There are a multitude of useful mathematical rules in personal finance. Rule 69/70/72 allows you to calculate when investments will double. The 4% rule is used to estimate financial independence.
Few people write about one of the most important numbers *: Your point of financial inflection
If you do not know the term inflection point, I found two definitions from the search in the Google dictionary:
- Math – A point of a curve where a change of direction of curvature occurs.
- Business – a period of significant change in a situation; a turning point.
When you combine these two definitions and apply them to your own finances, you get something extraordinary:
Your money works more for you than you.
As my slogan has said for years: "Make my money grow, so I do not have to." This is where the "Lazy" brand comes from.
Some people may not understand the concept of making money work. It's letting your investments make money passively. Even if you are not personally familiar with the investment, you have probably heard the following saying: "The Rich Get Richer".
Imagine you won a medium lottery, you had $ 10 million, and the money was recovered immediately. If you invest and earn 7% a year, they will earn $ 700,000 a year. It takes McDonalds many years to make so much money. These investment dollars are working hard.
It's fun to claim $ 10 million, but what about the reality?
Suppose a zero. If you amass a million dollar portfolio, your money can earn you $ 70,000 a year (assuming 7% investment gains). It's a very good second salary, maybe even better than what you do working for yourself. Although a $ 1 million wallet may seem out of reach, the magic of compound interest can make the job easier than you think. (This may require you to make a lot of money and / or avoid significant debt problems such as tons of student loans or health problems – here's how to reach $ 1 million in 20 years.)
Calculate your own point of financial inflection
In the last two years, I have noticed that our investments are doing very well. It's not my imagination, investments to have been fine for almost a decade now. That made me think, did we reach our own point of financial inflection?
The calculation proved easy and surprising. His:
Income / Expected Return = Inflection Point
So, let's say your income is $ 50,000 a year. You expect markets to return to 7.5%. The calculation of 50 000 / 0.075 = 666 666.66 $. Although this number seems bad, it is not so serious in reality. You may want to call $ 700,000 if markets do not behave as well as you think. This seems much more achievable than the $ 1 million example above, right?
When I did the math, I was extremely surprised to learn that we are far from our point of financial inflection. It was like we were there.
What is it that did not go well?
There were three problems:
- Our revenues have increased slightly in the recent past because I started a lot of freelance work. The number of incomes has recently increased. This raises the bar for the point of inflection.
- I've plugged in an expected return of 7.5%. Although this is a reasonable expectation, I compared it to the returns of the last few years … which were NOT reasonable. Someone should slap me with a mutual fund prospectus because "Past performance does not prejudge future results".
- I watched the growth of our net worth, not just our investment gains. I have no excuse other than to be just a bone.
When I realized how far we were, I was disappointed. Then I realized that two out of three "problems" were very good "problems". Who does not have more income? Who does not fear a period of double-digit investment that distorts their expectations? Who does not fear being a bonehead? (Ummm, ignore this one.)
Fortunately, there is an easy solution. My wife is due to retire next March when she is entitled to a military retirement pension (at age 43). I have to remove all advertising here and quit any freelance work. This will solve this pesky income problem. I'll also assume that the markets will show an annual return of 12% because there was a time when that was normal. I will not even get into asset allocation issues that may be below my optimal expectations.
What is the value of your point of financial inflection?
If you do not understand my sarcasm in the last paragraph, you should be ashamed of not being a little more obvious. I wanted to illustrate the fact that at some point, reaching your point of financial inflection may not mean much. It's really a big milestone, but it may not be realistic.
If you are a medical doctor earning $ 300,000 a year, your financial breakthrough point would be $ 4 million (with a gain on investments of 7.5%). If you invest "only" half of that amount in your investments, you will get gains of $ 150,000 a year, probably.
Your point of financial inflection is most useful when it is combined with your planned expenses.
Last May, I projected our planned spending over the next 45 years. (Yes, it was crazy and you should read it right away).
The quick and dirty answer is that we will probably have about $ 35,000 in spending a year. We do not need to completely replace our revenues as suggestions for financial inflection points. Our money must only work hard enough for us to need it. This was one of the factors to take into account when buying solar panels. Even though we may not be investing towards our point of inflection today, we are invest in reducing our expenses in the future.
* At the time of publication, I decided to do a research and I found that The Green Swan covered this topic very well, but in a different way.