There are three methods of paying for stuff. Some work and pay as they go. Some borrow and pay interest. And other live off the interest. I will try to make this as simple as possible.

The three ways look like this

  • You can pay as you go. You save money and then you spend it. If you don’t have the money, you can’t afford it and if you can’t afford it, you don’t buy it. For example, if you save $1,200, you spend it on something that costs $1,200. This could be a recurring cost of $1,200 per year or $100 per month.
  • You borrow money to buy things you can’t afford because you haven’t saved the money. In return you pay interest. For example, you borrow $1,200 and in return you pay $36 in interest each year. This is how most people do it.
  • You save much more money. About 33.3 times as much or $40,000. Then you lend it out to 33.3 people in the example above and they pay you interest. Each pay $36, so in total they pay $1200. You use this to pay as you go.

Financial independence means not having to finance like the people in class 2 and it usually also implies not having to earn money by working, but lets not get hung up on words. This blog primarily talks about class 3 financing. My life is financed like this. (Note that DW’s life is financed like class 1. We do not buy anything on credit.)

Now, you can decide whether you spend $100 or $80 per month on entertainment. For class 3 financing, that would cost $40,000 and $32,000 respectively. Now, perhaps we can agree (I know this is the hard part) that for some the $80 version is as entertaining as the $100 version. Perhaps one is tennis and the other is soccer, what do I know. Saying that one is more entertaining than the other is kinda ridiculous though. Similar for food. Perhaps one involves a diet of red meat (which gives me a heartburn) and potatoes, and the other involves rice and dahl which I really like. Why would anyone pay more for something they don’t like?

Housing is more expensive and so a $500/month house would cost $200,000 to finance in class 3 where a $1500/month house would cost $600,000. Of course it is ridiculous to think that price tells the entire story. $600,000 around here (San Francisco bay area) buys you a wooden 1 story house with about 3 bedrooms, a bathroom, and a front lawn. $600,000 in the Midwest buys you a McMansion with 6 bedrooms, 4 bathrooms, 4 acres and lake front access. I submit it’s more fun to live in the bay area, so with more limited means, we only finance about $200,000 worth of living costs when calculated this way. This means living in an RV. On the other hand, $200,000 in the Midwest would buy substantially more—about what $1,000,000 buys around here.

More important though are more intangible effects. Suppose we go back to the food plan. Now, depending on where and how you buy it, you get different amounts of the very same food for $100. So, for example, just walking into the closest upscale supermarket and indiscriminately pulling food down from the shelves might cost $160,000 or $400/month, whereas shopping at stores like Aldi with few but good choices will only cost $40,000 or $100/month.

Now to some saving that extra $120,000 will be no problem but others may value not having to save that much in exchange for more careful shopping.

Pardon me while I digress … but it is not silly to work for years to accumulate a retirement fund allowing you to finally relax and do what you want to do. Of course it just may be that working all the time is exactly what you enjoy most of all, but it seems that this is not always the case even for people who enjoy their jobs. They want to take some time off to do other stuff, but they can’t because they must return to their jobs. Saving for decades is silly as it the idea of remaining in the work force for 5 more years because staying 5 more years will allow one to have a retirement which includes that much more spending, because … what if you get hit by a bus tomorrow?

There are a lot of stories about people who wanted to squeeze in just one extra bit of work to meet some retirement target. Then when they reach it, they think to themselves, well, if I worked just a little longer, I could buy this and this and that. If I retire now, my salary will never get this high again, so I should keep working. They set a new target. The same thing happens a couple of times and then the poor bastard dies of a heart attack, get Alzheimer’s or develop a chronic depression before retiring.

Thus, figure out the price of various things you could easily live with and work out a class 3 finance. Add all these together. This is your number. Once you hit your number, pull the trigger.

Now, if you want more stuff, do class 1 finance. Get a simple job and pay as you go. Unless your sole activity is reading books or watching TV, anything you do will be worth something to someone. Remember that even $100 will stretch pretty far when all your needs and most of your wants are met.

The main problem of course is that if you presently feel great with 1 bathroom but a few decades down the room, you suddenly feel you need 3 of them. Then you made a huge mistake and have to return to the workforce quite possibly at a lower income. Your only consolation then would be that you enjoyed a few decades of freedom.

Daily Yakezie: The Average Worker Financial Cycle @ Moneymonk, Proof You can Only Push High Income Individuals Around So Much! @ My Journey to Millions, & There’s An App For That: 35 Ways To Slash Your Household Budget @ MyMoneyMinute

Originally posted 2010-03-27 14:26:05.