Hello everybody, it's Sam from the Financial Samurai podcast and in this solo episode I want to talk about the minimum investment amount where work becomes optional. I started Financial Samurai in 2009 to make sense of the global financial crisis. And that was the time where I really wanted to start leaving work, getting out and doing my own thing or just retiring early.

I didn't know exactly what I wanted to do, but I knew I didn't want to work in finance anymore. Ten years had passed and it was starting to feel like a big grind and it was no longer fun either. The correlation with performance and reward was going downhill because structurally the industry was in a decline, commission rates were coming down much like the real estate industry right now and it didn't feel good not to get rewarded based on merit anymore.

As a result I decided to save and invest as much as possible to one day break free and break free I did in 2012. But back then I didn't have a simple formula to help guide me into how much I needed to accumulate in my investments in order to feel comfortable to break free from work.

But now I have come up with a formula. And this is also a formula based off of my 12 years of experience not having a day job. I've gone through some ups and some downs, mostly ups because it's been a bull market, but of course I've gone through the market crash in March 2020 when COVID happened, the 2022 bear market, and then the growth of my household expenses due to the growth of my family.

So it's been somewhat of a topsy-turvy ride, but in general it's been up and to the right again thanks to a strong economy and a strong market in the real estate market, stock market, and many other markets. So if you are tired of work, you don't like your job, you want to retire early, take a sabbatical, maybe go back to school or take care of your young ones until they go to school full time, I have come up with the minimum investment threshold formula where work starts to become optional.

And that formula is taking the inverse of the historical return of the asset class you own and multiplying it by your gross annual income. When you reach this minimum investment threshold, the annual return from your investments has a high chance of equaling or exceeding your annual gross salary. Additionally, since long-term investment income and capital gains are generally taxed at a lower rate than your W-2 job income, you'll have an even larger after-tax cushion.

And once your investments can regularly match or exceed your annual gross income, you're more free to do what you want. You don't have to work at a soul-sucking job anymore for big bucks or that healthcare. You can take things down. You can work at that job you've always wanted to work at, but that doesn't pay as well.

I think about high school college applicants all the time where they write about how they start non-profits and they try to save the world, basically to be a better human being and help one's brothers and sisters. And then they go to college, they pay a lot of tuition, some get into a lot of debt, and then they see the typical industries, tech, consulting, finance, and they say, "You know what?

I'm going to join these industries even though I don't like them because I need to make as much money as possible." You see that over and over again if you have that opportunity to take it and then you forsake the things that you really like to do. Well, once you achieve this investment threshold, you can actually go back to your roots to try to do what you really, really wanted to do in the first place, if it's not those high-paying industries.

And the beauty of my investment threshold formula is that it takes inflation into account because incomes are indexed towards inflation. So whatever income you're making is calculated based on some inflation index and whatever raise you're going to get next year is based on some inflation index. So every time you have an income change, hopefully a raise, you just recalculate the formula.

In turn, the investment returns are also helped by inflation and historically have greater returns than the rate of inflation. So you don't have to calculate a real rate of return. All you have to do is run the numbers again, especially every time you get a raise. Other key assumptions for my investment threshold formula.

Well, I assume the financial freedom seeker lives within their means, doesn't carry expensive revolving credit card debt, and saves at least 20% of their after-tax income every year. 20% folks is the bare minimum, especially if you're listening to this personal finance podcast or reading Financial Samurai. We've talked a lot about raising that saving rate to as high as possible.

If you can get to 50% saving rate, well, that means every year you work and save is one year of freedom you buy. Another assumption is that the financial freedom seeker maintains their usual spending habits. We're not talking about living on delicious ramen noodles and water to cut expenses to the minimum so you can achieve financial freedom sooner or lower that investment threshold amount.

No, we're talking about living your normal life, living a good life, living a rich life, not limiting yourself to living like a monk, shunning travel, renting a crappy studio apartment, or living on a boat or a van, avoiding having children, and forcing your partner and love of your life to work so that you can be free.

