Money Mindset – Living The FIgh Life

Is The Stock Market Becoming a Ponzi Scheme?

The convergence of the widespread use of 401k and similar retirement accounts coupled with the rise in index fund investing has created a Ponzi scheme-like dynamic with the stock market over the past 30+ years..

What is a Ponzi scheme?

From Wikipedia, a Ponzi scheme “is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors.” Is the stock market truly a Ponzi scheme? No, but since 1980 it has taken on some similarities with a Ponzi scheme that investors should be aware of.

Stock Market Valuation to Scale

Most graphics of the stock market (the Dow Jones Industrial Average) that include performance data before the 1980s, use a logarithmic scale. The log scale distorts the long-term variations in market value to make it appear that the changes over time are more consistent. On the chart below which uses a logarithmic scale, it visually doesn’t look like anything unusual happened around 1980. The only sizable blip in the trend is the Great Depression.

Source: https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart

A couple of years ago, I stumbled across an unusual graphic of the stock market’s historical performance that surprised me because it was to scale.

Source: https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart

I was shocked to see that, relative to the performance in the last three decades, the previous eight decades were basically flat to include the Great Depression (now a very minor blip on the chart) and the industrial economic growth of the 50s and 60s. I wondered what happened around 1980 that exponentially changed the dynamics for stock market valuation.

What Happened Around 1980?

Four major things: 1) invention of index funds (1971), 2) Individual Retirement Accounts or IRAs (1974), 3) the 401k plan (1978), and 4) increased institutional investment of pensions in the stock market. (Note that for this post I am using “401k” to mean all similar plans to include 401a, 403b, 457b, and the Thrift Savings Plan (TSP).)

Jack Bogle invented index funds well before 1980, but they did not take off on a mega-scale until the 401k, IRAs, and remaining pension plans began growing in number and size and therefore dramatically increased their share of the stock market.

Section 401k of the Revenue Act, which became the namesake for the retirement accounts it authorized, was passed on November 6, 1978. The first 401k plan was implemented 3 weeks later. Since then, public and private employers have gutted the traditional pension plan. Employers have either replaced pensions entirely with a 401k (sometimes with matching funds), or they (often government entities) have deeply cut the value of their pension plans and then offered a 401k option to help offset the lost value.

According to a 2021 CNBC article, “401(k) and other defined-contribution plans like it quickly replaced traditional pension plans. From 1980 through 2008, participants in pension plans fell from 38% to 20% of the U.S. workforce, while employees covered by defined-contribution plans jumped from 8% to 31%, according to the Bureau of Labor Statistics.”

Even though the number and dollar value of pensions has sharply declined since 1978, they still represented 10% of stock market value as of October 2020.

So How Does This Create Ponzi Scheme Dynamics?

According to Annie Lowrey in an April 2021 Atlantic article, “[s]ome $11 trillion is now invested in index funds, up from $2 trillion a decade ago. And as of 2019, more money is invested in passive funds than in active funds in the United States.”

The issue here is that index fund investing works differently than other types of investments. Most IRA, 401k, and pension accounts invest in index funds each month regardless of the performance of the market or any particular company in the market.

Index funds are cap-weighted, meaning that if a large company like Google represents 5% of the value of the index (e.g. S&P 500) then every month passive investors (i.e., everyone with a 401k in the stock market) will invest 5% of their monthly retirement dollars on Google whether or not Google is a good investment right then. This monthly automaticity arbitrarily drives up the price of Google stock because the index must buy the stocks in the index at their cap weight. Likewise, every other company’s stocks in an index are also purchased independent of performance.

Many stock investors, especially those investing for retirement, are not selling their shares each month when these new index investment purchases need to be made. They want to avoid stock market volatility. This dynamic creates supply and demand price pressures that help keep the valuations going up.

The growing demand for index fund investments drives up the valuation of the stock market. This helps explain, at least in part, the meteoric rise of the stock market’s valuation over the last three decades.

It doesn’t matter if the company is actually worth what its stock is valued at as long as investors keep passively buying the stock at a high price and driving it higher. And if this dynamic sounds familiar, it is: this is similar to how new investors in a Ponzi scheme keep the returns high for the older scheme participants.

The expansion of retirement account vehicles like the IRA and 401k, with their strong tax incentives coupled with the increased ease and lower costs of stock investing, have helped this trend grow. The big question is, when will the new money stop rolling in every month and the first investors start selling off more than they are investing? This turn of events could cause a partial collapse of stock valuation, create great losses, and leave the more recent investors waiting for long-term returns holding the bag – again, similar to the effects of a Ponzi scheme collapse.

