Posted by Tim Stobbs on February 27, 2013
So after last week’s post regarding not having an interim goal until full financial independence I started thinking a bit more about financial independence (FI) and realized something important: it can be broken up in phases or layers.
The classic example of this is to consider each of your major bills and celebrate as you get enough savings to be financial independent for each bill. So if your power, water and natural gas bills are $2250 per year in total, when you have saved about $56,250 (I’m using the 4% safe withdrawal rate), then you FI for just those bills. Yes the separation is purely artificial, but it can be useful to create interim goals on your way to full financial independence. The term for this, in classic motivational theory, is a success spiral (yes, it is official I read too much ).
Also after you start stacking up those layers you end up with your FI cake. So in my case, I have the mortgage paid off which is the base of my FI cake. Then depending on how I stack those next layers I could break it down bill by bill, yet in some cases those layers are going to be so thin that a 3D printer would have problems laying them down. Case in point we only spend like $264/year for both cell phones, which would require about $6600 to fill that FI layer. Since I can save about $4000/month, that level of granularity is getting a bit ridiculous.
So now I have a Goldilocks problem, I don’t want too thin of a mattress (or layer) and the interim goal feels too easy, too thick of a layer and it feels too hard. Where’s the middle ground? Well to work that out I started a bit backwards, on our basic spending of $24,000 a year, how much of that can be covered by the profits from our small businesses? A rough number of that would be $10,000/year, so that leaves $14,000/year to fill in. So how much savings to I need to roughly generate that level of income…$350,000 (or $14,000/0.04). Given I’m already around $200,000 saved, that means I need to save another $150,000 which at my current savings rate is just over three years.
Thus in a puff of smoke and some magic words I have a new savings goal: get my investment net worth to $350,000 in three years or Jan 1, 2016. Is it artificial? Why yes it is. Is it contrived? Of course. Who care as long as it works for me!
So that folks is the point of your FI cake: motivation. Make your layers any size you want, add pink or purple icing for all I care. As long as it works for you…do it. The point is to turn a huge problem (saving for your retirement) into smaller more near term goals, which you can see the end to and do something about. Long term goals are a bitch to meet without smaller sub goals (think how many people you know say they want to write a novel, but never do it).
So what is your next FI layer? Or do you use interim goals?
Posted by Sheryl on November 14, 2012
This is a guest post from Sheryl in Ontario, who is 40 years old with a grown daughter, and is trying to rebuild her retirement dream just 20 years too late for early retirement.
How much of anything is worth doing something constructive with? $5 ? 10 minutes? A half portion of pasta sauce? How many times do we dismiss the importance of the small amount? We clip coupons, turn out our unused lights, make coffee at home, but to what end? What do you save, and what do you waste?
I used to practice a home maintenance system whereby everything was done 15 minutes at a time. It is amazing what you can get done if you want to finish within a certain time frame.
If I budget $300 to spend on food, gas and other living stuff for a month, and I manage to only spend $260, how important is that other $40? Compared to the size of my mortgage, it almost seems like too small an amount to matter. What about a about a mail in rebate? I just received a cheque for $8.51 for dishwasher soap that had an incentive like that. That half cup of sauce? I’d have to add more to it to make a meal.
The small things add up. I have some containers in my freezer that I add small portions of leftovers to, they end up as soup, or a mixture of assorted pasta toppings (chopped tomato, basil, Italian sausage, roasted garlic and marinara on linguini anyone?).
I’m still trying to figure out the best system for small amounts of money though. Should I put that random $10 or $20 on my debt at the end of the week as I start my new weekly budget? Should I have it in my sock drawer to pay for unexpected yet non emergency fund worthy items? Should I put it in a high interest savings account and empty it on my debt when it reaches a certain level? Or should I use it as my fun money?
I know from experience that if I leave it in my wallet, there will always be a sale on something at a “stock up” price, or an invitation for dining out that will be too tempting. Depositing small cash into the bank seems tedious (I can imagine the bank teller’s face if I went in to deposit $7.89 in cash to my savings account).
$20 a week saved is $1,040 over the course of a year, which is definitely not an amount to dismiss. What do you do with little bits of things? Do you track it if it’s money? If you save $10 using coupons, do you just buy something else with the money you saved?
Posted by Tim Stobbs on August 22, 2012
In the personal finance world we tend to gush over things like compound interest saying how great it is and how if you start early in saving it will do wonders. While this is true the heavily under rated concept of marginal utility will likely help you almost as much as compound interest if you understand it and apply it correctly.
So what the hell is marginal utility? Well you can read the entire Wikipedia entry here, but I shall summarize it briefly here: it’s the declining usefulness of obtaining more of something. So let’s say you get a unit of water every day (perhaps 2L). That first two litres of water lets you live, so it is highly useful to you. Then you get two units of water a day, well now you can also do some cleaning on yourself so again it is useful, but not as much as keeping you alive. Then by 120th unit of water a day, you don’t get anywhere near the same value you did out of first two units, but this point you are flushing an ounce of piss away because you have nothing better to do with that unit of water.
Basically a lot of things in your life fall under the concept of marginal utility, electronics being perhaps the most obvious one. Not having a cell phone to having a cell phone can be a big jump in usefulness in people’s lives. Yet upgrading from an iPhone 4 to an iPhone 4S will give you almost no additional feature that you already use, so basically as an investing from a marginal utility point of view the upgrade is basically nearly pointless or brutally expensive for some very minor features.
Now you can also expand this concept to just about everything you use in life. That first steak you buy in the summer and put on the BBQ will likely have a high degree of marginal utility, but from there it drops off. So what does this mean? Well to get the most out of your spending in life you focus on buying the first few units of everything and then forget about the rest. Enjoy that first glass a wine with your supper, but don’t bother getting drunk…you won’t even really taste the wine at that point.
So the lesson from this? If you do excessive consumer spending it is entirely possible to hack that spending down hugely yet notice a very minimal difference in you daily life. You will still eat, you will still enjoy the odd luxury, but you won’t be wasting your money nearly as much. Your first $20,000 of spending will be very useful to you, but by $80,000 per year you are chasing diminishing returns on your investment. You life will not in fact be four times better than if you spend only $20,000 per year.
So do you ever think about marginal utility in your life? What are some other areas where you have noticed this concept applies?