Why do we work?

We work to pay the bills. Or at least that is the philosophy of many Americans. That philosophy seems to be about monthly payments, endlessly refinancing 30 year mortgages without ever paying it off, car loans, etc. So many people don’t realize that they don’t have to spend all of the money that they earn or that they don’t have to wait until age 60 or 65 or whatever the retirement age is today to stop working because no one taught them to save.

I alternate a lot between “savings is more fun than spending money” and the issues of lifestyle inflation. I have spent a lot of money this year for a single person – it will probably be close to $50,000 by the end of the year. On the other hand, I estimate that I will have saved about $65,000 this year.

Some days, it feels like it’s not a race to financial independence. Other days, I dislike getting up and going to work enough that I don’t want to keep doing this. Other days, I just like seeing my mortgage balance go down and my savings and investments balances go up.

My spending plan right now is around $3,800 per month. If I cut out most of the wants, that could go down to $2,600 including the mortgage! So…there’s definitely a fair amount of lifestyle inflation in here, to the tune of $1,200 per month. Taking that extra $1,200 out of my budget each month would shave 6 months off the mortgage, bringing it down to just under 3.5 years.

I think I’ve done a somewhat reasonable job of enjoying today (expenses) versus preparing for the future (savings). I max out my tax-advantaged accounts, plan to pay off my mortgage within 5 years, and hope to be financially independent within another 5 years after that.

Why do I work? Most days, I like my work for the intellectual stimulation. I would say that I enjoy the socialization, but then I realize that it’s forced socialization with people that I don’t necessarily like or get along with well and this crazy corporate feel. I could probably find good intellectual stimulation by reading good novels, by playing with spreadsheets, and working on personal coding projects. Sure, with personal coding projects, you can’t get as much done as quickly, but you have the freedom to work the hours that you choose.

Some days, I look at the higher level management and wonder if they need the money or if they are just at work for fun. I wonder how they’ve made the trade-offs between time and money and what they do with the, I’m assuming, even larger amounts of money than what I make each year. Do these people enjoy the politics of the office work environment? It’s certainly not for everyone. I’m not sure if it’s for me long-term. Personally, I’m not someone who needs a TON of socialization – work is definitely way too much socialization for me.

Readers, why do you work? How do you strike the balance between now and the future?

Would I take a job I hated for double my salary? Triple?

My net worth estimation as of July 31st is as follows:

  • Checking accounts: $8,400
  • Savings: $26,100
  • Taxable investments: $10,400
  • Tax-advantaged investments: $52,200
  • Condo equity: $86,700
  • Total: $183,800

A friend threw out the question “Would you take a job you hated for a few years if the base salary was $200,000? What if it was $300,000?” These numbers seem super unrealistic to me (or maybe I just underestimate how much companies will pay), but I thought it was an interesting exercise.

So, I made a spreadsheet! I took into account the increased taxes, hitting the social security tax earlier, and still maxing out my 401(k). For the sake of this exercise, I used 2012 income tax rates since I don’t have any future tax tables available.

$200,000 base salary: Throwing everything at the mortgage, it would be paid off by May 2015. After that, building up my taxable investment account such that 4% of the value would provide me with $30,000 per year would take until December 2021.

$300,000 base salary: Throwing everything at the mortgage, it would be paid off by April 2014. My taxable investment account would be sufficiently large in December 2018.

Estimation with my current salary including bonuses: Mortgage would be paid off by June 2017. Taxable investment account would be sufficiently large by 2025.

Would being financially independent, not needing a salary anymore, 4-7 years earlier than at my current income level, be worth giving up the reasonable work/life balance that I have now? I’m not sure that it is, considering how young I would still be in 2025.

Maybe it would be worth it to do that now, put in a few years at that level of commitment. But honestly? That’s what I did in college. I took a heavy course load, working 70 hours/week on school for 4 years. I’m not sure that I have that level of commitment in me anymore. I know that I burn out quickly and need time to re-group before I can go back at it again.

So I feel like now is the time to take a slight step back (only slight really since dating happens mostly outside of normal work hours) in my career and put more of an effort on dating. Since graduating from college, I haven’t made a huge effort towards dating or finding a relationship. I feel like my social life has dwindled mostly down to my coworkers and I’ve been going on pairs of dates endlessly. I’ve finally gone on more than two dates with the same person and I’m dating someone :) That’s why I’ve been a bit less active around the blog and commenting elsewhere.

