Over this past weekend, I read the article How To Quit Working In 5 Years With $330,000 In Savings by Michael Foster Financial Services. I love hypothetical articles like this because they have the ability to condense years or decades worth of history into a brief statement we can wrap our minds around. It's difficult to watch compounding occur over the span of decades - and it never happens linearly as we'd like it to. Still, I took issues with the premise of the article because of the assumptions it makes.
- Jane, the article's hypothetical investor, is a 25-year old Millennial professional earning $70,000 per year after tax with an after-tax savings rate of 65%. This Millennial is spending $24,000 per year on living and saving the rest.
- The article makes no mention of student loan debt, and as near as I can figure assumes Millennial Jane is debt-free.
As a Millennial who went to an engineering university whose friends are almost exclusively in engineering, law and medicine, I don't know a single person anywhere who was making $70,000/year after taxes and had no debt at Age 25. This sample size is as close to zero as you're going to find in the population. I don't doubt that someone out there, somewhere, somehow pulled this off, but it is statistically 0% of the population. Most Millennials at Age 25 can't get a job making $70,000/year pre-tax, and are saddled with tens of thousands, if not hundreds of thousands, of dollars worth of student loan debt. I know plenty of people with six figures worth of debt from a basic 4-year degree, let alone a masters or doctoral degree.
Instead, I would like to attack this premise from the other angle. I want to assume a scenario that sets the bar so low, practically anyone with nothing more than their mental and physical health can accomplish this. We're going to assume our candidate is the ultimate slacker, never learning any trades, obtaining any degrees or certifications, never going to college and working $10/hr equivalent jobs for their entire life. However, our hypothetical Millennial has ONE skill:
Disciplined investing and a willingness to live life below their means. While Michael's hypothetical Millennial is virtually none of us, my Millennial could have been virtually all of us.
We'll call our Millennial John.
Step 1: John Gets Married At Age 18
One of the most powerful things you can do to increase your earning power is to get married. Statistically speaking, if the relationship is healthy, the earlier you can combine incomes the better in most cases! (We will ignore the "marriage penalty" for high income earners because high income doesn't apply to this example.)
Decades ago, marrying your high school sweetheart was a very common thing - and it was great for the bottom line if both spouses were employed. Just like so many generations before him, John marries his high school sweetheart, who is also working a very similar $10/hr job. By combining incomes, John's household income will be $41,600.
Quick calculation: ($10/hr)x(40 hrs/week)x(52 weeks/year)x(2 incomes) = $41,600.
John doesn't go and mess it all up by having an expensive wedding. John considers eloping and flying to Vegas to save money. Instead, he holds the entire ceremony in his parent's back yard, potluck style. John knows debt is the #1 enemy of success, and he gets a jump-start on life by coming out of his wedding collecting more money in gifts than he spent on the festivities.
Sorry folks, nobody NEEDS a 5-figure wedding, even if you think you do. It'll probably bring you more misery than happiness when you get the bill.
Step 2: John Eliminates Debt
Debt is our #1 enemy in this example - even "good debt." John doesn't go to college - it's too expensive versus the return on investment these days. He's not even buying a car. He and his wife both get two wedding presents - their parent's old handed-down station wagons, which they commit to driving into the ground.
Step 3: John Moves To Morristown, Tennessee
Too few people consider location when it comes to building wealth.
According to TaxFoundation.org, the Morristown, TN, metropolitan area is one of the most high-value locations in the entire country. In Morristown, TN, the cost of living is so low that the relative value of $100 is $122.10. Compare that value to New York City, where the relative value of $100 is only $81.77. That means a person who relocates from New York City, NY, to Morristown, TN, gets an automatic 49.32% increase in earning power even if they were to get a job earning the exact same amount of money.
A second huge advantage for John and wife: Tennessee has no state income tax.
In 2016, the Federal Standard Deduction was $12,600.00 for married couples filing jointly. With a household income of $41,600, the couple's federal taxable income becomes $29,000. That places them in the 15% tax bracket.
