According to a recent article, Warren Buffet believes doubling someone’s net worth won’t make them happier. We of course disagree. That said there are two sides of the spectrum, doubling someone from $10 for example to $20, doesn’t do much. Similarly, doubling someone who has $1 billion dollars or more (like Buffet) is not going to change their day to day life either. Somewhere there is a line in the sand and we’ll go ahead and outline our own mathematical way to come up with optimal amounts of money. Remember, the vast majority of rich people are extreme risk averse and boring. They don’t believe in touching principal so our numbers are likely on the aggressive side if you were to poll a large number of well off people.
Age Matters: While everyone learns the “discounted cash flow” analysis in college, we’d say the value of money declines at a *faster* rate as you get older. This means a dollar at 80 years old is probably worth 1 cent compared to a thirty year old. This is less about compound interest and more about visiting a hospital and seeing what life is like when we’re old. If you’re in amazing shape we’d say the “good years” are from age 20 to about 75. Very big range. And. The point remains. Would you rather be 20 years old and have $500K or 80 years old and have $5 billion? The answer is clear, $500K since your time is limited. (yes we’ll keep it simple and assume an expected life span of 85 years old).
Since this is a net-worth post we’ll put the numbers up: Age 30: $2million, Age 35: $4-5M Age 40: $10+ million. If you’re able to hit any of these numbers the incremental net-worth isn’t really going to change much. Maybe some of you already own private jets and think these numbers are small (great!) that said, the life style is very difficult to change if you get into double digit territory at age 40.
With the numbers out of the way, the question is “why is it much lower”… the answer is you’re going to work. It is not fun waking up every single day with nothing to do. Take a trip back in the time chamber and remember “summer vacations”. Unless you were born rich, summer vacations were pretty boring since you had nothing to do. While you can solve some of this boredom with classic hedonism, the challenge of producing is exciting in a different way. Some people actually love working all day (bless their souls) and end up ultra-rich.
Mathematical Explanation of the Numbers: The reason why money is one of the rigged games in life is due to momentum. When people see $2 million or $4-5 million, they assume there is no cash flow. This is practically impossible! Unless someone stops entirely, they are going to generate multiple six figures while maintaining their net worth. Why? Well the only way to get to a few million that quickly is by generating a large amount of money. When you think about it that way, you’ll see the snowball effect take place. We’ll use basic numbers of 5% on investment returns and unless you develop a terrible addiction to drugs/alcohol/materialism… it’s difficult to fail.
At age 30, if you made it to $2 million, it means that you’ve saved an average of $160K per year (roughly). For fun if you want to check this math, plug in $160K in savings per year multiplied by 5% investment return. You get to about $2 million if we assume you start at age 21. This is not easy and is a fantastic achievement.
Here is where the math gets out of control. If you were able to get to $2 million, it means you were investing $160K per year (see above). This *includes* all of your expenses. The only way to invest $160K a year is if you have covered all of your expenses first. Getting to $4-5 million does not seem unreasonable at all anymore. If your income does *not* go up for the next decade (unlikely) you’re going to sit on $3.45 million on the same numbers. If you continue to save $160K with 5 percent returns… that’s what you get. Despite age 30-40 being years where income typically goes up.
Money and Fun: Let the controversy begin! What exactly will you do with your extra money? If you’ve already gone through a partying phase and bought a few nice things for yourself… there isn’t much left to do. Sure you can go ahead and buy the super car or a net jets account… that said… is there a lot of incremental gain here? The marginal benefit isn’t that high and many of these higher end purchases have recurring costs (the worst type of cost and best type of business to run!). We’d take the reverse approach (no surprise) and spend on things that free up time. This would be services as we have mentioned in the past: 1) clothing, 2) cleaning, 3) massage/physical help, 4) blood work/private doctor and 5) food. If you can have someone else do the tasks you would be forced to do, what you have done is freed up more time. With this free time you can make up the cost of the services (if you still enjoy working) or you can use the free time for fun.
