Today, I have a treat for you …
… it will save you from going broke when you are on the cusp of success, so print this off and keep it somewhere safe!
It came about because of a great question from somebody who is (or should be) gearing up to move from Making Money 201 (increasing your income) to Making Money 301 (maintaining your wealth) …
… it comes from Donovan who asked this question by way of a comment on this post – appropriately about the ‘myth of income’:
My questions is, if my income is roughly $1,000,000 to $2,000,000 a year and I have no debt other than two small car loans. How much house can I afford?
I told Donovan “super-high-income can be a curse – not the blessing that the rest of the world imagines it to be”.
Now, tell me in your heart of hearts – if you are not already on a super-high income ($500k++) can you imagine what the problem/s might be?
Sure you can: too many girl/boy friends; too many cars and houses; cirrhosis of the liver 😉
On the serious side, these ‘excesses’ point to the real issue: living beyond our means is an even bigger problem for those on super-high-incomes than for those on ordinary incomes … really.
Here’s why …
You may be saving $200,000 (pre-tax) of your, say, $1,000,000 gross annual income … that’s 20% – a respectable percentage and huge dollar amount in anybody’s language.
But, that’s not the problem … it’s the $400k that you spend (after you pay Uncle Sam his ‘dues’) that is …
… the problem is this:
How ‘well off’ will you be when the income stops as it surely will (one day)?
If you don’t believe that this could be a problem: recall MC Hammer.
If not MC (who went from multi-millionaire to broke), then how about Elton John (nearly … he recovered financially) and many other sports stars who fell out of contract (or retired) or celebrities who time/circumstance took from A-List to C-List to …
Or how about the 4 out of 5 major lottery winners who are financially worse off 5 years after winning the lottery?
Here is the problem in a nutshell: living off your ENTIRE current income when it is likely (or even just possible) that it may not continue for ever.
If you are lucky enough to dramatically increase your income (and, if you follow my Making Money 201 strategies, you surely will), here is how you need to start thinking:
Income of any amount – and the more your earn, the more appropriate is what I am about to tell you – is the ‘fuel’ that builds your Investment Net Worth …
… your Investment Net Worth is like a (one day huge … if you follow the 7million7year strategy) battery that you are trickle-charging or fast-charging with your income.
The amount available to charge your battery is purely based upon what you DON’T spend from that income today.
For example, when I was earning $1,000,000+ from my businesses, I still took home a miserly $50,000 a year (plus cars, business trips, and other legal ‘perks’) and diverted the balance to ‘fast-charging’ my ‘battery’.
My battery consisted mainly of income-producing real-estate investments (plus some stocks).
What you can happily spend should tend towards what your battery can generate when it is unplugged from the mains (i.e. your income) …
That way, when your income stops, your battery can kick in like an Uninterruptible Money Supply, and you never need to take a decrease in your standard of living (a very difficult and humbling experience that I urge you to avoid).
I like the battery analogy, but I prefer a ‘perpetual motion’ battery which cannot exist in physics; but, here’s how it can work financially:
– You build up the charge in your battery as fast as your Income LESS Spending can make it happen. Can you see how you have two levers here: 1. Increase your Income, and 2. Spend less … also, a third lever 3. Increase your battery’s efficiency (i.e. increase your investment returns?
– Once your battery is fully charged (this is entirely up to what YOU consider to be ‘fully charged’) you can cut over to battery power … hopefully, this comes at a time and with an amount that suits you … if so, congratulations, you are retired!
– Just remember, that when you are on battery power, you have two forces that are serving to drain the battery (your retirement living expenses, and inflation) and only one force serving to keep it topped up (investment returns), so you need a MUCH LARGER BATTERY than you may, at first think.
So, when figuring how much of your $1,000,000 – $2,000,000 yearly income to spend, Donovan, think about this:
– Do you ever want to spend LESS in your life than you do now? You are a fool or a saint if you think you can.
– Multiply the amount that you WANT to spend per year NOW by 20 (or 40 if you are as conservative as me), and that is how much you must have in your battery if you were to retire TODAY on your current income.
– Double your battery size for every 20 years between NOW and when you DO want to retire (to allow for the trickle drain of just 4% inflation).
This simple three step process answers a very important question for our Super-High-Income (indeed, ANY income friends) …
… if the battery is too large for you to every conceive getting, simply lower your current spending wants until you come up with a number (and, a timeframe) that does seem to work. The good news is that as you lower your current spending, you can divert more to charging your battery!
How has this worked out for me?
Very well indeed, but you might be surprised to hear that I COULD live off much more than I do, but I also like the concept of keeping some of my battery power in reserve against unforeseen circumstances …
… after all, if you were relying on just battery ‘power’ for the rest of your life, wouldn’t you want to at least keep some in reserve? 🙂
Adrian, finally an analogy that really works for me! I totally relate to the battery concept, particularly as to wanting to have a “reserve” in case the size battery I thought I would need to keep my “puter” running turned out to be inadequate. It also helps with visualizing that batteries – which tend to have shelf lives – can also run down (lose value, thereby lose spending power from the juice we take from it), so that we need to ensure that it is either very safe, or as you put it, backed up with reserves.
The list of three also helps simplify how to deal with where I am today in expenditures and income versus where I want to be when I am running on battery (and hopefully not (running on) ’empty’).
@ Di – Never deplete a finite resource. It’s like being ‘green’ with your money … and there are so many puns in there, I can hardly keep track of them all 🙂
Very true – if you want to live off investments you need to either earn way more than you spend, work for a long time to gradually build up investments that replace your income, or win the lottery literally or figuratively. And I don’t like working for a long time or uncertainty 🙂
@ Richard – How many Powerball tickets are you buying then? 🙂