What’s an eco-friendly standard of living?

Fellow blogger, Jonathan Ping, was kind enough to include a chart from one of my earlier posts in one of his recent posts, so I thought that I should repay the favor by including one of his charts, here:

I recommend that you read his original post, but the chart itself is pretty self-explanatory; it shows the problem in personal finance … and that’s:

As your income grows so do your expenses.

It’s called ‘lifestyle creep’ and is one of the key reasons why the actual wealth of high-income earners (as indicated by the grey shading between the green income line and the red expense line) is not necessarily that much higher than that of some medium- (or even low-) income earners.

The obvious solution, according to Joe and many other pf bloggers, is to reduce your spending:

Low Income


This way, you decrease the red expense line relative to the green income line …

… in the process, enlarging the grey-shaded area between the two lines i.e. allowing, at least in theory, even low-income earners to increase their wealth!

The problem with this strategy is that saving – especially, saving more (probably a lot more) than you do now – is really, really, really hard.

Austerity hurts. Austerity is against nature (well, my nature).

It gets worse: saving now so that you can spend later simply doesn’t work!

To make this type of cookie cutter personal finance plan actually work, you need to be debt-free and be able to live on just half your current annual income for your whole life.

In other words, you need to drop the red savings line to no more than half the green income line … not later, but now … and keep it there for the rest of your life.

Never fear, I have a better plan …

… it’s one that is far more natural, because it allows you to maintain your current standard of living, even increase it over time:

wealth graph

Let’s say that you start off as an average-income earner; here are your steps to success:

1. You can start to save a little, perhaps more than you have done in the past. Don’t worry, this austerity is temporary … after all, you already know how I feel about too much belt-tightening.

2. Once you have a little money beginning to pile up, you should find a way to put it to use to help you grow your income. Perhaps you could: start a part-time business; buy an ‘absentee-owner’ franchise; or open a car wash. You could work a little smarter and score that big (or little) promotion. Maybe you could collect a windfall: a tax refund; find a rich aunt who dies and decides not to leave all her money to her cat after all; or, you get really lucky and hit a small jackpot at Binions.

3. As your income grows, you should increase your spending by no more than 50% of your after-tax ‘pay rise’. The rest must go back into your little pile of money. Then you should concentrate on finding even more ways to put it to use to help you grow your income. Are you beginning to see a pattern here?

4. As your income grows at a (much) faster rate than your spending, you will slowly begin to see that you are actually already tending towards saving 50% of your income without even trying!

Keep it up for 15 to 20 years, and you’ll be able to sustain that savings rate all the way through – and beyond – retirement, as you build a big enough bucket of wealth (your net worth) as shown by the green-shaded area between your income and expense lines.

What’s more, this fully sustainable standard of living is always more than your current standard of living, so you never, ever need to tighten your best. The secret with this plan is that you simply don’t loosen your belt as fast as other high-income earners tend to do.

Obvious, really …

Now, that’s what I call eco-friendly finance 😉

[You can also read this post in the Carnival of Personal Finance:  http://wealthpilgrim.com/carnival-of-personal-finance-happy-days-are-here-again-edition ]

But, I’m not smart enough to be rich!

Firstly, let me warn you: this post will have absolutely no bearing on how wealthy you will become!

Now, do you need to be smart to become wealthy? Is “but, I’m not very smart” a valid excuse for not even trying?

It turns out that the answer to both questions is NO.

You see, your IQ (more correct: your cognitive ability – i.e. your ‘smarts’) has very little to do with how wealthy you will become …

… studies have shown that 97.5% of the factors that can explain wealth have nothing to do with how smart you are:

Zagorsky found a correlation of 0.30 between IQ and (recent annual) income, which is relatively low — roughly 9% of the variance in income can be accounted for by IQ, and the other 91% is due to ‘other factors’. On average, he found that each IQ point added about $200 to $600 in annual income. As for net worth, the correlation with IQ was even lower, at 0.16, meaning an explanatory power of about 2.5% (leaving 97.5% of the variance to be explained by non-IQ factors). In his words, “Since the statistical results are not distinguishable from zero, this suggests IQ test scores and net worth are not connected.” You can view a scatter plot of net worth vs. IQ here: http://www.flickr.com/photos/pke…


the non-relationship between financial worth and iq

from the journal intelligence

He also dives into about 30 other variables with interesting outcomes. For example, your net worth at age 28 has only a slight correlation of 0.13 with your net worth at 33-41. Self esteem has a correlation of 0.11 with net worth. Being US-born (as opposed to being an immigrant) has a correlation of negative 0.01 with net worth, while having siblings has a net worth correlation of -0.06; but don’t worry, those aren’t significantly different from zero either.