It’s Not Really a Ponzi Scheme, Right?

Right. A Ponzi scheme is illegal, and there is nothing illegal about the investment vehicles I’ve just described. BUT, there are some Ponzi scheme dynamics at play in today’s market. I recognize that a large part of the amazing overall stock performance that I have enjoyed over the last three decades, particularly since 2009, is in no small part due to my fellow index fund investors who continue to invest in the stock market every month, regardless of performance.

While the stock market will continue to respond positively and negatively to economic events (e.g., COVID-19, an oil crisis, AI, interest rates, etc.), market drops are dampened and gains are propelled by the drumbeat of the monthly capital infusions from index funds.

I agree with the MorningStar MarketWatch assessment that the market is overvalued based on any measure. Much of this overvaluation can be attributed to the relentless monthly retirement stock investments (passive and active). This overvaluation should not pose a problem unless (until?) the infusions of new investments in the market become significantly less than the amounts being withdrawn by investors over a prolonged period.

To prevent this devaluation, we “older” investors need to keep encouraging new index fund investing among our fellow citizens until we have sold our shares. Then those investors will need to encourage future generations to do the same. The current structure of the stock market will continue to need new investors, investing monthly regardless of individual stocks’ performances, to keep that line on the graph moving upward.

So while I remain fully invested in the stock market, I also remain vigilant to mega trends that might indicate the tide is turning on the Ponzi-esque dynamics on the market from index fund investing.

My Top 10 Accounting Principles for Everyday Life

Accounting helps businesses track and organize financial information so business leaders can make informed decisions. Similarly in personal finance we all implement some level of accounting to help manage our finances to track, budget, spend, save, invest and file taxes. In a past life I managed multi-million dollar businesses with complex financial statements and taught basic accounting to US Air Force Officers. While individual people are not required to follow business accounting principles for their personal finance, key accounting concepts have helped me keep my personal financial path on course and helped me with many of life’s other important decisions. Here are my top 10:

Conservatism. When budgeting and forecasting (when exact numbers are not known), always estimate expenses on the higher side and estimate income on the low side. A conservative approach will build confidence in one’s financial plan. Having conservative estimates in our financial projections helped convince my wife and I that we could afford to quit our jobs and travel the world full-time.

Accounting Period. The accounting period is the timeframe (week, month, quarter, year, etc.) used for financial analysis and reporting. In my personal finance and rental business, I use a monthly period to track my expenses and an annual period for tax purposes. By tracking our spending and savings each month, my wife and I have a built in opportunity to discuss our finances and progress towards our goals and make adjustments. I use an annual period for net worth tracking update and taxes (since that is the IRS’s cycle) and we see our progress over time (e.g., year-over-year). Establishing the accounting period(s) helps me better manage my finances and apply the revenue recognition and matching principles.

Revenue Recognition. The revenue recognition principle requires that revenue should be reported when it is earned, rather than when the cash is received. So for example, a catering business who receives a deposit in December on a wedding for the following June, should not recognize that revenue until the accounting period of June occurs, which leads me to the…

Matching Principle*. The matching principle states that an expense should be reported (“matched”) in the same accounting period as the revenue generated by the expense. This allows for a better understanding of profit and loss in the accounting period (month or year). For example, when I book airfare or a month-long AirBnB in one year for future use in another year, I keep a separate spreadsheet to track these major expenses so I can account for the expenses in the month I actually used them and I have a better understanding of how much my nomadic traveling life is costing me. Note, I only do this for “major” expenses which leads me to the principle of…

Materiality. Something is considered material if omitting or misstating it would impact a reasonable user’s decision-making. The principle of materiality requires businesses to properly account for all material items. For example, the purchase of a single $30 alarm clock for a large hotel would not require depreciating (more on depreciation later) the asset even though it would last for many years. However, purchase of 500 $30 alarm clocks for the same hotel would likely be material as the $15,000 total expense could significantly impact the current month’s financial statements. In an FI example, closely tracking and managing small expenses (e.g. daily lattes) is material for someone in credit card debt, and/or little savings, and getting started in turning their financial situation around. For those at FI or well on their way, tracking every miniscule expense is likely immaterial for that person. While my expense tracking is automated with Mint, I don’t track small cash expenses like tips and small street food and drink purchases – it is not worth my time and immaterial to my FI success now that I am FI.

