In a previous post, I discussed the futility of working when your net worth is declining. During a stock market crash or recession, your Return on Effort (ROE) for working drops significantly. Therefore, the only way to increase your ROE is to work less, not more.
At some point in your life, you’ll reach an investment threshold where you may regularly start making (or losing) more from your investments than from your annual job income. When this happens, work begins to feel optional as you start questioning the trade-off between time and money.
Since stocks and real estate prices tend to rise about 70% of the time in any given year, your desire to retire early or pursue a less stressful and more exciting profession grows stronger. As time becomes more valuable with age, your tolerance for workplace frustrations diminishes.
This post will help you identify the minimum investment threshold to aim for, keeping you focused and motivated. With a clear financial goal, achieving it becomes much easier. Once you achieve the investment threshold, that is when you should have more confidence to change your life for the better.
The Minimum Investment Threshold Formula
The minimum investment threshold where work starts to become optional is calculated by taking the inverse of the historical return of the asset class you own and multiplying it by your gross annual income. The formula visually looks like this below.
When you reach this investment threshold, the annual return from your investments has a high chance of equaling or exceeding your annual salary. Additionally, since long-term investment income is generally taxed at a lower rate than W-2 job income, you’ll have an even larger after-tax cushion.
Once your investments can regularly match or exceed your annual gross income, you are free to change jobs, take a sabbatical, or potentially even retire early. I’ll share three examples below, but first, some key assumptions.
Key Assumptions for My Investment Threshold Formula
In my investment threshold formula, I assume the financial freedom seeker lives within their means, doesn’t carry revolving credit card debt, and saves at least 20% of their after-tax income every year.
Another assumption is that the financial freedom seeker maintains their usual spending habits. Of course, if you choose to spend less, you’ll need a lower investment threshold, and vice versa. However, I view spending less as “cheating,” which is why I use a multiple of gross annual income instead of annual expenses.
I want you to achieve financial goals without overly-compromising your desired lifestyle. There’s no point in retiring early only to live near poverty. It’s also not ideal to live near poverty just to retire early and continue living that way.
After helping kickstart the modern-day FIRE movement in 2009, I’ve seen and profiled numerous people who decided to live like monks, shun travel, rent, live on a boat or in a van, avoid having children, and force their partners to work so they could be financially independent. Not being free to live fully is suboptimal.
Instead, I encourage everyone to live well. When you decide to step away from work, you should be able to maintain or even improve your quality of life. Taking a step down feels bad, but if you choose a more frugal lifestyle, the increased freedom should compensate for any loss in lifestyle quality.
Investment Threshold Example #1: High Risk Tolerance, 100% Allocation in Stocks
Let’s say you earn $100,000 a year. The S&P 500 has historically returned about 10% annually since 1926. The inverse of 10% is 10. Multiply 10 by $100,000, and you get $1 million. As a $100,000-a-year income earner, once you have $1 million invested in the S&P 500, you should feel free to explore other options if you no longer enjoy your job.
At 38 years old, you may feel you have a high risk tolerance and are comfortable with a 100% allocation in stocks. Suppose you’re tired of working for the government and want to try your hand as a writer earning $40,000 a year. You can do so because you have $1.1 million in stocks, thanks to saving and investing 50% of your after-tax income for 15 years.
If you are able to survive off a $40,000 a year salary and not touch principal, you only need $400,000 invested in stocks using my investment threshold formula. However, since you decided to switch your career at 38 years old with $1.1 million in stocks, you have a $700,000 investment buffer. As a result, you might feel incredibly rich and free in your new lifestyle.
If you prefer a different asset allocation, you would calculate a blended estimated historical return to find a new gross annual income multiple.
Income Threshold Example #2: Ready to Retire, 60/40 Stocks/Bonds Portfolio
Now, let’s say you’re 45 years old and tired of working after 23 years post-college. You earn $300,000 a year in tech, a notoriously volatile industry. Instead of 100% in stocks, you prefer a 60/40 stocks/bonds portfolio. When can you retire?
Given that bonds historically return about 5%, the historical return of a 60/40 portfolio is around 8.5%. The inverse of 8.5% is 11.76. To find your investment threshold, multiply $300,000 by 11.76, which equals $3,528,000.
Unfortunately, you “only” have about $2.5 million invested in stocks and bonds, with no other assets. Given that you can save $100,000 a year after taxes, a compound return calculator estimates your portfolio will reach $3.547 million in three years, assuming an 8.5% annual return. Of course, a bear market could extend your timeline.
Income Threshold Example #3: Prefer Real Estate Over Stocks or Bonds
Let’s say you grew up in a culture that values real estate more than stocks or bonds. Real estate provides shelter, generates income, and is less volatile than stocks, so you invest all your money in residential real estate for retirement. Bonds are boring and simply don’t provide enough upside.
Historically, real estate has returned about 4% annually on average, or 2% above the long-term inflation rate. Some sources, like the San Francisco Fed, suggest that real estate has historically returned 7% annually since 1850. You earn $200,000 as an associate in banking and are already burned out after three years at age 26.
To calculate how much real estate you need to make work optional, use the same formula. The inverse of 4% is 25. Multiply 25 by $200,000, and you get $5 million. Now you must do your best to live off of $200,000 and save and invest as much as possible on any income earned above $200,000.