Ironically, you will need a reasonably high IQ just to understand what this is all telling you, so let me simply remind you of a story that I shared some time back:

I bumped into a friend of mine, who was voted “least likely to succeed” at high school. I was surprised to see him stepping out of a shiny, new, red Ferrari.

After we exchanged pleasantries, I congratulated him on his success, told him that I wrote about personal finance, and asked him how he made his money.

He said that he simply bought and sold stuff on a 3% margin, and that’s been enough to fund an amazing lifestyle and a huge real-estate portfolio to underpin his retirement.

Well, I was incredulous … only a 3% margin?! And, I told him so.

But, no, he said: “I really do work on a 3% margin: I buy stuff for $1 and sell it for $3. That’s 3%!”

As I said, whether or not this post makes any sense to you whatsoever, it will have absolutely no bearing on how wealthy you will become … thank goodness 😉

Getting the keys to the golden treasure chest …

golden keyI love it when I receive an e-mail that begins:

As much as I know that I should read some of your posts to better understand some of the questions I’m about to ask, I thought it may be faster to drop you a line.

Yep, this really is part of an e-mail that I received today …

Now, I don’t mind – in fact, I love – receiving e-mails from my readers.

And, as many of you will attest, I really do try and answer them all (often backing up my answers with a post, such as this one)!

But, there are so many online sources that provide great, basic information …

… so, why waste your time asking a multimillionaire how to tie up your shoelaces, when he’s willing to almost-literally (well, as good as) give you the keys to the golden treasure chest?

Instead, I heartily suggest you first try doing your own basic research then, by all means, ask me to help you fill in the blanks

[AJC: Google is an amazing tool for finding the answers to standard personal finance questions. Another great tool is the comment section to my posts, where one of the other readers may be able to help; and, I often respond to comments, as well]

… believe me, I’ll be more than happy to do so.

And, if you’ve put in the work ahead of time, what you’ll end up with is some information that you will not be able to find anywhere else.

That, I can promise!

Happy googling 🙂


I’m going to make a fortune, effective immediately!

Screen Shot 2013-03-22 at 9.21.59 PMAs catchy as the title is of today’s post, it has very little (but not, nothing) to do with the image on the left …

… which image simply serves to illustrate my preferred – or, should I say ‘accepted’ – approach to investing.

But, wait, you say!

Surely, the quadrant to the bottom-right (where the combination of profit and risk is optimized) is the most efficient?


So, why would I want my arrow to hit the target in ‘no mans land’?!

Well, that’s the exact question that I threw to my readers in my last post

There were a lot of amazing comments (and, you should go back and read them all), but Dustin wins a signed copy of my book for his comment, which summarizes my views nicely:

there are significant gains to be made with a moderate increase to your risk … however the long term of the investment should moderate that for the endgame result. Technically it is a less “efficient” investment, but only statisticians care about that, not real world investors.

And, JD earns an ‘honorable mention’ (and, also wins a signed copy of my book) for his comment, which adds a crucial caveat to my views:

I worry less about potential losses for incremental investments. I may be biased since I am young enough to earn it back (I’m in my late 20s)

Whilst I would argue (as would Warren Graham who provided the source chart and much valuable commentary to my original post), that learning about the efficient frontier is valuable to investors, not just statisticians, Dustin has hit the nail on the head by focussing on the “endgame result” …

… for me, your overall investment objective drives everything.

The aim, in my opinion, isn’t to find the optimal investment where ‘optimal’ is defined as sitting on some curve, it’s to find the investment from the limited range typically available to you in the real world that delivers the result that you need.

