As you start to make more and more money, something typically happens… You spend a grip more. Practically everyone will make mistakes once they start to feel rich (including every single one of us as well!). It typically doesn’t feel like you’re increasing your lifestyle by a large margin until you look at the year-over-year change in net worth and are unpleasantly surprised!
Not Financially Independent
If someone is not financially independent: negative lifestyle inflation is when your savings rate declines. Without financial independence, every single year needs to see an increase in your overall savings rate. You’ll establish a lifestyle that you enjoy and once that is set you’re going to throw every single cent into new businesses, investments and basic savings as well.
The Most Important – Generate More Income Every Year: This is and always will be the focus of the blog. While many continue to say that “you’re still saving XX% so its all about cutting costs!!!” they don’t understand that a high income is *needed* to generate a savings rate in excess of 50% or so. Trying to save 50% of income on a $50K pre-tax salary is absolutely not going to work. Your standard of living would be so low that your retirement would not be very fun at all! Can you imagine retiring in 17-20 years and living off of $20-25K a year? We can’t either. Step one is always going to be “generate more income each year” this will help you avoid negative life style inflation.
Every Single Pay Raise is Reinvested: If you’re not independent, then you’re still in hell. Knowing you are relying on someone else to help pay your bills is not a comfortable place to be psychologically. Again, you’re in hell. This means every single pay-raise must increase your savings rate. If you’re stuck in a position where you have an “ok” salary and a “mediocre bonus” you have to first work on moving into high paying careers and second save every cent you can in the meantime (potential to leverage into business/investment opportunity). If your investing rate is below 50% in your 20s, something is going terribly wrong. You have to put away 50%+ as soon as possible if you want to invest in a new business, get into real estate or otherwise.
90 Day Psychology: Any time you get a new windfall (bonus check hits, you have a great month of sales or another one time windfall), then you’re going to put that money into a 3 month CD. This is boring. The reason why you’re doing this is to allow your dopamine levels to settle at its normal baseline (you’ll have a temporary spike after receiving the windfall). We’ve found that 90 days is enough time to allow your body to reset (get used to the money). If you spend a single cent of the windfall within the first 90 days it usually leads to “buyers remorse” which is just another way of saying regretful purchases. We’ve deployed this tactic many times and continue to do so despite being financially independent (no one likes regretting purchases).
3 Months of Cash Flow: The second rule of thumb is to invest 100% of new cash flow for the first 3 months. This is specific to online properties. If you have a passive business that is generating $1,000-2,000 a month, then you’re not going to spend a cent of the first $6,000. Go back to point 2 and remember to throw it into CDs. This forces you to have a savings rate of 3/12 or 25% at minimum for year 1. It’s hard to predict variable revenue like an online property, so in a worst case scenario it goes to zero and you made a few bucks off of it. For people who are not yet financially independent, trying to operate at a loss for long periods of time just doesn’t work unless you’re planning on building a major technology company that operates at a loss (if so you’re probably not reading a finance focused blog!).
Avoid Brand Name Items: If you’re 25 and walking around with a Patek watch or $800 loafers, you’re only hurting yourself. There is no reason to try and impress anyone if you haven’t made it to financial independence yet. Think about the cost of a single luxury item and you’ll see that the return profile doesn’t work for a 20-something year old. Most will view a 20-year old with money as a trust fund baby who never had to work for anything in his life (don’t be that guy). Instead, keep all of your items as basic as possible, only buy more expensive material items if the return is higher than the additional cost (quality shoes without the brand name are good examples of this). Buying a Patek Watch when your iPhone tells the time perfectly well is beyond crazy. You can buy those items when you don’t need the money.
Spend to Free Up Time for Work: This is a critical part of success. You can absolutely spend for services (laundry, apartment cleaning, food delivery, etc.) if and only if you’re going to use the free time to generate more income. If you don’t have time to do laundry and it’ll cost you $50-100… But… You’re going to spend that hour or so generating more than $100, make the trade all day! If you’re idea was to spend $100 in order to free up time for catching the latest football game, you just don’t want it badly enough. Now we’ll give another basic hint. Re-read the underlined portion of the sentence. This doesn’t mean you *have* to earn $100 in that specific hour! If you spend an hour to improve a business that will lead to $1,000 once the change is made (over the course of a year) it is clear you should make that trade!