Depreciation. Depreciation is a reduction in the value of an asset with the passage of time, due to use, wear and tear, or obsolescence. Keeping depreciation in mind helps me understand how much the stuff I own (cars, furniture, outdoor gear, etc) loses value over time (often immediately after I buy it). Depreciation also makes me think about the amount of money I need to set aside in my emergency fund to replace major items that break or wear out over time. I also use depreciation to think about the value of what I buy over time. For example, if I decided to buy a $50K RV to live in full-time, I would not treat it in my tracking as a single housing expense in one month, but I would calculate the monthly depreciation expense of the RV over its useful life and consider only that portion to be my monthly housing expense.

Consistency. The consistency principle states that businesses must use the same accounting methods across accounting periods and financial statements or well-document any changes. Applied to your FI journey, maintaining consistency of how you track your finances will help you better identify areas for improvement as well as progress over time. For example, consistently tracking my alcohol expenditures separate from eating out and groceries, enabled me to see how much I was spending in this category and the significant cost reductions when my wife and I focused on having a drink at home on our deck instead of at a restaurant or bar.

Opportunity Cost. Possibly the most powerful financial concept on this list, opportunity cost is simply the loss of potential gain from other alternatives when one alternative is chosen. So my choice to maintain higher cash balances has an opportunity cost in terms of lost interest. For example, spending $200 at a fancy restaurant has the opportunity cost of lost long-term interest and dividends from investing the $190 (the other $10 spent eating at home instead). But likewise, investing all of my money in long-term stocks has an opportunity cost of lost flexibility (or potential financial loss). This concept also applies to my finite time on this planet and what I decide to do or not do and who I want to be. The hard part about opportunity cost is that it is often hard for me to see and value what I didn’t buy or do. For major decisions, I am in the habit of first asking myself what else could I do with this time and money before committing the resources. The answers frequently change my mind.

Cash Flow. Cash flow refers to the net balance of cash moving into and out of a business (or your personal finances) at a specific point in time. Cash flow enables a business (or a person) to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. For example, having cash on hand enables a business to take advantage of bulk-purchase discounts even though the item purchased may not bring in income for several months or years. For FI, I like to keep a good amount of cash available to handle my cash flow needs. For example, I use a large emergency fund to self-insure for auto comprehensive and collision, travel insurance, and extended warranty protections. To meet my cash flow needs, I keep a healthy balance in my checking and savings accounts to ensure I never have to worry about covering several credit card payments at once or making large advance purchase. Before starting my nomadic traveling, I was able to fund about 8 months of advance airline and AirBnB purchases so I could take advantage of discounts and lock-in preferred choices. If too much of my money was locked up in stocks or other long-term assets, I wouldn’t be able to cash flow my spending as easily.

Sunk Cost Fallacy. While not an accounting principle, no list of financial or business concepts should exclude the sunk cost fallacy. Simply, the sunk cost fallacy is our tendency to continue with an endeavor we’ve invested money, effort, or time into—even if the current costs outweigh the benefits. For example, the weight of spending well over $1,000 on my electric guitar, amp, and hours of lessons was keeping me from moving on even though I knew I no longer prioritized learning to play and wanted to travel and learn a language instead. This concept often applies to non-refundable purchases. If I had to miss a non-refundable show at the last minute the cost of that ticket is a sunk cost. This sunk cost should not impact my decision whether I should buy another ticket to the same show. I have to remind myself that purchases I made in the past should not prevent me from doing something different even if I can’t get my money (or time) back.

Accounting gets a bad rap being complex and boring, but it is really an important part of our financial lives and provides valuable tools to better understand and manage our finances. Like fractions and percents, everyone should have a basic foundation in accounting principles.

If you would like to learn more about the basics of accounting, the best method is taking an introduction to managerial accounting class, but since that may not fit your time or budget, there are some simple accounting books that, based on their online reviews, may help such as Wayne Label’s Accounting for Non-Accountants or Mike Piper’s Accounting Made Simple. Less-formally, search the internet for each principle above (Investopedia.com is pretty good) to find more details and examples of each. You are also welcome to drop me a question in the comments.