If you’ve been following this blog for a while, you’ll realize that – in order to pin down that ‘result that you need’ – I advocate a Top Down Approach To Investing:

This means, knowing how much money you need; when you need it; and, using those answers to derive your required annual compound growth rate.

It’s this growth rate, as indicated by the horizontal line on the chart below (the positioning of this line will be different for everybody) that should dictate what investment choices you go after:

Screen Shot 2013-03-22 at 9.41.46 PM

Each of these investment choices (and, in my experience, there will be very few to choose from, since you need access, education, and aptitude in each type of investment in order to proceed) will bring with them their own risk profile …

… and, you will be amazingly lucky, if one of those choices (e.g. as represented by the black squares on the chart above) happen to fall on the intersection of the horizontal line and the ‘efficient frontier’ curve.

If not, and if you want to achieve your Number by your chosen Date [AJC: you do, don’t you?], you will go ahead and make that investment, anyway, even if it doesn’t fit neatly in the quadrant on the bottom-right of the image at the top of this post.

Because, as JD says, even if your investment fails, hopefully, you will still be “young enough to earn it back”.

We get one opportunity to live our Life’s Purpose; we get many opportunities to make investments to help us get there, but only if we have the mettle to choose the ones that have the potential to meet your minimum required annual compound growth rate.

To me, the investment choices that can help us reach our Number are the most effective of investments …

… they just may not be the most efficient 😉




How much do you really need?

2013-02-14 17.05.10My soon-to-be-nephew is having his wedding at our house; he’s an event organizer (amongst other things) so this is his opportunity to create his (and my niece’s) ideal wedding …

… we were, of course, delighted to be able to lend our house.

As he was supervising the erection of the marquee over our tennis court and false flooring over the pool, we were chatting about wealth.

During the course of discussion, the subject came up of how much do you really … and, ideally … need?

What is the Perfect Number?

If you’ve been following my blog for a while, you will know that I’ve said that you need as much passive income as you need to live your Life’s Purpose.

Even without knowing your Life’s Purpose, though, I can still tell you roughly what your Perfect Number should be:

You should aim to live no better than your closest group of friends.

Let me explain with a personal example …

We have a long-standing group of friends.

We eat often eat together. We party together. We travel together.

Not always. Not only. But, often enough.

Now, how would you feel if you travel coach, most of your other friends travel coach, but one of your friends is always at the front of the plane?

How would you feel if you like to eat out at a mid-priced restaurant once every couple of weeks with your friends, but one of your friends is always trying to arrange 5-star dining? And, 5-star hotel’ing?

I think your friend would eventually price herself out of your group of friends.

Well, I am in danger of becoming that friend.

Our friends are all quite well-off, because they are all professionals (both husbands and wives) drawing great incomes for many years. All of our children privately school together, and vacations are now flying coach (with kids) or business class (without kids), staying at international 4-star resorts at least once, and probably twice, most years.

But, our house is clearly the best in the group. Our cars are the best (and, could be better, but I’m starting to realize that I should hold back a little). And, we could be flying business class (sometimes even international first class), and easily stay in 5-star hotels.

In short, we have to be careful not to make the difference obvious.

That’s why I told my nephew (to be) – as I am telling you now: aim to live no better (but, no worse) than your closest group of friends, assuming that you wish them to remain your friends.

I can add a little more:

– Aim to be towards the top of your circle in terms of sustainable annual income.

– Aim to have a buffer, so that you can maintain that standard even if something goes wrong.

[AJC: This is not the same as an emergency fund: this means, for example living on the same $50k p.a. as your friends, but actually earning $70k p.a.]

– Aim to be able to maintain that standard of living (with buffer) when you begin to live Life After Work.

– Make sure that your Life After Work (i.e. very early retirement) makes you still ‘look’ busy

[AJC: Sitting on a beach all day while your friends still 9-to-5 it 50 weeks a year will just as quickly put you in the ‘former friend’ category as flashing your cash]

So, how much money do you really need?