What is fun for *you*? We phrased this very carefully. The implied message in the question is *fun* without the approval of others. Fun means something that you enjoy doing that doesn’t require some sort of ego stroke. If it’s fun for you regardless of what other people think, then you’ve moved into the right direction. If you can strip down the items to things you actually enjoy (attention shouldn’t be on the list) then you’ll find a normal spend rate. We’ll be shocked if someone actually enjoys flying around all the time on a jet (note to younger readers: people who glorify frequent travelling are usually poor because traveling is awful after a period of time). Similarly, people who have to travel all the time generally have high incomes, people don’t travel on business to lose money!
With that backdrop take a look at the items you can do with money that would be fun: 1) partying, 2) sports/athletics, 3) arts/crafts, 4) music, 5) outdoor activities ranging from hiking to gardening, 6) extreme sports – skydiving etc. and 7) learning a new trade such as pilots license. We are sure we have missed a few (writing – a hobby you see here) but most of these do not require large amounts of money! The big cash outflows go to the same standard items: housing, taxes and food. Since the last one is limited and the first one should be minimal (paid off home/apartment), it is quite difficult to spend up from here.
As you can see we’ve gone full circle now. If you’re able to get to a few million dollars (excluding value of primary residence) there are practically no costs. Keeping it simple, with $10K net profit a month with zero rental/mortgage expenses… it is quite difficult to burn the money even if you quit working entirely (you won’t).
Breaking Down a Month: This number sounds small if you’re living in NYC, that said you can always move. For fun, we’ll run the numbers assuming a $10K spend and it is still quite difficult to call this a “bad life”. In order to go through $10,000 you can do the math as follows: 1) $1,000 tax/HOA cost, 2) $1,500 on health/fitness/services, 3) $3,000 a month on food ($100 a day assuming you’re not going to eat out constantly – terribly unhealthy), 4) $500 on utilities and 5) Fun/other up to $4,000 a month! It is quite difficult to call $10,000 a month in spending with no real mortgage/rent payment a “tough life”. Remember, this is a level of spending that assumes you don’t even work because 5% on $2.4 million is… $10K a month.
Spending to Zero: Another fun part of this game is considering “going negative”. While it is certainly smarter to never touch the principal (just keep a basic income stream going), if you’re forced to go negative you’ll see an even longer “tail”. As a basic example, if it is impossible for you to work past age 35 for an unforeseen reason… $4-5M is still going to push you through age 80 or so. You could spend between $89K and $111K a year… for forty five years assuming zero percent returns!
This is an interesting set up because we know that it is highly unlikely for anyone to stop working prior to age 50 or so (you’ll be bored stiff). This gives you 15 years of active income + a guaranteed 45 years of income if you really decided to call it quits. We know about the simulations that suggest the 4% rule breaks down (yes there is a chance of 50% correction) that said it assumes you are actually forced to sell which is just not likely if you’ve made your money early.
The last important item in terms of spending to zero is the time frame. Going back to the top, since we know that you can go to zero percent return and live for 45 years… it means there is no reason to save after age 45. That is right, saving money makes less and less sense from a utility maximization framework. Even if you decided to have kids, you don’t want them to grow up without a work ethic. Handing over a boatload of money to someone who never worked for it rarely ends up working out.
Figuring Out Your Own Number: While we’ve given a framework you can go ahead and come up with your own estimates as well. Some of you want to become billionaires (fantastic!) and some of you want more/less (the classic $10M number seems to be constant amongst the ambitious). Here is how you can figure out your number.
You’ll need two figures: 1) the amount of money you want to spend per year in terms of dollars today and 2) the year in which you’ll actually stop working. We’ll go ahead and guess and say you’ll call it quits at age 45 but you can plug in any number you like. We’ll assume a life expectancy of 90 years of age.
Basic Formula: (Life Expectancy – Age You Quit) * (Money Needed Per Year)
That is all there is to it. Going beyond this number is quite literally off the curve. If you ever reach a point where you can live off principal to death (money would be in TIPS – items that track inflation and other risk free assets), then you’re done. As you can see from the beginning this happens a lot sooner since we heavily doubt anyone gets to a few million dollars without having a high income (doesn’t make sense!)
Now for the fun part, we’ll open the comments below to questions and answers related to how much money is needed to call it quits. We’re interested in hearing your formulas and ways you think about life. Many of you will unlikely quit working making this post moot as well.