*A note on the matching principle. I technically use a cash-accounting system for my small rental business (integrated with my personal finances as a sole proprietorship) instead of an accrual accounting system most businesses use. As a result, I am required to report expenses (e.g., rental furnace replacement) and income (e.g., advance payment for rent) at the time I receive it for tax purposes. I use this requirement to my advantage. I plan my rental house improvements to fall in the tax year that I am trying to minimize my income, so my rental business has a lower profit in that year. Likewise, when my renters prepay their rent 6 months in advance (yes, I have some great renters!) I am able to ask them to pay on either December 31st or January 1st to enable me to recognize the revenue in the tax year I prefer. This helps me smooth out my taxable income fluctuations over tax years or help me maximize my Traditional to Roth IRA conversions in the 12% tax bracket for a particular year. This fluctuation would not follow the strict definition of the matching principle, but it allows me to “match” the expenses and revenue to my tax advantage.

Has the FIRE movement lost its way?

In a recent episode of ChooseFI podcast (a favorite of mine), a visiting host (Katie, from MoneyWithKatie.com) talked about buying “a very nice car [a pre-owned Porsche Macan with 8,000 miles].” She was quick to acknowledge that this decision was “breaking the cardinal sin of FI/RE” but the main ChooseFI host, Brad, quickly said that because it was something she “valued”, it was no problem.

Hmmm. Is this still a FI podcast? Are these hosts even interested in FI anymore? We need to talk about this.

Over on her blog, Katie justified the purchase because she could afford it (thanks to her many devoted FI-minded followers, it seems). Buying new (or nearly-new in this case) cars, let alone high-cost luxury cars, is well documented in the FI community as a financial mistake.

It should still be recognized as a financial mistake, regardless of the changes in her income.

She justified the purchase by claiming this was the least expensive car she had ever bought as a percentage of her income. No. It is still the most expensive car she’s ever bought because–and I would expect a personal finance blogger to be clear on this point–it costs tons more than any previous car she bought.

She wrote, “Sometimes I think we just want to buy nice things for ourselves. They become symbols of our hard work.” She’s not alone in using that logic, of course. That logic is why many Americans are in high credit card debt, thinking, “I work hard, so I deserve this purchase.” But she may be alone among FI-minded bloggers in trying to pass off this logic as somehow connected to FI. In the FI community, our hard work does not need a luxury status symbol to show off what we have accomplished (to ourselves or to others).

In short, I have a simple response to Katie’s position on her new Porsche:

Buy what you want, but don’t try to change the definition of FI to justify it.

Honestly, it doesn’t bother me that she bought a high-priced luxury car. She can spend her money anyway she wants. It bothers me that she used her FI platform to justify her purchase in non-FI ways.

She wrote about how much she enjoys her car purchase and how excited she is about it. If she were approaching this from an FI-minded perspective, she might notice that her Porsche is an example of the hedonic treadmill: We get a temporary high when we buy something, but the high soon wears off and the new thing becomes the new normal. What more will she need to buy in a couple of years to be a symbol of her hard work when the luster of the Porsche (and the warranty) wears off?

But enough about Katie and her Porsche.I am bothered even more that Brad, the main host of Choose FI, a podcast that has been a great source of FI information for many, claimed a new definition of FI: that she should buy what she “valued,” and since she could “afford” the car and wanted it, then sure, OK.

Really?

ChooseFI is an influential platform in the FI community and this justification of a luxury car purchase is going to be confusing to many who are striving toward FI.

The definition of FIRE (Financial Independence/Retire Early) or FI hasn’t changed. Controlling spending is still fundamental to FI, and buying a very expensive luxury car (or any similar item) isn’t a FI-minded decision, even if we’ve always wanted one.

True value-based decisions are, of course, an important part of FI. Getting the best quality for the best price is a very good idea. For example, buying a high quality skillet that will last longer and cost less in the long run than a cheap skillet that will need to be replaced one or more times. A Porsche Macan, however, is not. Katie described the car’s unreliable quality (it has already been into the shop for a cracked axle), high insurance costs, her concerns over knicks in the doors, paying more for garage parking because of weather concerns, etc. Does it represent a good value over time in how to move herself from one place to another? Of course not.

We should not confuse buying anything that a person desires as an inherently value-based decision or as the new definition of FI. This is a dangerous slippery slope: we could kick our self-justification machines into high gear and say, “This X (put name of your favorite high-priced consumer good here) is what I value because I deserve it as a symbol of my hard work” regardless of X’s true value and its impact on our FI progress.