Step 1: Take what your friends are earning and add 20% buffer

Step 2: Multiply that by 20

Step 3: Add the amount remaining on your mortgage (or, what your mortgage would be if you bought one of the better houses owned by your friends)

Step 4: Add any additional ‘crazy money’ that you need for some of your ‘keep busy’ Life’s Purpose activities.

Step 5: Double your final total for every 20 years until you expect to be able to accumulate that amount of money (or, add 50% for every 10 years), to account for inflation.

That should give you a very practical Number … you might even say your Perfect Number 😉

Now, you just need to go out and get it.

A new year’s resolution …

2 doorsThe New Year brings new choices … think of each choice or decision as two doors, and you have to choose one to step through.

Choose the wrong door and it seems you have changed the course of your life forever … but, will it change for the better or worse?

My son has finished high school and now has to choose from his top two college / course choices. What decision will he make?

Will it even matter?

I’m not stressed for him, even though he may be – facing such seemingly life-altering choices – because I remember that I made a few – and, really important – ‘wrong’ choices in my Life’s Journey, yet here I am today.

You see, I now believe that I would have arrived at roughly this point, no matter (within reason) what choices I would have made – or, decisions I would have taken – along the way …

… and, if you implement just one key change in your life, you will come to see that, too.

First, you need to understand that when you choose to go through Door A or Door B, as my son is now, that’s not the end!

There’s always another two doors behind Door A, and yet another two doors behind Door B

Door A

What are the correct choices to make, when presented with these two new doors? How will you know for sure?

The answer lies in knowing your overarching goal: if you know your Life’s Purpose, then you will have a compass that will guide you back to the right course, even if you choose Door A, when perhaps you later realize that you should have chosen Door B.

Door B

Life is really just a series of decisions and choices that we need to make – or, doors that we need to go through. Our choices can sometimes be difficult … as a result, our decisions can seem random or less than optimal. Sometimes, we make the out and out wrong choice.

But, when you have the compass that is your Life’s Purpose, then it will guide you back to the correct path through later and later choices.

With your Life’s Purpose to guide you, no matter whether you choose Door A or Door B, you can end up living your Life’s Purpose; your choices along the way may affect exactly how you get there and what you will be doing when you finally get there …

… but, it will be close enough.

For example, I now know that no matter what path I would have taken, I would ultimately be sitting here and writing this blog post for you.

How do I know this?

Simple. Because I would not have stopped choosing doors until I got here!

So, I’m not sweating my son’s choices … neither should he.

And, neither should you sweat the choices that you make this year.

May it be a good one!




The only personal finance chart you need …

When I’m not blogging, you can often find me hanging around on Quora, the brilliant question and answer site …

… and, that’s where I found Chris Han’s personal finance chart (to the left).

Chris says:

  1. Wealth is the shaded area in the diagram.
  2. You can increase the shaded area by increasing the slope of the green line, or by decreasing the slope of the red line.
  3. Decreasing the slope of the red line becomes significantly harder over time as you grow accustomed to your lifestyle.

Chris is right, but he needs to add a 4th bullet-point, and it’s the same observation that I made when I used a similar chart in this post to explain how businesses should manage their finances for growth:

4. Notice that it is easier to grow Wealth dramatically by increasing the slope of the green Income line than it is to decrease the slope of the red Expense line.

So, let’s break this down …

Regular personal finance will tell you to concentrate on the red (expense) line.

These authors will say that frugality, paying yourself first, and debt reduction (thereby, reducing your interest expense) will increase your wealth through the combined effect of:

– Decreasing expenses, and

– Time.

Decreased expenses allow you to save more, and time allows the full effect of compounding.

Voila! 40 years to fortune!

But, I think that you give up too much for too little, if you follow their advice:

First of all, you give up too many of life’s little pleasures now for little-to-no-reward later (if you can’t afford the lattes now, you sure won’t be able to in retirement).

Next, you have to wait – hence work – for far too long.

Instead, you should focus on the line that they are missing: the green (income) line. If you take my advice, you will concentrate on:

– Increasing your income,

– Using that increased income to build up a larger investment pool, quicker,

– And, aim to get better returns (hence, even more income) through better – and, more leveraged (i.e. using even more debt) – investments

Of course, you can’t simply ignore expenses, but they are best kept in control through delayed gratification, which means:

– Waiting to make purchases; the more major, the longer you should wait, and

– Not increasing your lifestyle (hence expenses) as your income increases.

