When you earn an income that is noticeably larger than what you were given or earn previously, you have the tendency to inflate your lifestyle. Such situations are when you get a 10-20% pay raise, when you go from being a student getting an allowance to an actual paying job.
Without a fundamentally sound decision making system, usually we will buy a lot of crap. Think back if you are old enough, what are the things that you subscribed to and you wish you haven’t.
The sensible way of evaluating purchases is based on whether you really need it, and as well as how much you value the thing and service. Often our brain only see Yes or No, Can or Cannot, Get the best or Don’t. Usually most things are a meter ranging from low to highest. You don’t have to get the best. You can get what is 25% below the best and it would still be very good.
Since you have to pay for most of the stuff and services, the best way is to tie it to the dollar value. One way of evaluation is to project how much the item or services will cost you in the 10 years or 20 years to maintain it (read What if you got 10 years of income today?)
Joshua Sheets from Radical Personal Finance (15.30 min) that he did. In fact, this interview was a wealth planning things that I usually agree with all roll into one 1 hour bomb. So do listen to it if you can while going for a job, at work, or at commuting.
He said: Multiply the stuff and service you want to purchase by 300.
This will tell you how much of a wealth machine (property, business, stocks and bonds) you require to fund that recurring expense to perpetuity.
A good example is your handphone bill. Suppose your bill is $50 per month, to fund the hand phone bill with your stocks and bonds portfolio, you need to reach $50 x 300 = $15,000.
You can then evaluate, if I want to stop working fast, do I want something like this expense.
Another question to ask is that can I live with a $30 per month hand phone bill when I don’t have such an intense job any more?
The amount will be cut to $30 x 300 = $9,000. You need $6,000 less!
This is an example of looking at things as a gauge or meter instead of it being a simple yes or no. Shift until it matches the optimum level.
Why does recurring stuff and services matter? Because it is likely that this is something your family will be habitually addicted to and you think you will need it to perpetuity and that you cannot cut down.
Is this true? I will let you figure that out. My job is to put the possibility out there for you to think about each of your recurring services.
One recurring service is your holiday. It was a good to have. But nowadays the common awkward topic at work will be “So where did you go for holiday this year?”
It becomes a culture that you have to go on a recurring basis.
So a $4800 per year holiday for 2 every year, you will need $4800 x 25 = $120,000 in your stocks and bonds portfolio to fund this level of holiday. Do you value the holiday that much?
So next time, other than projecting 10 years forward, you can multiply by 300, and see if you really want something like that. Be more critical about your expenses if you find freedom important, or when you are drowning in expenses.
The idea behind the number 300
The number is not some magic voodoo. It is a mathematically number that Mr Money Moustache simplified. Suppose you have a wealth building method that makes you 8% per year and you can spend down 4% per year, your money will last for a long duration (25-40 years). These are usually through passive stocks and bonds portfolio or property rental. You may not agree with this but that is a topic for another day.
Suppose you would like to stop working tomorrow and your annual expenses is $36,000, your wealth machine needs to let you get out $36,000 per year. To spend down at 4% rate, you need $36,000/0.04 = $900.000. Instead of $36,000, suppose your annual expense is $1. You will need $1/0.04 = 25.
300 is only 25 x 12 months since the amount is monthly.
To find out more how I de-construct how much in your wealth machine you need to create to be close to financial independence, I shared the generic formula to put your fixed deposit, stocks and bonds, property and business in perspective of how to create a perpetual wealth machine here.