And, if I can justify buying X, then I can also justify buying Y, and Z, and XX, and YY, and ZZ, and soon I’m back to square one with a closet full of rarely worn clothes, numerous subscriptions I don’t use, eating out frequently, daily lattes, etc., and I’m left to wonder where all my money goes each month. Did this redefinition work out for me? No, thank you.

Just Because I Can Afford It Doesn’t Mean I Should Buy It

FI is different for everyone. Some people don’t want to live an extremely lean life to get to retirement or while they’re in retirement. But also, we can’t undermine the importance of controlling expenses when pursuing FI. By limiting what we spend, we can more readily put aside enough money in investments to produce perpetual income to cover our expenses in retirement.

I first learned of this concept through Vicki Robin in her book Your Money or Your Life, and Mr. Money Mustache hammered it home for me in his popular blog. The core of their messages is that we need to learn what is enough and resist all of the shiny trinkets that the American marketing machine pushes on our society. The result is a good life that is also good for the wallet and good for the environment.

Don’t touch my daily latte!

The Porsche Macan isn’t the only indicator that there are leaders in the FI community who may be eroding the concept of controlling spending. I keep encountering FI blogs and podcasts that have “evolved” in their thinking, and they now embrace a buy-whatever-you-value mentality.

I first noticed the change in financial debates around the daily latte. With voices like Remit Sethi saying not to worry about the daily coffee expense (who Brad has echoed on ChooseFI). I have seen many blog commenters who ask “Why can’t I spend $5 or more a day on coffee in a disposable plastic cup? It is what I value!” Or, “$5 won’t make a difference in my retirement if I focus on earning thousands more in income instead.”

Many FI content creators appear to be persuaded by this pushback and have seemingly stopped mentioning the lattes, and softened their guidance on controlling costs for cutting subscriptions and eating out less often.

A basic tenant of FI is to spend less than you make. A person interested in pursuing FI needs to control spending somewhere and the non-essential categories like daily lattes — or any small luxury you indulge in on a regular basis, such as bottled water, fast food, beers at a bar — are a good first step.

The daily latte is simply a good example of how many Americans can quickly save some money to pay off debt and start an emergency fund. This advice may not be getting clicks or new listeners, but the original FI advice is still the solid, simple, effective advice that is going to help get a person to their FI number.

We could skip the daily latte and buy a decent coffee maker, get some quality coffee grounds and a reusable, good-for-the-environment coffee mug (with a no-spill lid), and make our own. We’ll achieve the same quality (if not better) coffee while saving money and making a better environmental decision as well. There is almost always a way to get the same or similar value for less money with a little bit of effort.

FI requires some effort and a bit of sacrifice

My favorite spending cuts are ones where you don’t end up losing much if any value from the cut back in spending (e.g., brew your own fresh coffee as mentioned, drink with friends at home on the patio/deck instead of at a bar, watch free movies through your town’s public library Kanopy account, negotiate discounts for the same service for less, etc.). Fundamentally, we need to control spending to make progress toward FI. Same as it’s always been.

But what if I just make more money, right?

Well, no. If we don’t control spending, additional income can disappear just as fast. This is well explained in The Millionaire Next Door, where a person making $400K or even $800K a year can still be living paycheck-to-paycheck and not build much, if any, wealth. Authors Dr. Stanley and Dr. Danko refer to these people as Under Accumulators of Wealth. No matter how much you make, there must be some control of spending.

Even doctors married to doctors have to put a limit on the number of boats they own, and amount spent on luxury cars, eating out, high-priced luxury real estate if they want to be able to stop working at some point and enjoy a fat FIRE lifestyle. Controlling spending is a key FI tenant, and we content providers in the community should not shy away from this.

We as a community need to continue to emphasize that controlling spending is essential to FI, even if it is not sexy or popular. Cutting daily $5 lattes is still a good example, and we need to help hold each other accountable on our discretionary spending so all of us can successfully make it to our FI goal.

FI content creators in particular need to keep the definition of FI focused on controlling spending and having enough. Let’s not dilute the definition of FI to justify buying whatever we want in the moment. People just finding FI for the first time deserve to hear from us what really works. Let’s keep it real.

*Photo by Kelly Sikkema on Unsplash

Calculating Functional Net Worth

Net worth is a key measure of building wealth. I have been calculating my net worth since 2011 so I can see my progress over time, and it’s a really useful tool.