It is this combination – increased/reinvested Income and controlled/slow-growth Expenses – that can quickly create a huge wedge of Wealth.

This is a very useful chart … you will do well to remember it.

Where’s the emergency?

When you get pulled over by the police for speeding, they often ask: “Where’s the fire?”

And, when anyone tells me that they have 3 to 12 months living expenses sitting in a CD, I have to ask: “where’s the emergency?”

The assumption is that you will have unexpected expenses at some time in your financial life, and you will have to come up with a way to fund them without having to sell the kids or the dog … but, definitely not your boat!

So, the questions are: Do you need an emergency fund? If so, how much should it hold?

Today Forward presents an interesting way to look at how much to hold in your Emergency Fund:

According to the author:

If you have a full year’s worth of expenses set aside, only once every 33 years would an emergency come up that would wipe out these reserves.

Basically, you look at the chart to see how often you would tap out the fund according to how large the fund is (i.e. how many months of expenses do you have set aside as an ’emergency fund’?):

  • 0 months = 100%, guaranteed to have problems
  • 1 month = 70% chance (or every 17 months)
  • 2 months = 49% chance (or every 2 years)
  • 3 months = 31% chance (or every 3 years)
  • 6 months = 10% chance (or every 10 years)
  • 1 year = 3% chance (or every 33 years)

But, these are hypothetical numbers; what is the real-world chance of an emergency cropping up?

Well, the Pew Research Center set out to find out the answer to that exact question …

… and, it was 34%

Only one in three of the 2,000 families surveyed had a ‘financial emergency’ in the past year.

Combining that with the graph above, and it would seem that you would need about 3 months living expenses set aside.

However, I think it’s also important to answer one more question: how much will the average ’emergency’ cost?

Well, the Consumer Federation of America found the figure to be surprisingly low:

Households … typically report unexpected expenditures annually of only $2,000.

What are these unexpected (or ’emergency’) expenditures?

The Pew Research study found they typically fell into the following major categories (which add up to more than 34% because many families reported more than one category as having occurred in the same year):

Given that the chance of an ’emergency’ is so low (34% in any one year), and the reality is that most are affordable (~$2,000 in any one year), why carry an emergency fund at all?

Let’s take a closer look …

Let’s say that you earn $50,000 and pay 25% tax. Since you keep an emergency fund, let’s also assume that you save 20% of your take-home. That means that a 3 months living expenses ’emergency fund’ for you is around $7,500.

Since you’re going to need to keep it in a CD (earning just 1%) instead of investing it (8%+), you are giving up at least 7% interest (or, $525 in Year 1) compounded.

On the other hand, you have a 34% chance of having an ’emergency’, which will then cost you $2,000. Where will that money come from? Well your break-even point on that expense, if you had to borrow it, would be 26%.

So, borrow it on your credit card for all I care!

[AJC: Actually, I do care … the key is to have a plan to pay it off within 12 months; if you do, then a 0% card set aside for exactly that purpose would be ideal. Borrowing against your home via a HELOC would be OK, too, as would borrowing against your 401k. Sure you wouldn’t like to do any of these things, but you are dealing with the unexpected so a little short-term discomfort is probably OK]

Now, the reality is that if you were merely going to stick the $7,500 in an index fund, and earn an extra $500 or so, then I would say just go for the emergency fund … for your peace of mind.

But, why have it lying around earning next to nothing, when it could be the seed capital for your new business or the deposit on your first piece of investment real-estate?

Oh, and if you’re worried about the possibility of losing your job, well, don’t (unless you have GOOD reason to) …

… I’m not sure how different these numbers are in the USA, but if you live in the UK (according to MetLife) you have only a 6% chance of losing your job in any one year. And, when you do, you have a 30% chance of getting a job within the next 3 months, or close to 100% chance in the next 9 months.

Rather than putting your retirement at risk by setting aside too much money for an event that has only a small chance of occurring, realize that:

1. Your money is always better off working for you, and

2. While you are able to work, you can always borrow (and pay back) enough to recover from any financial catastrophe that the typical emergency fund is large enough to cover.

