Suppose you make \$30,000 after tax and suppose you spend \$6,000 after tax. Also, suppose your expenses increase by 3% per year, as does your income, and that your savings grow by 6% per year. Then,

• After 1 year: You have \$24000, your expenses increased to \$6,180, and your income increased to \$30,900. Next year, you will get \$1,440 in investment income.
• After 2 years: You have \$50,160, your expenses increased to \$6,365, and your income increased to \$31,827. Next year, you will get \$3,009 in investment income.
• After 3 years: You have \$78,631, your expenses increased to \$6,556, and your income increased to \$32,781. Next year, you will get \$4,717 in investment income.
• After 4 years: You have \$109,574, your expenses increased to \$6,753, and your income increased to \$33,765. Next year, you will get \$6,574 in investment income.
• After 5 years: You have \$143,161, your expenses increased to \$6,955, and your income increased to \$34,778. Next year, you will get \$8,589 in investment income. Also, you’re wealthier than the median person now.

This is how your finances could look like if you saved 80% of your income. After 5 years of working, you will pass the crossover point. Note that this does not account for having to beat inflation on the principal. If wage income stops after 5 years, the portfolio would last “only” 38 years. It only takes about a year of extra work to add many years to that number. I also suspect it would be unlikely for anyone to earn absolutely nothing over the next 38 years.

Let’s assume instead you think you need \$12,000 instead of \$6,000. It is however more likely that you still only need \$6,000, but that you want to spend \$6,000 more to “live a little”. Then it would take 10 years to reach the crossover point.

“Living a little” costs you 5 years of work where you could have “lived a lot”.

Of course on the \$6000 per year of needs sans wants in the first example, you are pretty much prevented from spending \$6,000 to “live a little” for the rest of your life compared to “living a lot” within a decade. Maybe 5 years of extra effort is worth it?

It’s that old decision between dollars and heartbeats. You only have a finite amount of heartbeats. Maybe they’re better spent working, maybe they’re not.

There are many ways to have fun without spending \$6,000 a year. The challenge here is more one of competence and the willingness or ability to get out of the consumer mindset. Getting out of the consumer mindset is also key to reducing expenses in the “needs” department. Lacking competence or willingness it’s easy to just add a few more years of work to the equation. Some even add 30 years or more, but in a productive and affluent country, anyone can choose the number of years they want to work.

Originally posted 2010-09-30 12:22:22.