Many people are familiar with calculating their net worth: you add up the value of all of your assets (e.g., stocks, bonds, real estate, and savings*), subtract your liabilities (mortgage, loans, and credit cards), and the difference is your (hopefully positive) net worth.

Of course, you may have other assets that are harder to account for in this formula. For example, a military pension. My military pension provides valuable monthly income and I believe it should be included in my net worth, but it doesn’t lend itself easily to asset valuation.

How to Calculate the Functional Net Worth

How do we calculate the value of a pension—or other benefit that provides monthly income (or reduces expenses)—and include that in our net worth? This is where my handy functional net worth calculation comes in.

To calculate the value of my pension, I use the 4% rule. This rule, first proposed by William Bengen in 1994 and validated in a 1998 Trinity University Study, is based on historical investment return research.

They found that investments in a combination of stocks (50-70%) and bonds (30-50%) historically returned 4%, annually adjusted for inflation, without running out of money over a 30-year period.

But Why Calculate the Functional Net Worth?

Before I get into the formulas, I’ll briefly explain why I believe Functional Net Worth is useful.

Many personal finance books, articles, and podcasts in the FI arena make the assumption that most assets are invested in stocks and bonds and real estate. Advice around diversification, spending limits, and other guidance often relates to a percentage of total assets invested.

But if I include additional assets, such as my military pension, I can treat the pension asset as a very stable (i.e., low risk) part of my portfolio. I can invest the cash portion of my portfolio in higher risk investments (e.g., stocks) as a result with less need for investing a large portion in lower-risk bonds.

When I view my entire net worth to include my stable (and inflation adjusted) military pension, the remaining portion of my investment portfolio can take on more risk.

Military Pension

Here is my calculation formula for my military pension:

annual gross pension income*25 or ((monthly gross pension income)*12)*25)

On my Excel spreadsheet the formula looks like this: =((XXXX*12)*25)

where XXXX is my monthly gross pension income

If monthly pension income is $3,500 per month, the calculation would be ((3500*12)*25) and would result in a pension value of $1,050,000 – yep, if you have a military pension paying you $3500 gross per month, you are a millionaire in my book.

This formula takes the annual gross income (before taxes) and multiplies it by 25, or multiplies the monthly gross income by 12 and then by 25.

Tax Exempt Benefits (e.g., VA Disability)

For tax exempt benefits like VA disability payments, the formula is a little bit more complex to account for the tax savings.

annual gross disability income*25 or ((monthly gross pension income)*12)/tax rate)*25)

On my Excel spreadsheet the formula looks like this: =((XXXX*12)/0.YY)*25

where XXXX is my monthly gross tax-exempt payment and YY is the tax rate subtracted from 100 (e.g., for 22% tax bracket the number would be 0.78, for 12% it would be 0.88).

If your monthly disability payment is $2000 per month in a 12% tax bracket, then the calculation would be =((2000*12)/0.88)*25 and would result in a disability value of $681,818. This number would be higher if you are in a higher tax bracket.

Military Healthcare Benefits

This same formula (minus the low annual TRICARE premium, if applicable) also works for calculating the net worth value of the military retiree lifetime healthcare benefits. To estimate this value, I estimate what I would pay for commercial healthcare, either through an employer or the state exchanges (adjusting for any subsidies I may qualify for).

With my military income, rental property income, and retirement account income, I wouldn’t qualify for much (if any) subsidy. For a $1500 unsubsidized monthly healthcare premium (using a 22% tax bracket), the functional net worth value would be ~$576,900.

Conclusion

Calculating functional net worth, not just net worth, is a very useful exercise for military retirees and others with pensions or disability payments.

By adding the projected value of pension income and other high-valued benefits into my net worth, I am able to better identify what portion of my FIRE number needs to be investments, and how those investments should be diversified.

I can also better manage the risks of my investments over time. Seeing the equivalent investment amount, I would need to provide similar inflation-based income, as my pension and health care benefits, is a valuable marker of the progress I have made toward achieving FIRE.

* I don’t include cars, furniture, clothing, or other household items in my net worth calculation, because I view them as depreciable expenses that will sell for much less than I purchased them for and will generally need to be replaced when sold.

The Meaning of “Millionaire”

When host Regis Philbin asked his game show contestants and audience “who wants to be a millionaire?,” he tapped into a belief many of us learned as children, that a million dollars was the pinnacle of financial success.