That's suboptimal. Those are suboptimal decisions. Of course, anybody can do it and if you enjoy that, then more power to you. But I want you to live a comfortable life because I don't think there's a point to retiring early only to live near poverty and I also don't think it's ideal to live near poverty your entire career, your working career, just to retire early and continue to live in the same way.

Instead, I think it would be much better to continue working or at least continue working in a job that you enjoy that might not pay as well. Alright, so the investment threshold formula in action, again, it's taking the inverse of the historical return of the asset class you own and multiplying it by your gross annual income.

So let's use three examples that I wrote in my post. First example, say you are 38 years old, you work in the government, you have high risk tolerance and you're comfortable with 100% allocation in stocks. Well, we know that stocks historically have returned about 10% on average since 1926, therefore the inverse of 10% is 10.

So you just take 1 divided by 0.10 and that equals 10. And then let's say your income is $100,000, so you take 10 times $100,000 equals $1,000,000. So as a $100,000 a year income earner, once you have achieved $1,000,000 invested in the S&P 500, you should feel free to explore other options if you no longer enjoy your job.

So let's say you don't enjoy being a government worker with 2-3% raises and a lot of bureaucracy and you've always wanted to be an author or writer. It doesn't pay very well, folks, I know, but you've wanted to pursue this dream since you were a child. So you try your hand at writing and you earn $40,000 a year, which frankly is not that much money.

But guess what? You can live off that. You're happy because you're doing what you want and you have a $1.1 million stock portfolio after 15 years of working, saving, investing aggressively without fail. So if you're able to survive off a $40,000 a year salary and not touch principal, you actually only need $400,000 invested in stocks using my investment threshold formula.

And since you decided to switch your career at 38 years old with $1.1 million in stocks, you actually have a $700,000 investment buffer. So this is the example that I'm talking about where you can work at your higher paying job that you don't like, you gut it out for 10, 15, 20 years, but if you save and invest diligently, you can transition, you can quit the money and step away and do something you really enjoy that's going to nurture your soul instead of suck it dry.

Here's a second example of how you can use my income threshold formula to figure out when to retire. Let's say you've worked for 23 years post-college and you're 45 years old. You earn $300,000 a year in tech, a notoriously volatile industry. So instead of being comfortable with 100% allocation of your retirement portfolio in stocks, you'd rather have a 60/40 stock/bond portfolio.

When can you comfortably retire? Well, given that bonds historically have returned about 5%, the historical return of a 60/40 portfolio is around 8%. Now the inverse of 8% is 12.5. To find your investment threshold, multiply your gross annual income of $300,000 by 12.5 which equals $3.75 million. So if you have $3.75 million in a 60/40 stock/bond portfolio, that is when you can consider retiring early or doing something else.

Unfortunately in this example, you only have $2.5 million invested in stocks and bonds with no other assets for simplification purposes given this example. Given that you can save $100,000 a year after taxes, a compound return calculator estimates your $2.5 million portfolio will reach over $3.75 million in about 3 years and 10 months, assuming an 8% annual return.

Of course, a bear market could extend your timeline and that's why you're dynamic. You're going to change as the conditions change. But overall, you feel great knowing that after using my investment threshold formula, you have a high probability of retiring in the next 5 years and no later than 6 or 7 years.

And once you have that target date in mind, I'm telling you folks, work becomes more bearable. You don't have to fret about all those meetings and the performance as much. You see the light at the end of the tunnel. And when you see that light, you just get motivated to keep on going, to break free.

Alright, here's the final example of how using my income threshold formula can help you decide to take it down a notch at work or do something different. Let's say you're 26 years old and an associate in investment banking. You're already kind of burned out, kind of hate your lifestyle, but you're making $200,000 a year, which is great money for a 26-year-old.