Using this awesome calculator, we can estimate John's household tax burden.
|Morristown, TN Tax Type||Marginal Tax Rate||Effective Tax Rate||Tax Amount|
|Total Income Taxes||$5,390|
|Income After Taxes||$36,210|
|New York, NY Tax Type||Marginal Tax Rate||Effective Tax Rate||Tax Amount|
|Total Income Taxes||$7,257|
|Income After Taxes||$34,343|
Not only does John and wife see their purchasing power increase by nearly 50% moving from a very high-cost area like New York City to a very low-cost area like Morristown, TN, but they also see a 5.44% increase in after-tax income thanks to the elimination of state and local taxes.
Similar gains in income can be seen by moving to the other 7 states that do not levy an income tax - Florida, Texas, Wyoming, South Dakota, Alaska, Washington and Nevada (New Hampshire does not levy an income tax but they do tax capital gains income) - but only Florida, Texas and Tennessee have areas of extremely low-cost living according to TaxFoundation.org.
Similar costs of living in income-tax free states can be had in:
- Sebring, FL
- McAllen-Edinburg-Misson, TX
- Brownsville-Harlingen, TX
John chose the Morristown, TN, area because it has another major advantage: it is the most temperate climate of those choices. While low-cost areas of Florida and Texas have mild winters, their summers are unbearable without constant air conditioning use. This will lead to high utility bills about 6 months out of the year.
While Morristown, TN, sees all four seasons, average high temperatures in January reach about 46 degrees F while average high temperatures in July only reach about 87 degrees F. Spring and Autumn are long seasons, which minimizes the amount of time the heat runs in the winter and the A/C runs in the summer.
Expect the lowest overall heating and cooling bills in Morristown, TN, but all the areas listed above have a very strong cost and tax advantage versus the rest of the nation - which leads me to my next point.
Step 4: Minimize Living Expenses
The United States has the "wealthiest poor" in the world. Much of our poverty is self-induced because we have little concept of the word "necessity," and our wants drive huge outflows of our respective incomes. John will exercise better restraint, but still have a pretty decent lifestyle far from "the bare necessities."
- Television: Our couple are cord-cutters. They have a basic antenna to pick up local broadcast HD channels and a $7.99/mo subscription to Hulu (NYSE:DIS) (NASDAQ:CMCSA) (NASDAQ:FOX) (NASDAQ:FOXA) (NYSE:TWX).
- Food: Our couple does all their own grocery shopping and cooking. Shopping using sales circulars, they easily subsist on $75/week, or $300/mo.
- Mortgage: According to Areavibes, the median home value in Morristown, TN, is $112,400. I performed a dummy search on Realtor.com in the Morristown area and found a basic home with a 1 car garage with a price tag of $112,900. A 30 year fixed mortgage at 3.52% interest with a 0% down payment yields:
Principal & Interest $ 508.00 Property Tax $ 79.00 Home Insurance $ 37.00 Mortgage Insurance $ 97.00 TOTAL $ 721.00
- Average Gas+Electric+Water Budget: $150/mo.
- Morristown offers incredible 50MB/50MB fiber internet service for $34.95/mo. I'm impressed.
- Sorry kids, no smartphones, here. They're not necessary, and frankly, a distraction that destroys productivity in most people. $50/mo combined for basic flip phones for both of them.
- Car payment: none. We're driving our beaters into the ground.
- Entertainment budget: $100/mo.
- Stuff happens expenses - new clothes, car repair, broken coffee maker, leaky sink, etc: $200/mo.
- One vacation a year fund: $1,500/year
Total annual outflows: $20,267.28.
Step 5: John Doesn't Have Children
There is typically no greater expense a couple will face than having a child. Our couple has no interest in having children because, let's face it, it's an effective way to impoverish yourself. They choose to live for themselves and only themselves.
Step 6: Adjust For Inflation
Just like in our referenced article, we will assume a 2% inflation rate per year. However, we will also assume our hypothetical couple gets 2% raises each year as typical in the workplace. This rate is beyond conservative - we can actually expect minimum wage to increase faster than this - but we will maintain this for the sake of the argument.
As work experience builds, it is easier to outpace inflation with income growth, but I want to set the bar low, here.
Step 7: Healthcare Expenditures
Our first assumption is that our hypothetical couple's health insurance is covered by their place of employment. To do that, we need to make a small extrapolation.
