New FI Math (an Update)
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Two weeks ago, I talked about the value of cutting $100 from your monthly expenses which leads to an astonishing $30,000 reduction in your FI Number.
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But thatu2019s not even half of the benefit of cutting $100 per month as the actual value is:
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$90,000
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You are $90,000 closer to FI when you cut $100 per month from your budget.
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The missing link is this:
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Youu2019ll invest that $100 per month into the stock market (most likely a low-cost index fund) and youu2019ll expect to earn an 8% annual return on that newly invested money.
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I opened up a compound interest calculator assuming and assumed three things: a 20 year path to FI, 8% annual return and $100 monthly investment.
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After 20 years, this $100 per month is worth nearly $60,000.
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Add the $30,000 reduction in your FI Number for cutting that $1,200 per year expense out of your life and the total value over your 20-year FI journey is $90,000 for every $100 you cut from your monthly budget.
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Hereu2019s a Real-World Example:
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Pre-FI letu2019s say you were earning and spending $5,000 every month or $60,000 in annual expenses. Since we said you spent every dollar, your savings rate was 0%.
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Your FI Number on $60,000 in annual expenses would have been $1,500,000.
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Since your savings rate is 0% youu2019ll never reach FI, so you know you need to make some changes ASAP.
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Letu2019s say you look at Mr. Money Mustacheu2019s u2018Shockingly Simple Mathu2019 article and see that you need to have a savings rate of about 40% to reach FI in 20 years, so you set out to do just that.
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After a series of changes in your budget, your annual expenses are now $36,000 and your new FI Number is $900,000 (always 25x your annual expenses).
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Crucially, you are now saving $2,000 per month (40% of the $5,000 monthly budget you started with) and investing that money with an anticipated 8% annual return.
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After 20 years, your investable assets from that $2k/month savings is nearly $1,200,000.
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In this example you made the equivalent of twenty $100 per month cuts to your budget ($2,000 per month cut)..
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Your net worth increased by $1,200,000 and your FI Number decreased by $600,000 for a total swing of $1.8 million.
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You cut $2,000 per month which is the equivalent of twenty $100 monthly cuts, so we just proved out that each of those cuts really was worth a $90,000 swing in your journey to FI ($1,800,000 / 20 = $90,000).
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Note: In this example, since your FI Number was now only $900,000, you actually overshot by quite a bit with a $1.2 million net worth, so your timeline to FI would have looked much more like 17.5 years instead of 20. A good problem to have!
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Is the 1% Rule Still Relevant?
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Last week in the newsletter I went through the math of real estate investingu2019s u20181% Rule.u2019
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As a reminder, if you get 1% of the purchase price in monthly rent ($1500 per month for a $150k property for instance), thatu2019s a 12% gross return and thereu2019s a similar u201850% ruleu2019 where you expect to spend roughly 50% of your gross rent in expenses, so that brings you down to a 6% net return (my examples are unleveraged and exclude appreciation).
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There was some pushback in our forums, especially from people in HCOL areas, asking whether the 1% rule was still relevant.
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The subtext was simply, u201cI canu2019t find anything like this in my area, so how could it still be relevant today?u201d
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My pushback was this:
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The math is the math and youu2019re asking the wrong question.
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Itu2019s agnostic as to where you live or where you want to invest.
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If a 1% rule rental property, which IS hard to find, only gets you a 6% return on operations, then the real question you need to ask yourself isnu2019t if the 1% rule still holds, but whether itu2019s even remotely plausible to buy rental real estate in most areas and expect to get something even approximately a worthwhile return.
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Again, for all the real estate purists, Iu2019m talking about unleveraged property and not considering appreciation, which is impossible to forecast, but realistically in an environment where a HYSA gets you 4% interest, rental real estate in much of the country looks increasingly unattractive.
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The further subtext to my argument is this:
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Maybe the rent vs. buy calculus changes for your own living situation when you identify youu2019re in a market where landlords reliably only get ~0.3% – 0.5% of the purchase price per month in rent as many in our forums reported.
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