I grew up on the rural eastern side of Washington State, and many people I knew were (and still are) ritual lottery tickets buyers. Almost every week since the 1980s, these folks have purchased $1 to $5 of lottery tickets. They are buying the hope of becoming a millionaire.

Author Morgan Housel in his book The Psychology of Money asserted that “[w]hen most people say they want to be a millionaire, what they might actually mean is ‘I’d like to spend a million dollars.’ And that is literally the opposite of being a millionaire.” This statement helps frame a common misconception of what it really means to be a millionaire.

The common image of a millionaire is someone who owns some amazing stuff – high end sports car, mansion, designer clothes, annual golf club membership, First Class airfare, Rolex watch, nice boat, snowmobiles, etc., etc. But that image doesn’t account for living expenses. In day-to-day living, it just doesn’t work that way.

To illustrate this point, I decided to calculate how much money I have earned–and spent–in my 54 years of life (so far). I pulled up my taxable earnings from the online Social Security statement, then I added conservative estimates of military housing allowances, military pension, and other income sources. (Note that I did not include my wife’s earnings in this thought experiment–just mine.) Since I started working in high school (37 years ago – 30 years of full-time work), it turns out that I have earned over $3.6 million before taxes. Taking out an average of 15% tax (a very rough estimate of my lifetime tax rate to date) leaves me $3.1 million. Wow! I must be crazy rich!

Ah, but alas, I do not have $3.1 million in the bank. My wife and I have been good savers, but we still spent well over $2.5 million over those 37 years. We don’t own the glitzy stuff I mentioned. We have an ordinary house (with a mortgage), very used cars (19 years and 8 years old), clothes purchased with function and durability in mind, furnishing and appliances I have repaired and maintained, and my $28 watch is a trusty plastic Timex. No Rolexes here.

A lot of high-end stuff is purchased on credit. Our choice to avoid such purchases also means we’ve avoided consumer debt and its high interest rates. Excluding a lean period when I paid my way through college, I have never since carried a credit card balance or taken out any payday or other consumer loans. I paid off my student loans in my first year of full-time employment. (I recognize that college tuition has increased so much that I would need to dedicate more time and resources to pay off a comparable amount of debt today.) Other than our first car out of college (paid in full in two years), we have only paid cash for our (few) cars over the years.

So where did the $2.5 million go? Living life. Mortgage payments, food, transportation, raising kids, and other middle class life trappings. Some highlights that come to mind: we bought a $3500 used pop-up camper and enjoyed numerous fun family camping trips; we traveled abroad for two weeks each year over the 9 years before the pandemic, using home exchanges and travel rewards hacking to keep costs down. We paid our two kids’ college tuition (in-state rates). Once, with my wife’s parents, we enjoyed an amazing 5-star meal at the Inn at Little Washington for their 45^th wedding anniversary. Nothing too exorbitant (except maybe the 5-star restaurant – but hey, it was a 45^th anniversary!). Spending a million, or two and a half million in my case, over four decades is just not the same as the popular image of a millionaire – being rich.

So, $3.1M minus $2.5M… you might be asking, where did the remaining $600K go? I saved and invested it. Not very good investing, mind you, during the first 19 years (spoiler: we lost money), but in the last decade I got a little smarter and much luckier. Today my net worth is over 7 figures. Wow, a millionaire, right? But what about the plastic watch, old cars, and ordinary house (no master bath or garage)?

It was a tradeoff. Yes, I could have spent that $600K on unnecessary stuff. Instead, I decided to save and invest. I’m a millionaire because I have a million dollars of net worth. A major lottery win, big inheritance, or sensational entrepreneurial idea aside, it takes saving and investing, not spending, to become a millionaire and to stay a millionaire.

Since I didn’t trade that $600K for stuff, what did I trade it for? Time. I will spend most of this money saved to buy back years of my life without working. My investments will pay me enough every year to forgo having to work an additional 15 years from traditional retirement age. Since I’m retiring early, at some point in the future I may no longer be a millionaire (but I will have enough). Instead of a million dollars, I’ll have years of memories of pursuing my interests and spending time with my family.

We all have the same 24 hours a day, and the older I get, the more precious those hours feel. I’m choosing not to spend 40+ hours a week working to pay off debt as I buy more stuff for the garage and attic or spend it some other way. Instead, I will live my same simple, mostly frugal life with more hours every week to spend with family and friends, to learn, to explore, and to just be.

In a way, I feel like I won the lottery.