And let's say you also grew up in a culture that values real estate more than stocks. Real estate is a tangible asset. It doesn't just go poof overnight like stocks. Real estate provides shelter, generates income, and is less volatile in general than stocks. So, you invest all your money outside of banking into residential real estate for retirement.

Bonds, simply a little too boring. Real estate is like bonds plus, right? Higher upside and similar amount of downside. Not the same, but similar. When the economy is going down, rates are going down, demand for real estate tends to get betrayed because affordability increases. Now, historically, real estate has returned about 4% on average, 2% above the long-term inflation rate.

When inflation is up, real estate returns tend to go higher as well, as we saw in 2020, 2021. Now, interestingly, I have looked around the internet, research papers, and some publications such as the San Francisco Fed suggest that real estate has historically returned 7% annually since 1850s. So, real estate is local, but overall, let's say 4% annual rate of return for the country.

To figure out how much real estate you need in order to make work optional, you do the same formula. You take the inverse of the historical rate of return and multiply it by your gross annual income. So, in this case, the inverse of 4% is 25, and you multiply 25 by 200,000, your gross annual income, to get $5,000,000.

Now you must do your best to live off of $200,000 or less as your income grows and save and invest as much as possible on any income above $200,000. $5,000,000 in real estate sounds like a lot, and it is a lot. But in our system today, people with good credit and stable income are able to acquire real estate using a 20% down payment.

So, you really only need $1,000,000 to buy $5,000,000 worth of real estate over time. I'm not talking immediately, I'm talking about over time where you're building your residential real estate portfolio. Now, $1,000,000 down payment is $1,000,000 less or 50% less than you would need if you preferred to have 100% of your portfolio in the S&P 500.

Because if you were making $200,000 and you preferred 100% in stocks, you would take the inverse of 10%, which is the historical rate of return for stocks, and you'd get 10, and 10 times 200,000 is $2,000,000. So, with real estate, you only need $1,000,000 in down payment to command $5,000,000 in value.

Now, of course, if you own residential real estate and are a landlord, you're going to have to spend time and money managing your properties and tenants. Additionally, with significant debt, your real estate equity could fluctuate much more dramatically. But the thing is, you're 26 years old, so in your 20s and 30s, you have a lot more energy and time and desire to make more money, so you are comfortable managing people and trying to gain sweat equity by remodeling and expanding your property.

The key is to own rental properties that generate strong cash flow, which you can live off of. And fortunately, as we read in a previous post, rental property income yields are higher than stock dividend yields in general. And also, the power of rental property income is greater because to generate that rental property income doesn't require the same amount of degradation in the asset as stocks.

When you're paying a dividend from the company's balance sheet, let's say it's a $100 dividend, your balance sheet, the cash balance goes down by exactly $100 as well. It's not free money dividends. But when your rental property generates $100 in income, it's not like $100 worth of damage and property taxes and so forth occurs.

I hope these three examples help elucidate how you can use my investment minimum threshold to make work optional. The key here is to actually make a change, to have a courage to change your life for the better. I know quitting the money is hard, it can be scary, but if you've reached that investment threshold and you're not happy with your life, you have to make that change because when you get older and look back on your life, you're going to feel regret.

And as I've learned and experienced over time, regret really starts eating you up inside and it actually grows. But the good thing about this uncomfortable feeling of regret is that it propels you to make a change right now and propels you to think more analytically and take more risks so you don't have as many future regrets.

I want to make it clear that my investment threshold formula represents the minimum amount you need before feeling comfortable transitioning out of your current job. It's the practical and responsible minimum amount you need to change your life. Obviously, you can change your life much sooner than before you hit the minimum investment threshold, but it's a little bit more risky.

Also, once you achieve this minimum investment threshold, it's unlikely you're going to be able to or feel confident enough to retire early. And that's not the point of this threshold. This threshold is to help you figure out when is that time where you can start taking it down a notch, but not fully take it down a notch.