According to the Bureau Of Labor Statistics, the median hourly wage for all incomes in Morristown, TN, is $13.86/hr. We are assuming a $10/hr figure to be ultra-conservative, which is 27.85% lower than median hourly wage. Since both John and his wife combined are working for $7.72/hr less than median hourly wage, we will assume two things:
- That extra $7.72/hr, or $16,057.60/year below median income the couple isn't collecting in their paycheck, is being utilized behind the scenes by their employers to cover their healthcare costs.
- John and his wife take that extra money to the healthcare marketplace to obtain their own private coverage. Using an estimated healthcare cost calculator, we can determine that two adult non-smokers between the ages of 21-64 with no children and a household income of $41,600/year are likely to be offered a subsidized rate.
Based on the information you provided, your income is equal to 261% of the poverty level. This means you are likely eligible for financial help through the Health Insurance Marketplace.
Estimated financial help: $173 per month ($2,073 per year) as a premium tax credit. This covers 37% of the monthly costs. Your cost for a silver plan: $295 per month ($3,540 per year) in premiums (which equals 8.51% of your household income). The most you have to pay for a silver plan: 8.51% of income for the second-lowest cost silver plan Without financial help, your silver plan would cost: $468 per month ($5,613 per year)
Even if John and his wife didn't quality for a subsidy - and they more than likely would - their income is so far below median hourly pay that the difference would more than cover the cost of good health insurance several times over. Bronze healthcare coverage can be had for about $197 per month ($2,360 per year).
Our second assumption is that our hypothetical couple eats well, exercises and takes care of themselves, which keeps them healthy and out of the hospital.
Step 8: John Saves EVERYTHING Else
Our hypothetical couple has one investing strategy: invest everything they can 100% into the S&P 500 (NYSEARCA:SPY).
Using the parameters above, we can calculate our couple's financial future. We will assume their investment grows at an 8% CAGR, which is very typical for the S&P 500 over the long haul.
|Age||After-Tax Income||Spending||Annual Savings||Nest Egg (@ 8% CAGR)|
I chose to run this chart out to Age 65 because that's the typical retirement age people shoot for, but in this example our couple are millionaires by Age 38 and multi-millionaires by Age 46.
I'm not going to tell you what to do with this income. You can sell your holdings and move them into higher dividend funds. You can draw down your income at 4% per annum. Maybe you decide you love working and you'll never stop and become obscenely wealthy into your 60's. When you're a millionaire in your 30's, the world is your oyster. You have options.
This example does not include the effect of capital gains taxes on the reinvested dividends that will be distributed over the years. Why? Because we don't need to. Federal Capital Gains taxes for the 15% income tax bracket are 0%. Recall that because of the low income, John's capital gains tax is 0% AND they live in an income-tax free state, so all that money is reinvested tax-free!
Becoming obscenely wealthy is simple, even when you earn a very low income, if you live below your means and invest aggressive amounts into conservative funds that have stood the tests of time. These principles are exactly how Ronald Read, a Vermont gas station attendant and janitor, became very wealthy by the end of his lifetime. As long as you are blessed with your health and maintain discipline, virtually anyone in America can do this, but we don't for a very simple reason:
We have the "I WANT EVERYTHING NOW mentality," and we're not willing to delay gratification.
Now, what would happen if we re-ran this example with two people that decided to learn a trade immediately after high school? Instead of committing to the lowest skilled employment positions, our hypothetical couple join a skilled trade Union and become apprentices. Instead of making $10/hr, they make $25/hr and amass no debt in the process thanks to the nature of apprenticeships. This allows a pre-tax household income of $104,000.00 household, or $83,676 post-tax. What happens then (capital gains taxes excluded)?
|Age||After-Tax Income||Spending||Annual Savings||Nest Egg (@ 8% CAGR)|
The numbers start to get stupid. Let's also recall most Unions have pension funds, so that's more money they'll both have coming in later in life.
Patience, frugality, discipline and aggressive investing in conservative, passive index funds is all that's needed to get super wealthy, even at $10/hr, folks. Most instances of poverty in America are self-induced. So are most instances of wealth! The power to choose between poverty and wealth is in your hands.
Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: All information found herein, including any ideas, opinions, views, predictions, commentaries, forecasts, suggestions or stock picks, expressed or implied, are for informational, entertainment or educational purposes only and should not be construed as personal investment advice. I am not a licensed investment adviser.