I ever had that.
00:05:01.420 | Maybe I'd buy a fancy car, maybe a Lamborghini.
00:05:04.800 | Probably not.
00:05:05.800 | I live in San Francisco and the hills are hilly.
00:05:08.280 | Would I go on an awesome luxury cruise?
00:05:11.040 | I would if there wasn't any COVID, but I'm not going to get on a cruise with my family
00:05:14.840 | during the time of COVID.
00:05:16.660 | So I'd probably just reinvest it and it would make no difference to the quality of our lives
00:05:22.000 | and our happiness.
00:05:23.000 | Therefore, there has to be some sort of crossover point where spending any amount of time making
00:05:29.460 | active income becomes a waste of time.
00:05:31.860 | So the only way you would spend time making active income is if you truly love your work.
00:05:36.860 | So I truly love writing and now podcasting on Financial Samurai.
00:05:41.900 | If I didn't, then you wouldn't see me writing random posts about things that would make
00:05:47.300 | me no money.
00:05:48.300 | You know, the post on if you want to naturally be nicer, get richer.
00:05:52.220 | That's not going to make me any money.
00:05:54.100 | Posts that are going to make me money are sponsored posts or if I do a review on some
00:05:59.220 | new product, which you see a lot of other personal finance blogs do, is because that
00:06:03.200 | focuses on making money.
00:06:04.900 | My focus is on writing and connecting and discussing important real life topics that
00:06:10.860 | we all experience.
00:06:12.300 | And that's one of the reasons why I want to write my book with Penguin Random House because
00:06:16.540 | I'm going to cover some of the big life scenarios that we all will face or most of us will face
00:06:22.280 | at some point.
00:06:23.400 | And I want to decide between help you decide between this choice or that choice.
00:06:28.420 | So let's talk about the investment returns crossover point.
00:06:32.020 | I believe there are two conditions an investor must achieve before they can drop active income
00:06:37.380 | due to investment returns.
00:06:39.060 | And I want to point out that we are talking about investment returns, not investment income.
00:06:46.160 | Investment income is passive income that I've been trying to build to live off.
00:06:50.900 | But thinking about investment returns is a different way of thinking about trying to
00:06:55.460 | retire with the money you have.
00:06:57.940 | So investment returns is about what your portfolio will return every single year to pay for your
00:07:03.500 | desired living expenses.
00:07:04.980 | So the condition number one is at least three years of outperformance.
00:07:09.180 | If your investment returns are greater than your active income for at least three years
00:07:13.740 | in a row, or four years out of the last five years, I think you have the green light to
00:07:19.140 | take things down a notch, retire early, change careers, work at a job that doesn't pay well
00:07:24.700 | because you love it.
00:07:26.020 | Now, three years helps minimize the chances that your investment returns are not a fluke.
00:07:32.300 | We just don't want to confuse our brains with a bull market.
00:07:35.980 | We're in a bull market.
00:07:36.980 | So of course, it's easier to make money in our stocks and bonds and real estate investments
00:07:41.980 | and so forth.
00:07:43.120 | And given bear markets, which are defined as a 20% plus sell off, happen every about
00:07:48.580 | four years, I use the benchmark of four years out of five years to account for a couple
00:07:54.780 | of potentially bad years.
00:07:57.020 | The second condition is investments equal to at least 10 times your annual active income.
00:08:03.540 | So in order for your investment returns to generate more than your active income for
00:08:07.400 | three years or longer, you likely need a sizable investment portfolio that is 10 times or greater
00:08:13.380 | than your annual active income.
00:08:15.700 | And it's really fun how to analyze this because you just run the numbers and you can realize
00:08:19.980 | that 10x really is kind of the key benchmark.
00:08:23.500 | Let's say you make $100,000 a year, you would likely need at least a $1 million portfolio
00:08:28.740 | for a chance to generate $101,000 a year.
00:08:32.740 | So that's where your investment returns beat your annual active income.
00:08:37.220 | To generate $101,000 in investment returns on a $1 million portfolio would require a
00:08:43.180 | 10.1% return.