After all, if there's a 70+% chance of your investments making money any given year, there's a 30% chance of your investments losing money in any given year. Therefore, you're likely to aim to accumulate more investments or continue working even after reaching this investment threshold. It's very logical and I've gone through this experience since 2012.

So let's say you expect a bear market to happen and your investments to decline by 30% one year. Well, to give yourself a buffer, aim to achieve 142% of the minimum investment threshold amount that comes out from the calculation. That way, you have a 30% downside buffer. And let's say you think there's going to be back-to-back years of 30% declines, which is extremely rare, then mathematically speaking, you just need to accumulate 204% of the minimum investment threshold and then you're protected.

Pretty cool how there's a simple mathematical calculation for anything. The hard part, the trick is figuring out how much is enough that corresponds with your risk tolerance, your hopes, your dreams, and your goals. I really want everyone to take action once you achieve this investment threshold. Not only calculate it, but be methodical and then take action to change your life for the better once this threshold is reached.

This means not wasting another minute at a job you dislike, hopefully you negotiate a severance package. This means leaving a terrible relationship behind because you're no longer financially dependent on someone, but you're independent and you can do whatever you want. Changing your life for the better also means doing the things you've always been afraid to do because money has held you back.

Finally, I suggest everyone stay dynamic. Stay on their toes and calculate this formula every single year. And just do a gut check to see where you are progressing, how far you have to go, what's the latest income figure you have, and whether this is enough to make you happy and live the life that you want.

Because life is always changing, always. On your financial journey, you're undoubtedly going to experience fear and doubt as economic and personal circumstances evolve. The key is to remain flexible with your financial goals and adapt to the changing conditions. For example, when my wife left her corporate job at age 35 in 2015, I thought we'd be very happy, very comfortable living on $10,000 a month, right?

Sounds pretty good in less expensive Honolulu, Hawaii. Based on my conservative investment return target of 2-3 times the 10-year treasury bond yield, retiring early with $3-4 million invested seemed like enough. But the problem is this was a static number and it was just a number. I hadn't lived this.

I was just imagining this. Then in 2017, our son was born, followed by our daughter in December 2019. And then a year later, the pandemic hit, prompting the government to inject trillions of dollars into the economy, which fueled inflation for two years. It's kind of unpredictable, scary times. So relatively quickly, the $120,000 was no longer enough to raise two kids in San Francisco.

It's funny because to qualify for affordable housing in San Francisco, you have to make around $120,000 or less. So now, in order to live the lifestyle that we want, which I think is a relatively middle-class lifestyle, a house, a car, 2-3 weeks of vacation a year, requires about $300,000 to $350,000 a year in annual household income.

And I know some of you folks living in lower cost areas of the country or the world will think that's ridiculous, but those are the numbers. And so using a 5% rate of return on our investments, that means needing at least $7 million invested where work becomes optional. And even if work isn't optional for some reason, for those of you just wondering when, how much money will I have where I will finally feel settled and comfortable and financially free?

Well, based on this example and calculation, that number is $7 million. Now it's not all going to be the same for everyone, but using my investment threshold formula gives you an idea of when you can feel that mental reprieve where you don't have to grind forever, for so long and so hard anymore.

So there you have it folks. I hope you use my investment threshold formula to your advantage. Back in 2009 and 2010, I didn't have this formula, this clear guide to help me shoot for what to save and invest in and how much. And so now we do. And I've gone through the past 12 years without full-time employment and therefore I really believe this investment threshold formula will help you achieve the life that you want in a responsible manner.

Thanks so much everyone. If you enjoyed this podcast, I'd love a share and a positive review. It keeps me going. And also please share this idea, this concept of the investment threshold formula to as many people as possible and run your own numbers. I haven't seen this type of formula anywhere, but it's clear and it's actionable and it's something that I love to come up with to help you achieve financial freedom sooner rather than later.

If you'd like to keep in touch, please subscribe to my free weekly Financial Samurai newsletter at FinancialSamurai.com/news. (gunshot)