The Minimum Investment Amount Where Work Becomes Optional

by MISSISSIPPI DIGITAL MAGAZINE


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 minimum investment threshold amount, that is when you should have more confidence to change your life for the better. For those of you far into your financial journey where you already have a lot of money, my formula can serve as a wake up call to stop wasting time.

Author Background

I helped kickstart the modern-day FIRE movement with the launch of Financial Samurai in 2009. In 2012, after a 13 year career and investment banking, I semi-retired at the age of 34 with a $3 million net worth. I haven’t had a day job since, but I have done part-time consulting work for startups in San Francisco, as well as written a couple of best-selling books to keep me busy.

For those with over $250,000 in investable assets who want a free financial checkup, you can schedule an appointment with an Empower financial professional here. If you complete your two video calls with the advisor before October 31, 2024, you’ll receive a free $100 Visa gift card.

In 2013, I had a free, no-obligation consultation with an Empower financial advisor that helped me identify a significant financial blind spot. At the time, I was conservative, holding a 52% cash allocation in my taxable portfolio after leaving my job the previous year.

In my mind, I had to invest like a traditional 65-year-old retiree. The advisor pointed out that I was still young (35) with many financial opportunities ahead. Following that advice, I invested my cash into stocks and real estate, which has paid off well over the past 11+ years.

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.

Investment Threshold Formula where once reached, work becomes optional

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 and capital gains are 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.

The beauty of my investment threshold formula is that real-time inflation assumptions are included given incomes are correlated with inflation. Simply run the numbers every time your income changes. Further, investment returns are also helped by inflation and historically return greater than the rate of inflation.

Please note my Investment Threshold Formula is meant to be used as a baseline reference point to help measure where you’re at or help you come up with an investment target. Once you come up with the figure, you can then plan accordingly based on other variables.

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.

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.

Probability of making money in the S&P 500 over time, percentage of time positive over various timeframes

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%. The inverse of 8% is 12.5. To find your investment threshold, multiply $300,000 by 12.5, which equals $3,750,000.

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 $3.75 million in three years and ten months, assuming an 8% annual return. Of course, a bear market could extend your timeline.

You feel good knowing that after using my investment threshold formula, you have a high probability of retiring in the next 5-7 years.

60-40 portfolio historical returns and investment threshold formula example

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 is tangible, 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 or less and save and invest as much as possible on any income earned above $200,000.

Real estate investment threshold amount where work becomes optional

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 over time.

$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.

Invest In Real Estate More Passively

Once I had children in 2017, I started investing more aggressively with the likes of Fundrise ($275,000 so far, and $970,000 total in private real estate). I didn’t want rental properties to take any more time away from raising my son and daughter.

In addition, I wanted to invest in the long-term demographic trend of people relocating to lower cost areas of the country. Thanks to 11 aggressive Fed rate hikes since 2022, there are a lot more commercial real estate deals to be had. Now that mortgage rates are coming down, I expect real estate prices to catch up to stock price performance in the coming years.

My favorite time to invest in real estate is before the start of a multi-year interest rate cut cycle. That time is now.

Past the bottom of the real estate cycle with upside - Fundrise

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.

Let’s say you expect a 30% decline in your investments, to give yourself a buffer, aim to achieve 142% of the threshold amount. This way, you have a 30% downside buffer. And if you think there will be back-to back years of 30% declines (highly unlikely), then you can accumulate 204% of the minimum threshold.

Please note that a 30% decline in your investments is different from a 30% chance of your investments losing money. Your investments could lose money one year, but could decline less or more than 30%. It’s usually far less.

Have The Courage To Change Your Life

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.

Back in 2012, I was absolutely miserable working in finance. I had chronic lower back pain, sciatica, and TMJ. My job was literally killing me. Six months after I negotiated a severance package, all my chronic pain went away. Even my white hairs, which began sprouting more often a year earlier, went back into hibernation.

Making a lot of money is nice, but health and happiness are way more valuable!

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. If you own multiple assets, then come about with the blended historical average return and make the appropriate calculation.

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, 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. Everybody needs to have a reason for being, or ikigai, as they say in Japanese.

Much of living your desired life involves overcoming mental barriers. However, if you consistently break through, I’m confident you’ll build more wealth and live a more enjoyable life than you ever thought possible.

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?

With stock market volatility returning and a potential recession looming, it’s more important than ever to get a financial checkup. Empower is currently offering a free financial consultation with no obligation for a limited time.

If you have over $250,000 in investable assets, don’t miss this opportunity. Schedule an appointment with an Empower financial professional here. Complete your two video calls with the advisor before October 31, 2024, and you’ll receive a free $100 Visa gift card.

A year after leaving finance, I had two free consultations with an Empower financial advisor that revealed a major blind spot. I had 52% of my portfolio sitting in cash, thinking I needed to invest like a conservative 65-year-old. The advisor reminded me that at 35, I still had many financial opportunities ahead. Within three months, I invested 80% of that cash and used the rest for a down payment on a fixer-upper—both decisions paid off well.

The statement is provided to you by Financial Samurai (“Promoter”) who has entered into a written referral agreement with Empower Advisory Group, LLC (“EAG”). Click here to learn more.

The Investment Threshold Amount Where Work Becomes Optional is a Financial Samurai original post. Fundrise is a sponsor of FS and FS is a investor in Fundrise. Everything I write is based off of first-hand experience. To achieve financial freedom sooner, join 60,000+ others and sign up for my free weekly newsletter.



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