00:08:45.880 | And that is bang in line with the historical S&P 500 average of about 10.2% since about
00:08:53.100 | 1926.
00:08:54.660 | So if your entire portfolio is in the S&P 500 and the S&P 500 returns its historical
00:08:58.860 | average, you've made it.
00:09:01.420 | However, the caveat is investment returns could be much lower in the future.
00:09:06.140 | So Vanguard in August 2021 came out with their 10-year return assumptions for stocks and
00:09:11.300 | bonds and it's very low.
00:09:14.380 | Vanguard is assuming a 4.02% return in stocks and even less in bonds.
00:09:20.020 | So if Vanguard's return assumptions come true, you're probably going to need at least 20x
00:09:26.460 | your annual income until you no longer have to work.
00:09:29.980 | And there is this debate between what metric to use as a multiple.
00:09:34.900 | A lot of people use expenses.
00:09:36.940 | I think that's fine.
00:09:38.540 | But I like to use annual income as a multiple for net worth targets because it's harder
00:09:43.340 | and it allows you to focus more.
00:09:46.620 | When you use your annual expenses as a multiple, it's easy to just cut costs and cheat so you
00:09:51.860 | don't have to save and invest so much.
00:09:54.620 | But if you use the income, you just can't cheat.
00:09:57.380 | You just have to go with the flow.
00:09:59.360 | And since most people make more money over time, using the income will keep you disciplined
00:10:04.300 | as you make more money.
00:10:05.860 | So the next obvious question is how long will it take investment returns to surpass active
00:10:10.820 | income?
00:10:11.820 | Now, the length of time will depend on your saving rate and your rate of return.
00:10:16.580 | Obviously, the higher your saving rate and higher your rate of return, the greater your
00:10:20.540 | chance of succeeding.
00:10:22.580 | Given I believe your capital needs to reach about 10x your annual gross income in order
00:10:26.780 | for your investment returns to regularly have a chance to surpass your active income, let's
00:10:32.220 | use two examples.
00:10:34.060 | The first example is using a 20% saving rate.
00:10:36.860 | If you start with nothing and save 20% of your annual gross income each year, in 18
00:10:42.540 | years, one eight, at a 10% compound annual return, you will have accumulated 10x your
00:10:48.180 | annual income.
00:10:49.180 | In the 19th year, if you continue to get a 10% return, your investment return will have
00:10:54.220 | surpassed your static annual income.
00:10:57.100 | Now, if your rate of return is only 5%, then you will accumulate 10x your annual income
00:11:03.180 | in 25 years.
00:11:05.340 | If a 5% rate of return continues, then you're really going to have to work about 36 years
00:11:10.060 | to finally see your investment returns surpass your annual income.
00:11:14.340 | The second example, if you use a 50% savings rate, which I think is the ideal savings rate
00:11:19.420 | everyone should shoot for, eventually, I think you're going to have to try to get there if
00:11:23.620 | you want to retire early or retire very, very comfortably.
00:11:27.820 | With a 50% annual gross income each year and 10% compound annual return, you'll reach 10x
00:11:35.820 | in about 11 years, and then on the 12th year, you'll succeed.
00:11:39.820 | Now, if the rate of return is only 5%, then you will accumulate 10x your annual income
00:11:45.060 | in 14 years, again, with a 50% savings rate.
00:11:49.140 | And if a 5% rate of return continues, then you will have to save and work for 22 years
00:11:54.060 | to finally see your investment returns surpass your annual income.
00:11:58.420 | Therefore, in conclusion, with a 20 to 50% saving rate and a 5% to 10% annual return
00:12:05.740 | assumption, it will likely take between 11 to 25 years until your investment returns
00:12:12.300 | steadily surpass your active income.
00:12:15.100 | Personally, it took me about 15 years to start regularly earning a greater return from my
00:12:21.500 | investments.
00:12:22.500 | So, the fun part about Financial Samurai is that I'm writing out this analysis using basic
00:12:29.220 | math and assumptions, but I'm also living it.
00:12:32.540 | I'm living it, folks, and I'm using my situation to double check whether the numbers are reasonable.