Levels of Financial Freedom

“Financial independence” in some ways is defined as when your passive income (i.e. income you receive outside of your day job) exceeds your expenses. But before you reach that point, there are other levels of financial freedom along the way.

The first level of financial freedom is when your income exceeds your expenses. You reach subsequent levels of financial freedom the wider the gap is between your income and your expenses.

For me, my most recent raise increased my internal level of financial freedom significantly. I was already comfortable with my monthly cash flow, but that last raise made me completely comfortable with my monthly cash flow. I now have about $2,000 in extra money per month after maxing out my 401(k) and taxes and my bonuses almost doubled from last year.

So long as I get a reasonable amount of enjoyment out of my job, this level of financial freedom is pretty sweet.

The next big level of financial freedom is when passive income meets expenses. That is quite a few more years away, but slowly over the next decade, my passive income will build up and I’m really enjoying watching it.

The third level of financial freedom, which I don’t want to ever reach, is when passive income / safe withdrawal of principal exceeds expenses by such a wide margin that one really never has to do any form of work ever again and could buy way fancier cars than I want.

Me? I love my job and my coworkers. Writing and designing code, mentoring junior engineers is fun. It’s a bonus that it comes with such a high income. I don’t need to spend it all and my expenses have stayed somewhat stable, so I’ve been banking more money each year. (This year, assuming I keep my job through the end of the year, I will gross almost $100,000 more than my expenses.) Eventually, my passive income could meet my expenses, but seeing as that’s a decade out, what I need to in the meantime is enjoy my life, not worry about money so much, and keep saving and enjoying my job.

P.S. I’m finally able to guess when guys are asking me out. This definitely results in more dates.

401(k) as post-59 1/2 money: How much do I need?

Mr. Money Mustache posted about how much money is TOO MUCH in your 401(k) last fall and I’ve spent a lot of time thinking about this.

I really like how he defines the money him and his wife put into their 401(k)s as the money that they will spend after age 59 1/2, so it’s really money that you don’t need for quite awhile. (I highly recommend that you read his article and then I’ll show you how to make a spreadsheet to calculate your numbers.) It took me some time to wrap my head around his math, so I made myself a spreadsheet.

My estimation of how much I need to live on, ignoring an estimated mortgage payment, is about $2,250 per month or $27,000 per year. If I assume that I can safely withdraw about 4% per year from my fund (I’m being a bit more conservative than his 5%), then I would need $675,000 in my 401(k) at age 60 to live for the rest of my life.

Next, I needed to figure out how much my 401(k) would be worth when I’m 60. So I made a spreadsheet (I <3 Excel) with the following columns:

  1. Age
  2. 401(k) balance
  3. Age 60 balance

I started Age at my current age and then incremented it up about 10 years to start.

On the first line of the 401(k) balance column, I inputted my current 401(k) balance. Then on the second line, I entered:

=B2*1.05+17000+BASE_SALARY*EMPLOYER_MATCH

where:

  • B2 is the cell containing the current balance
  • 1.05 represents an assumption that the balance will go up on average 5% per year after inflation
  • 17000 is the current maximum yearly employee contribution to a 401(k) plan
  • BASE_SALARY is my annual base salary before taxes, used to calculate the match amount (no, I’m not telling you exactly what my gross monthly pay is)
  • EMPLOYER_MATCH is the percentage of my base salary that my employer matches on my contributions

Then I dragged the B3 cell down to the last age value (B12).

And least but not last is the fun part! Now we add in the formulas for the “Age 60” column.

=B2*1.05^(60-A2)

where:

  • B2 is the cell containing the 401(k) balance at the age in A2
  • 1.05 represents an assumption that the balance will go up on average 5% per year after inflation

Based on these numbers, I estimate that it will take me about 4-6 more years to have “too much” money in my 401(k). That’s funny because I also estimate that it will take me about 4-6 years to pay off a mortgage after investing 20% of my gross income for retirement, including some of that going into my 401(k). Sounds to me that 4-6 years will be quite a magical time!

Readers, have you ever done this calculation? How far off do you think you are from having “too much” in your 401(k)?

Financial Independence: What I Would Do

A few weeks ago, I was at the gym and I realized that I have been spending my weekends running, playing multiple sports, going for happy hour with friends, reading, and writing code for fun.

You know what would be pretty cool? Being able to do that full-time. I could find some other sports! I could read and analyze books. I’m sure I could find smart people to talk to to keep my brain active.

