The Elusive Number

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The Elusive Number

Pick a Number by THEfunkyman.

Photo credit: THEfunkyman

Mark illustrates, in a practical way, the dilemma faced when considering one’s future from the perspective a young, single person who only needs a bag, a small stipend and some travel vouchers to be truly happy v. the family guy who needs the Gucci luggage and all the trimmings … well, not quite, but you get my point

When we were first asked to calculate the number, I did use the spreadsheet provided here. I did plugged in some formulas to account for inflation for both income and expenses. There are a few major purchases like a home, vacation home and transportation (car only). I was happy with the number since the total matches my original number in the initial application but it was for a slightly different time frame; 7 years vs 10 years.

However, as we did more exercises like coming up with a Lee’s List and refining the spreadsheet, the number did change. For example, in my previous spreadsheet, I did not factor in life events – for example, being married and having kids. I did account for the increase in life expenses but I’ve failed to accommodate new travel expenses. The travel cost ballooned quite a bit after considering additional seats to fill in and the need for larger an better accommodations. Hostels will not work for family, for sure. The original spreadsheet did not account for some of the items in the Lee’s List that we have been working on. I need to add seed money for an Education Foundation as described here.

I did use the Rule of 40 rather than the Rule of 20 for some reason. I think there is some fear of falling short but we will examine both scenarios. The huge buffer might be able to accommodate the additional travel needs, and Lee’s List items when using Rule of 20.

I did calculate numbers for 10 years and 20 years out but I settled for 10 years to be more aggressive. If I didn’t meet my number , I can have another 10 years to do so. Here are the major items in the spreadsheet:

1) Houses

Primary residence: $400,000 (in 5 years)
Vacation Home: $350,000 (in 10 years)

2) Cars

Used car #1: $30,000 (in 5 years)
Used car #2: $45,000 (in 10 years)

3) Travel

There are some elaborate calculations on the spreadsheet. It covers one destination in Asia, one other international destination and some domestic travel. I used the number for the future scenario of being married with 2 kids. The number in 10 years will be about $31,000

4) Living Expenses

The living expenses for the projected scenario of being married with 2 kids in 10 years is around $123,500. This is based on an inflation adjusted rate of 4%. We might be facing higher inflation rates but I hope the number calculated using the Rule of 40 can catch cover this scenario.

5) Items on Lee’s List

Education foundation: $500,000

Items in 1, 2 and 5 are one time cost items so we are not using the Rule of 20 (or 40) on these items. The total for one time cost items is $1,325,000.

For Travel and Living expenses, we have a total of $154,500. Using the Rule of 20, we will need $3,090,000.

The final number using the Rule of 20 will be $1,325,000 + $3,090,000 = $4,415,000 and if we round it up, it will be the same as my previous numbers at $5,000,000.

If I’m using the Rule of 40 instead like I did the previous calculation, it will be $1,325,000 + $6,180,000 = $7,505,000. So what will the Rule of 40 gives us over Rule of 20 besides having a higher number?

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Reader Comments

@ Mark – Did you allow for Income Tax? If not, you can divide all of your recurring expenses by .65 (same as assuming that they come AFTER a 35% tax) THEN multiply by 20.

If you want to allow for tax (on the investments that you need to sell in order to free up the cash) for your Major Purchases / One-Off Expenses, you should allow for a Capital Gains tax (currently 15%, but who knows what it will be in 10 years?) by dividing these one-off’s by .85.

@Adrian – I did allow for income tax for living expenses, as you can see, I don’t need a lot to live rather well. My hope is that the future nuclear family will follow suit. The comment on capital gains tax is a good one. I did not think about that in detail. However, I think we can hedge that via various investment vehicles like real estate.

Adrian – I don’t know about you and Mark, but I know that I have to account for state income taxes in additional to federal. There’s also the issue of city income taxes for some of us. I assume a higher than 35% tax rate to account for all of these.

@ mark – The CGT issue was specifically thinking ABOUT real-estate … if you sell down a real-estate (or, business, etc.) investment in order to fund your major purchases in retirement then CGT will be an issue.

On the other hand, real-estate (perhaps uniquely) allows you the opportunity NOT to sell the investment, merely to refinance it – using the proceeds to buy your ‘stuff’.

There are two issues with this:

1. Despite what most PF ‘gurus’ will tell you (i.e. that this is a ‘tax-free’ way to live off your RE equity, this is a grey area – taxwise – at best,

2. You will be living with an increased level of debt, just at a time when most people want to decrease their debt.

Whether you choose to build more tax into your Number, or assume that you will find a way around the tax, or lower your purchase values ‘just in case’ … it’s good to be aware of the possible impact.

@ Diane – good thinking, although the lower federal tax brackets are closer to 25%, so adding in the incremental taxes as your income (hopefully) increases, PLUS the state taxes, MINUS the benefit of using company structures and/or lower Capital Gains Tax Rates rather than income tax MAY mean that a planning figure closer to 35% is adequate … but, who knows what a future government will do, feel free to use whatever you feel comfortable with.

[…] the last year, I have been struggling in terms of aligning my goals towards achieving my number. I seem to do quite well following Money Making 101 and some of its rules, but I haven’t […]