Completely Financially Independent
The second group of people are the financially independent. Our definition of independent is a bit more difficult, you must be *rich*. This means your passive income will allow you to live a life you enjoy into perpetuity. If this is the case then the outline changes a lot. In fact you can ignore our entire outline if you’re not eating into the principal but we’ll go ahead and give our view anyway.
Continue to Do Something: Anyone who paid the life toll required to take the fast lane to financial independence is a hard working individual. If you started from *zero* and somehow made it to financial independence in your 30s (or earlier!) you’ve done an absolutely incredible job. The problem? You’ll be bored quite easily. As we stated you’re only rich if you’re happy with your life and we can all but guarantee you won’t enjoy living in Thailand collecting checks and spending them on beer. Watching the numbers go up in your bank account, trading account or other accounts is a fun dopamine rush.
Increase the Distance Adjusted for Inflation: Lets say you have $10K a month in monthly recurring passive income (your number needed may be higher or lower, this is simply an example). Then your goal is to create a spread between your ideal income adjusted for the rate of inflation every single year. 1) Calculate the inflation rate, 2) multiply it by at least 2x and 3) increase your monthly passive income needs by that much. Using the same example, if inflation is at 2.5%: it would be $10K x (1 + (2.5%*2) = $10.500.
An extra $500 a month is certainly not much *if* you were able to get to the $10K number in the first place. In addition, your goal is to actually increase the distance so you want to have $10,500+ in recurring passive income when the year is all said and done. This makes it impossible to lose your livelihood due to “inflation” as you’re doubling the level and beating it every single year. We use this as the minimum framework so you’re always improving in terms of cash flow.
Find a New Source of Cash Flow: Lets say you’re a real estate expert and made your riches through that route. It makes sense to develop a few other ways to earn passive/semi-passive income. Make no mistake, you’ll have a bread and butter skill-set driving your net worth, the goal is to simply learn a new form with a few hours a week invested into the activity. This will help diversify skill sets and add some entertainment as well (boredom is a common issue when it comes to work when you don’t need the money).
Spend More Time on Your Health/Hobbies: After paying your dues, it’s probably best to spend more time on your health. This can be in many forms: meditation, sleep, hours of exercise, flexibility, etc. You can also start checking off items on your “life to do list”. We don’t like bucket lists, but it serves as a good example. No reason to miss out on things you always wanted to do because we’ll never get our time back and health issues can rise out of nowhere. The extra money you’re making (you’ll never “retire” since you’ll have too much energy) can fund your to do list with no worries.
Avoid New Recurring Costs: This only applies to year one when you’re seeing if you can live off of your passive income. Try to avoid adding new recurring cost items (we don’t use Netflix but something like that won’t move the needle). Recurring costs would include a new major debt payment, a new luxury car or a life style upgrade that rips out 10%+ of your monthly income. If you can avoid the new costs you’ll be able to answer the passive income question pretty easily.
Not Financially Independent
– If you’re not financially independent your savings rate (percent of net income made) must go up every year
– You will focus the vast majority of energy on creating more income
– Only spend money that saves time *if* you’ll expend that saved time on generating more income (not to go get wasted in the club with no one you’d spend your free time with)
– If you get a new windfall, spend none of it for 90 days
– If you create a new income stream you save every cent for the first 3 months (not enough experience to know if it will last)
– No point in going from 70 hours a week of effort to 0. You’ll get bored so find a way to work less but still be actively earning a income
– Passive income needs to outgrow inflation
– Find new sources of cash flow outside of the primary skill-set to avoid a repetitive life
– Spend significantly more time on health and even traveling since we don’t get our time back
– In year 1, avoid recurring costs since it’ll make the math difficult to calculate