Taking the Leap — Living The FIgh Life

On August 28, 2020 at 5:47 pm, at age 52, I declared my financial independence (FI), packed up my personal belongings and left my GS-15 job at the Department of Defense after 9 years of civil service and 20 years of active duty. How was I feeling? As you can see from the below video, I felt great.

My financial path to this point started long ago with frugal living, focus on savings, and 28 years of investing (not always smart investing, mind you). Before we discovered FI, my wife and I travel hacked with home exchanges and credit card hacking, cut the cable cord, eliminated our home phone, switched to much cheaper cell phone plans, minimized subscriptions, drove old cars (2000 and 2003 respectively), but my FI journey can be clearly measured from just 2 years and 5 months before when I laid out a 5-year plan to quit my job for good and go to graduate school using my Post 9/11 GI Bill.

In April 2018, my son and I were touring a college campus on the last day of a week-long trip to the Pacific Northwest. On our trip home, I made a quip about not wanting to go back to work. My son, then a senior in high school, asked me, “why don’t you quit?” I told him that I didn’t have enough money to live on, and since Social Security was unreliable, I expected to work until I was 70. But he challenged that reasoning. “Why not live in another country where it’s less expensive?” he asked. This simple question was the beginning of my rethinking the parameters I had always accepted for how much money I needed to live.

I began searching for inexpensive countries for expats and found a long list that I could afford to live with good healthcare. One question led to another, and I was figuring out how much I needed to save to stop working. I had the Post 9/11 GI Bill benefits that would expire in 8 years, so I set 5 years as my goal to quit and go full-time to graduate school.

From that state of mind, it didn’t take long for me to find the FI community. I initially discovered The Money Habit blog and then the ChooseFI podcast that introduced me to numerous people thinking differently about money and time. I read their blogs, books, and articles, binged thousands of hours of FI-related content. I started closely tracking my spending with Mint and set-up numerous spreadsheets for monthly spending, cash flow scenarios, and how we would pay for our kids’ college after I quit.

Seeing the numbers changed everything. The more I learned and shared with my wife who pretty quickly came on board, the more we extricated unnecessary spending from our budget, and the faster our FI date came. I didn’t need 5 years. It now became more of finding the best way to offramp from work and begin my new life. In the Fall of 2019, I applied to graduate school.

Taking the Leap (my son is on the rock waiting to jump next)

Taking that calculated leap of faith to quit my job was exhilarating and reminded me of the time I jumped off a rock cliff on the North Shore of Hawaii. In 2017, we took a family vacation to Hawaii to visit where my daughter was born at Bellows Beach, Oahu, in the early 2000s. (She really was born at the beach, as we had a home birth on Bellows Air Force Station.) It was a great trip for so many reasons, but a highlight for me was a spur-of-the-moment decision to jump into the ocean from “The Rock” at Waimea Bay at sunset.

Tourists and locals jumping from “The Rock” — there was also a strong current warning sign — Photo Credit

When jumping off the rock cliff, I had to trust that others had successfully and safely made the leap. I had to understand the risks and determine that I was prepared physically and mentally. Leaving my career 15 years earlier than the traditional social security age required me to trust my numbers and recognize that many others in the FI community had already made this leap–I wasn’t alone. This community was more than great ideas to optimize investing, spending, taxes, safe withdrawal rates, and so much more. I found a community of support I could trust.

I found virtual mentors in Brad and Jonathan at ChooseFI, Paula Pant at Afford Anything, Joe Saul-Sehy at Stacking Benjamins, Brandon (a.k.a., the Mad Fientist) at the Financial Independence Podcast as well as their inspiring guests. I also read articles on blogs too numerous to list (shout out to Carson at Early Retirement Now), and read a pile of personal finance books, such as Vicki Robin’s Your Money or Your Life, J.L. Collins’ The Simple Path to Wealth, and Kristy Shen and Bryce Leung’s Quit Like a Millionaire. Each of these helped me confirm my numbers, but more importantly they helped me break loose from cultural constraints that were deeply ingrained in me.

I found my identity was closely wrapped up in my career, and it was hard to tell others (and myself ) that I would soon be unemployed. “What will you do?” was the common response. Being a graduate student helped me make the change by providing an acceptable transitional identity. “I’m going back to school,” I told people. I did two semesters during the pandemic, then decided I was done. Now I have developed the mental freedom to just say “I am financially independent.” Am I rich? no. But am I wealthy? More than I can count.