Is It Worthwhile To Live Like A Cheapskate?

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Includes: VT
by: Investment Pancake

Summary

Some contend that retiring in 8 years is complete fantasy.

Combine savings from salary with savings from dividend income to produce rapid portfolio income growth.

There is no reason to rely on assumptions about future stock prices. You can make better assumptions about dividend growth if you own steady dividend paying stocks.

A new acquaintance recently asked me whether it was worth going to law school. I replied that I can only answer that question from a strictly financial perspective. What does "strictly financial" translate to? Let me reframe the question my acquaintance put to me and put the answer thusly: law school is financially worthwhile only if it enables you to quit practicing law within a period of time that you find tolerable.

Before getting into the guts of my response to my acquaintance's question, can I share something with you? This entire exercise brings me back in time to two distinct moments in my own legal career. The first moment was the day I met David B. Dave lived in a group home during law school, and racked up some hefty tuition bills along the way. After graduating, Dave landed a coveted position at the law firm where I got my first job. I say "coveted" because this firm pays first year associates a monumental salary and bonus (for which associates are expected to devote monumental hours and no less than 2/3rds of their mortal souls). Not everyone is cut out for a life lived on such terms, which Dave must have recognized early on... BECAUSE even after landing this financial bounty, Dave continued to reside in his little group house in the East Village. Dave devoted nearly every penny of his after-tax earnings to paying off his student loans (that took about a year, if memory serves), upon which he beat a hasty retreat to greener pastures elsewhere. I have no idea where he went or what became of him, but wherever he landed, I expect that he felt free and breezy upon his escape from [insert big, high-paying law firm here].

The second distinct moment I recall is the time I did a bit of estate planning for a partner at a different big, high-paying law firm where I spent two sorrowful years working 15 hours a day for 7 days a week. I was in my sixth year of practicing law at that point, and I was shocked to see this partner's net worth. Despite the fact that this individual earned approximately 10 times a year more than I did, my net worth was easily 10 times higher than his. I remember thinking, what's the point of earning such an absurdly high salary if at the end of the year, you're no further ahead financially than you were at the start of the year?

I guess my problem is that I tend to avoid putting so much as one foot in the door unless I've already mapped out at least one clear path to the exit. This is not an ideal attitude for becoming a dedicated professional attorney, but it is a perfect approach for building and investing wealth. You see, once I realized that I could get fired (perhaps deservedly) at any second of any day, I saved every single last penny I could. I didn't have student loans like my buddy Dave B, but we were sort of kindred spirits, shopping for second hand suits at Century 21, eating lunch out of a brown paper bag, and so forth. Six years of constant waiting for the proverbial axe to fall on my livelihood can (and in this case, did) outperform 18 years of confidence, German sports cars, a seven figure salary, and a heavily mortgaged house in the Hamptons. At least if you get lucky with a few of your investments early on.

I only had one piece of advice for my acquaintance, and it has to do with a different sort of partnership. You start out in life and the only source of income you have derives from your own two hands, but very quickly, your savings and investment dollars start providing a bit of a financial lift, as well. In time, you're working in partnership with your investments; you kick in your savings from your salary, your investments kick in dividends, rent, interest or fund distributions. It's shocking how quickly your investment income grows when you combine the dual force of savings and compound income growth.

How quickly is "quickly?" That's where I wanted to focus my acquaintance's attention on the "should I bother going to law school" question. I suggest the answer is 8 years. If you pull a David B./ Investment Pancake type of cheapskate lifestyle, you can work for 8 years at a major US law firm and put yourself into a position where you afford to retire on dividend income at your accustomed standard of living.

It's easy to see what young lawyers earn. Here's a link to Law Crossing's recent annual survey. Associate Salaries. I plugged in numbers from a top US firm into a spreadsheet, calculated an annual spending amount (adjusted each year for inflation), built in an assumption for Federal, State and FICA taxes, and an annual dividend rate and dividend growth rate. For purposes of this spreadsheet, I assumed an absolute rock bottom lifestyle of a supremely cheap miserly miser. Think canned tuna for dinner. Riding a bicycle to save on bus fare. Living with obnoxious, slovenly room mates in a disgusting little apartment in a lousy part of town. Sounds fun, right? I don't know, six years that really suck, but then you get the rest of your life to do anything you want. Here are some numbers:

I'm calling your attention to column J. Notice how an associate's investment income can grow from $3,112 to nearly ten times that amount in just 6 years? Incredible, right? I wouldn't believe it possible, but for the fact that I've seen it in real life. The secret sauce is taking income on your savings from salary, income on your portfolio, and funnelling both, unrelentingly, into the acquisition of more income producing assets.

My answer for my new acquaintance is that yes, law school is worthwhile financially if you can land a job at one of those high paying law firms and then have the discipline to keep your expenses at a rock bottom level even as the temptations to upgrade your lifestyle swirl all around you. By your 8th year, your portfolio should be churning out more income than you spend on your cheapskate lifestyle - assuming you earn a 4% yield that grows by 7% a year on average. Where did I get those numbers? I picked them off the average for my personal portfolio of 77 stocks and 14 ETFs. You can use alternative assumptions about dividend yields and dividend growth rates, but for the curious among you, my investment allocations are here:

Bear in mind that my answer has nothing to do with whether the stock market is up or down or sideways or whatever over any given period of time. I'm strictly looking at how much cash flow your portfolio of investments generates, and I'm entirely ignoring the fluctuating prices for your various assets. If you are lucky enough to be working and saving and investing while the stock market happens to be crashing, your income is only going to grow that much faster thanks to higher starting yields on your new investments.

Is any of this worthwhile to any readers who are NOT contemplating a relaxing career at one of the nation's top law firms? Sure! Go ahead and copy the link to this spreadsheet, plug in some estimates for whatever salary you think you might earn at different stages of your professional life, adjust the tax assumptions to fit your personal circumstances, and then use whatever savings, dividend rate and dividend growth rate assumptions you like. The spreadsheet will give you an estimate of what it's worth to you (in terms of years) to combine a high savings rate with a reasonable portfolio income growth rate. Is Living like a Cheapskate Worthwhile?

Disclosure: I am/we are long VT.

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: I am long every stock listed in the attached spreadsheet. This is not investment advice and I am not an investment advisor. The article can only be read for entertainment value, and relied upon for nothing but that.