That’s why, at least in my mind, the best defense is always a good offense 🙂

Personal Finance = Emotive Finance

How many of you can honestly … and, I mean honestly … say that you are totally rational about money, and your personal relationship with it?

If that’s you, think again …

All financial decisions are made emotionally, then justified rationally later.

Of course, there will be a very few, clinical souls out there who are able to be totally rational about their personal finances: they read all the (good) books and blogs; they follow the experts; they max their 401k’s (at least to take full advantage of the company match); they examine investment classes and returns; and, they (generally) make sound investments.

But, they will never be rich.

Here’s why: in order to become rich, you need to drive your required annual compound growth rate sky high.

That takes passion … the kind of passion that drives massive action … and, it’s the massive action that will eventually lead to outstanding results.

But, passion is fueled by base emotion.

And, the two most powerful emotions – when it comes to money – are:

Fear and Greed.

I think, by far, the most useful of these two emotions is Fear.

You see, Greed will drive you to take speculative risks that may (highly unlikely) make you rich, or may (likely) send you broke. Even if you fail, Greed will make you try and try again, until you become rich …

or, you keep on failing until we simply never hear from you again.

But, Fear is the slow burn.

It drives some of us to:

– Create emergency funds: because we fear that we’ll run out of money

– Diversify: because we fear the market will tank

– Pay Off Debt: because … well … just because!

– Max our 401k’s: because we’re scared of retirement

– Live Frugally: because we’re simply too scared to spend money

Unfortunately, these tactics simply pander to your fear …

The irony is that these are the exact same financial mistakes that will – for most of us – bring about the outcome that we most fear: lack of financial security.

But, Fear also drives a fortunate few  of us to succeed, because we fear:

– That we won’t be financially secure

– That we will have to work for the next 40 years in a job that we will grow to hate

– That we will be overtaken by others

– and, so on …

So, we use that powerful emotion to push us well and truly out of our ‘comfort zone’ and help drive us to the only rational solution available: making the short term sacrifices, and taking the short-term (but, calculated) risks, that will ensure that we never have to worry about money again.

Still, if you discuss your wealth – or, desire for wealth – with most people, they will assume it’s Greed that drives you; typical is Kevin’s (@ Ask For Benefits) response:

Even 7 million is not enough if you allow your net worth and lifestyle to become your idol. At 7 million you begin to think, “if only I had 8, then I would be happy”.

True, for the person driven by money and Greed, $7 million won’t be enough … and, neither will $8 million. They’ll keep going and going until something stops them.

But, for the person driven by Fear – like me – we stop exactly when we have what we set out to get. And, that amount has been carefully calculated in advance to match exactly what we need for a financially safe, and fulfilling life.

No more, no less will do …


How do I multiply my money?

This is quite typical of the questions that I am asked:

How do I turn $20k, to $50k, to $100k, to $300k, to $1m etc. through the process of investment in different markets and/or general investing whether it be in an idea, or business.

Who could argue with a nice, smooth progression like this? 😉

However, our reader is missing two things in her question: 1. time frame and 2. an objective.

With the “etc.” on the end and the jumps of 2x to 3x between the values in this series, I am assuming that her plan is to keep going past $1 million to $3 million and then to $10 million (or more).

Also, I will assume that she plans to take 2 years for each ‘jump’ i.e. from $20k to $50k, $50k to $100k, $100k to $300k, and $300k to $1million … an 8 year period in total.

A few minutes with an online compound growth rate calculator (http://www.investopedia.com/calc… ) will show her that she needs a 63% annual return from her ‘investments’.

Shooting for $10 million in 12 years increases the required return to 68% and stretching her time frame to 3 years between ‘jumps’ reduces her required return to a ‘more manageable’ 40% annual return.

Now, what to invest in for that kind of return?

The reason for the higher returns as you work your way down the table is: higher risk + more hands on + leverage of time (using Other People’s Time) + leverage of money (using Other People’s Money).

No ‘passive’ investments allowed …

Who ever said it was going to be easy?!