The Ability To Borrow To Reach Your Real Estate Investment Threshold
While $5 million worth of real estate might sound like a lot, our system allows people with good credit and stable income to acquire real estate with only a 20% down payment. So, you only need to come up with $1 million to buy $5 million worth of real estate.
$1 million is $1 million less (50% less) than you would need if you preferred to have 100% of your portfolio in the S&P 500. Of course, you’ll spend more time and money managing your properties. Additionally, with significant debt, your real estate equity could fluctuate more dramatically.
The key is to own rental properties that generate strong cash flow. Fortunately, rental yields are usually much higher than stock dividend yields. When combined with ~4% annual real estate appreciation, you’re likely to earn enough to make work optional.
For those who want to get their hands dirty, they can always expand a property to boost its value and increase rental income. And for those who want to be completely hands off, they can always invest in a public REIT or private real estate fund that does all the work for them.
You’ll Likely Still Be Working After Reaching the Investment Threshold
My investment threshold formula represents the minimum amount you need before feeling comfortable transitioning out of your current job. It’s unlikely to be enough to retire, unless you do so when you’re eligible to receive a pension or collect Social Security.
After all, there’s roughly a 30% chance of your investments losing money in any given year. Therefore, you’ll likely aim to accumulate more investments or continue working even after reaching the investment threshold.
Once you reach the investment threshold, at the very lease, you should have the courage to change your life for the better. This means not wasting another minute at a job you dislike. Changing your life means you’re no longer financially dependent on someone else, so you can leave a terrible relationship behind. You also no longer have an excuse not to pursue your dreams, whatever they might be.
Too many people work at jobs they don’t enjoy mainly for the money. Think about all the starry-eyed high school students writing in their college applications about wanting to change the world, only to end up in an industry that pays them well, but has nothing to do with their dreams.
I understand it’s hard to walk away from the money, but you must, to pursue what you really want to do. If you don’t quit the money once you have enough, you might look back on your life with regret. The older I get, the more I realize regret feels more painful over time.
The Ideal Net Worth Target To Retire Or Declare FI
My investment threshold aligns well with my net worth target before declaring financial independence. My investment threshold formula is simply a more granular way to calculate the beginning of enough.
Instead of using 25X your annual expenses to consider yourself financially independent, I use 20X your gross annual income to determine true financial independence. Expenses can be easily manipulated to make your financial independence number easier to achieve. However, with income, you are paid what you are paid. As you earn more, you’re forced to save and invest an equal or greater amount.
I’m not a fan of shortcuts to achieve financial independence. Therefore, I’m not a fan of Coast FIRE or any other sub-FIRE strategy that awards you a trophy before you’ve finished the race. Because at the end of the day, you’re only cheating yourself and your family if you take shortcuts.
The greater the percentage of your net worth is allocated towards risk assets, the closer my net worth target multiples are aligned with my investment threshold amount formula.
Be Dynamic In Your Financial Calculations
After more than 15 years of writing about personal finance and leaving work in 2012, I can confidently say that following my investment threshold formula works.
On your FI journey, you will undoubtedly experience fear and doubt as economic and personal circumstances evolve. The key is to remain flexible with your financial goals and adapt to changing conditions.
When my wife retired in 2015 at age 35, I believed we could live happily ever after in less expensive Honolulu on ~$120,000 a year. Based on my conservative investment return target of 2-3X the 10-year Treasury bond yield, retiring early with $3,000,000 – $4,000,000 invested seemed like enough.
But in 2017, our son was born, followed by our daughter in 2019. A year later, the pandemic hit, prompting the government to inject trillions of dollars into the economy, which fueled inflation.
Relatively quickly, $120,000 was no longer enough to raise two kids in San Francisco. To live a middle-class lifestyle in an expensive coastal city now requires closer to a $350,000 annual household income. If we use a conservative 5% rate of return on our investments, that means needing at least $7,000,000 invested where work becomes optional.
As a result, we had to reinvest more of our investment income than originally planned, instead of spending it. Additionally, we needed to generate supplemental retirement income through writing, Uber driving, high school tennis coaching, and part-time consulting.
Doing What You Enjoy Makes Your FI Journey Better
Fortunately, I genuinely love writing and creating actionable ideas to help readers achieve financial freedom sooner. I also enjoyed coaching, which helps me prepare for when my kids become teenagers.
Although achieving financial independence can be a grind, transitioning to doing what you love makes the journey much more enjoyable.
Much of living your desired life involves overcoming mental barriers. However, if you stay consistent over the long run, I’m confident you’ll build more wealth than you ever thought possible.
Reader Questions And Suggestions
What is the minimum investment threshold you need to ease up at work, switch to a lower-paying job, or retire early? How do you calculate this minimum threshold? And if you have far more investments than you need, what’s holding you back from doing something more enjoyable with your time?
Read How to Engineer Your Layoff to learn more about negotiating a severance package. When it’s time to leave that dreadful job behind, try to negotiate a severance package instead of simply quitting. Since you planned to quit anyway, negotiating a severance only has upside. You could receive a severance check, subsidized healthcare, unvested stock and cash, job search assistance, and more. Plus, you’ll likely be eligible for unemployment benefits, which aren’t available to those who quit.
To build wealth through real estate, check out Fundrise. Thanks to 11 rate hikes since 2022, there are now more commercial real estate opportunities. With interest rates heading down, pent-up demand for real estate may be unleashed, potentially boosting prices in the future. Since real estate has lagged behind stocks since 2022, I expect its performance to catch up over time.
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