That’s how I see financial independence. Being able to play sports 24/7. I’m pretty sure I’m the strangest software developer ever.

But what do I need to get there? I need passive income to the tune of about $2,000 per month or $24,000 per year without a mortgage. I’m clearly quite far from that point now if my passive income goal for 2012 is $1,000 TOTAL for the year.

I would love to be FI by the end of 2020, but I’m not sure how possible that is considering that I not only need to build a decent-sized investment portfolio, but I also need to buy a condo or a house in cash or with a large down payment and pay off the mortgage. My net worth current projection for mid-2020 is in the low $700,000 range so maybe it is possible? Who knows.

Readers, what would you do if you were financially independent?

The Real Golden Goal: Financial Independence

I may write down a goal like “I want to retire at age 50 with 2 million dollars in investments and a mortgage paid off”, but that isn’t the real golden goal. The real golden goal is financial independence.

On my post “How Blogging is Helping Me”, nicoleandmaggie left the following comment:

I’d go straight for financial independence. ;)  How much would you need saved for the dividends to equal your living expenses (or alternatively, your current paycheck)?

Even if you don’t meet that goal, it gains you a ton of freedom later when life gives you options you’d never dreamed of.

What does financial independence mean to me? Financial independence means not needing my job to be able to get by – being able to save 100% of the income from my day job and live off of the income from my savings and investments.

In 2011, I saved around 50% of my net salary each month and 100% of the net income from my bonuses, for a total of 61% of my overall net income (salary and bonuses). My housing expenses have gone up this year, so I’m projecting to only save 57% of my overall net income.

I think that yearly living expenses, rather than my current paycheck, is the right figure because of how much of my paycheck is currently being saved. My total monthly budget adds up to $3,600 right now, ignoring travel. If you deduct the mortgage payment from my condo budget, my monthly expenses would be $2,500. On a yearly basis, that translates to $43,200 with a mortgage payment or $30,000 without a mortgage payment and that $13,200 difference actually multiplies out quite a bit. I made a chart showing various rates of return and how much I would need to have in savings/investments to earn enough in dividends and interest to cover my yearly expenses:

There are several points missing here:

  1. The dividend income required ignores the income taxes I would pay on it.
  2. The calculations ignore inflation and assume that my expenses level will not go up.
  3. The monthly/yearly expenses don’t include the money I’m setting aside to replace my car or the money I set aside to spend on travel.
So these numbers are clearly somewhat off, but I think they are a good starting point. I can learn the following from the above numbers:
  1. The 0.5% to 1% return on my savings accounts aren’t going to get me anywhere near financial independence.
  2. Buying a condo or a house instead of continuing to rent means that when I eventually pay off the future mortgage, my housing expenses will drop by about $1,200 per month, but I would still have to pay property taxes and HOA dues.
  3. Since I can’t withdraw from my 401(k) easily, I should only count taxable investment account funds towards the amount I have invested for the purpose of living off of the yearly earnings.

I’m going to say that 6% is a fair rate of return to assume, which means that I need to have $500,000 in taxable investment account funds and a paid-off mortgage to be able to live off of the dividends yearly without needing my monthly salary or bonuses.

Wow, $500,000 is a large sum of money. That needs to be acquired without too much sacrifice and doing the following:

  1. Investing for my needs after age 59.5 using my 401(k) and Roth IRA
  2. Taking all of the vacation days my employer lets me take and enjoying them
  3. Buying a 2 bedroom condo and paying off the mortgage early
  4. Investing my extra funds in taxable investment accounts
  5. Keeping my car in good condition

I wonder how long it would take me to reach $500,000 in taxable investment accounts. My current forecast is about $10,000 by the end of 2013.

I earned about $10,000 net more in 2011 than I did in 2010 and I’m estimating a similar step in 2012. If that pattern continues, the amount that I can save will grow faster than the amount the IRS will let me save in my 401(k) and my Roth IRA, which means that each year, I will be able to invest more in taxable investment accounts than the previous year.

I’m going to set a goal of having $500,000 in taxable investment accounts by the end of 2020 and enough passive income generated to cover my expenses. That gives me 9 years to save and grow an average of $55,555.56 per year. That sounds a bit crazy at my current income and savings level, but I believe in it!

Readers, have you calculated your crossover point to financial independence? Is it a crazy far-off number like mine is, have you already reached it, or is it in your sights?