00:12:39.140 | And I do think it'll take 11 to 25 years for the average person if they save 20 to 50%
00:12:45.460 | of their annual gross income.
00:12:47.360 | And I do want to differentiate again between investment income and investment returns.
00:12:51.900 | In normal times, I think generating enough investment income to cover your desired living
00:12:56.140 | expenses may be harder than generating high enough investment returns to cover your living
00:13:01.900 | expenses.
00:13:02.900 | Let's just do the math again.
00:13:04.660 | Let's say we're in a raging bull market.
00:13:07.500 | You've got a $1 million portfolio and it's returning 25% a year.
00:13:11.900 | So that's $250,000 in investment returns.
00:13:15.860 | To get $250,000 in investment income at a 2% yield requires a $12.5 million portfolio.
00:13:25.580 | And obviously, if you withdraw at 4%, it requires half that amount.
00:13:29.680 | But still, that's a lot more money than $1 million.
00:13:32.960 | So the reality is investment income and investment returns are intricately tied together.
00:13:39.860 | And the logical thing many people do who no longer want to work is change their investment
00:13:44.140 | composition towards less risky, more stable, higher income producing investments once they've
00:13:50.560 | achieved their ideal number of retirement.
00:13:53.300 | And that's different for everyone.
00:13:55.140 | It all depends on your lifestyle desires.
00:13:58.540 | And let me conclude by saying there is a dangerous level of capital where if you get that amount,
00:14:05.420 | nothing matters.
00:14:06.800 | You might completely check out and lose all interest in any type of money making endeavor.
00:14:13.100 | And it could be a little dangerous.
00:14:14.740 | It could be a little dangerous.
00:14:16.580 | And that level, I believe, starts at when your net worth is equal to over 20 times your
00:14:21.860 | annual income or over 50 times your annual expenses.
00:14:26.380 | The apathy starts really creeping in and taking over.
00:14:31.940 | And then once your net worth gets to over 40 times your annual income or 100 times your
00:14:37.020 | annual expenses, I think that's when you start completely checking out.
00:14:41.500 | And I found myself thinking a lot just in my head like, "F this BS.
00:14:46.940 | Screw this.
00:14:47.940 | I'm not going to do this because I just don't care anymore."
00:14:51.980 | And so that's dangerous.
00:14:52.980 | So if you want to stay motivated, let's say you have children to take care of.
00:14:56.820 | Let's say you want to be very productive in society.
00:14:59.400 | You want to produce something.
00:15:00.820 | I'm in the middle of writing a book and I got to stay motivated.
00:15:03.720 | You might ironically have to keep inflating your lifestyle.
00:15:07.480 | So instead of the base model car, you might want to get the luxury supreme model car.
00:15:13.500 | Instead of flying economy class, maybe you'll live it up and fly first class.
00:15:18.340 | Maybe you're going to go private.
00:15:19.980 | Whatever the case may be, you can always spend more if you want to stay more motivated.
00:15:24.520 | Or you can just give more money away and help other people.
00:15:26.900 | And of course, you can do both.
00:15:29.640 | So there's a big interesting phenomenon going on right now.
00:15:33.640 | And that is the greater the investment returns, the more apathetic workers get, or at least
00:15:39.300 | investment workers get.
00:15:41.520 | So if the strong returns and risk assets continue, eventually productivity will decline.
00:15:47.160 | And in that case, the only people left to do the work will be non-investors and new
00:15:51.720 | graduates.
00:15:52.720 | So I'd love to hear your thoughts on how to use investment returns, if at all, as a
00:15:58.320 | gauge to how much you should work and how long you should work.
00:16:02.600 | I'm also curious to hear from you whether you are getting demotivated as well.
00:16:07.380 | And if you don't agree with my multiples, I'd love to hear what your multiples are and
00:16:12.520 | why.
00:16:13.520 | All right, that's it for this episode, folks.
00:16:15.520 | I hope you enjoyed it.
00:16:16.920 | And if you liked it, please leave a positive review and share it with all your friends.