When I was first out of college and back in Chicago, it took me two years to find my first professional job. I filled the time trying and failing to launch an advertising agency and working for a landscaper. The first gave me something to put on my resume, the second put some much-needed money in my pocket.
That first professional job, when it came, paid the princely sum of $10,000 per year. They had originally offered $8500. Despite being bold enough (and that was pretty bold given I had no other prospects) to negotiate the higher salary, I still sat at my desk the first week or so wondering what I could possibly do for this company that would be worth ten thousand dollars!
Around this time I became friends with John P, a guy about my same age. From his grandfather, John had inherited a portfolio of stocks that produced an income of just about my salary: $10,000 per year. I remember thinking what a beautiful thing this was. Here was a guy who had all his living expenses covered and who was completely free to choose whatever path appealed, unburdened by the pedestrian need to earn money for food and shelter.
I lost touch with John when he moved to New York City. I often wonder how things turned out for him.
But as for me, his situation planted in my head for the first time the idea of having investments to do the heavy lifting of paying for life’s expenses. It would be a few years yet before I came across the term F-you Money and had a name for what had become my ambition.
Since I was groping blindly about in the dark and index funds were just being invented (and even once the news reached me I would still stupidly reject them for years), reaching this goal took far longer than it should have. Far longer than it will for the astute readers here.
But I’ve always wondered what it would have been like to have John P’s head start. Like him, would I have been smart enough to follow his grandfather’s advice and live on the investment returns, using the inheritance as a platform from which to build? I like to think so. It is certainly the advice I’d give to someone on the receiving end of such luck. Someone like Lars.
Just as I have little use for people who whine about not getting the breaks they think they should, I have even less use for those who fail to appreciate those breaks that come their way.
But Lars recognizes his good fortune and, as you’ll see, is busy making more of his own and is ready to work at making both pay off. Plus he presents an interesting scenario to explore.
Lars and his questions showed up in Ask jlcollinsnh last week. Here is our conversation:
Lars:
Jim,
I love your blog. I’ve read every single part of your “stocks” series, and send them to friends who ask me questions about investments.
I am a mid-20s man about to enter a very good financial situation via marriage to a great woman, also in her mid-20s.
We are both fairly thrifty and are completely debt-free. We have college degrees and steady jobs. We each have reliable, working cars that are paid-in-full. Our annual combined salary is about $125k, but will probably drop to $70k as we have children in the next few years.
Because a family member started a successful company years ago, we will receive about $6-7k per quarter in cash dividends.
We have already saved about $100k in combined 401k/IRA retirement savings (in VTSAX and index funds, thanks to your blog) and are maxing out our 401K/IRA accounts every year.
We have about $75k in combined cash savings. We don’t own a home or any other noteworthy assets. We live fairly frugally, and save about 40-50% of our after-tax income, and we plan to continue to do so in marriage.
Here are the details again in bullet form:
Total debt (student, credit, mortgage): $0
Combined annual salary (before tax): about $125k
Annual cash dividend: $25k (or $6-7k quarterly)
Current combined retirement savings: $100k
Current Cash savings: $75k
I know we have too much cash on hand, and I want to invest it. We’re not interested in buying a home soon, we would rather rent for a while. How would you invest our current cash on hand ($75k) as soon as we get married and how would you continue to invest $6-7k quarterly?
Any other investment allocation or other life-planning advice is MUCH appreciated.
Lars
The Good Fortune Buddha:
Shall we rub his belly or invest?
jlcollinsnh:
Welcome Lars…
…and thanks for the kind words and for passing the blog on to your friends. That’s the highest praise of all.
One of my pet peeves is people who look at the asset building strategies discussed here and dismiss them as accessible only to those who are very lucky.
You certainly appear to have been luckier than many who write me. But to your credit you are not squandering the luck that has come your way. Far too many would, followed by their complaints of how unfair life is.
So kudos!
The biggest risk I see for you is the lure of lifestyle inflation.
So my first suggestion would be to cap your spending at 35k, half the income you’ll have when the kids start coming. Or, if you are feeling really badass, live solely on that ~25k dividend and invest all your earnings. Then let your lifestyle expand only at the pace those investments grow.
That said, it sounds like you’ve already nailed my nine steps as described here: How I failed my daughter and A Simple Path-to-Wealth
Well done!
If you haven’t already, take a look at this: My Path for my Kid: The First 10 Years
While it seems you’re hitting most all these already, it never hurts to review as an aid for staying the course.
The 75k in cash I’d put into VTSAX. With your dual incomes and cash flow you can afford to have little or no emergency fund. This is especially true since you don’t own a house. Since houses require a relentless parade of often expensive repairs, they are the single biggest generators of the need for emergency cash.
While I am blissfully back to being a renter now, I’ve owned houses for over 3o years. In each case, I’m glad I did. But only because I wanted the lifestyle at the time. They are an expensive indulgence and as such should only be bought if and when that indulgence is worth the price and the price is one you can easily afford.
That may well be when your kids are around school age and school districts become critically important. But be sure to read this first, if only to be sure you enter homeownership with your eyes wide open: Why your house is a terrible investment
Then to be sure you fully understand the financial ramifications in your particular situation, run the numbers as explained here: Rent v Owning, opportunity cost and running the numbers.
VTSAX is also where I’d put your investable cash flow, either from those dividends and your saved income or from all your income as you live on the dividends.
First, of course, fully fund your 401k and deducible IRA accounts.
Congratulations on your upcoming marriage and the awesome financial start!
Lars:
Awesome advice Jim, thanks for the attention. Love your idea about living off the dividends.
Clarifying question: would you invest the $75k in VTSAX in one lump purchase, or would you space it out somehow using dollar cost averaging? If so, is there a DCA time-segment strategy you would use in our case? (i.e. $5k every month for 15 months).
jlcollinsnh:
Glad you like the living off the dividends idea, Lars. That’s what I’d do personally and it is what will get you to financial freedom fastest.
As for DCA (dollar cost averaging), I am not a fan. For three reasons:
1. It messes with your allocation. Initially with DCA you are way too cash heavy and then over time the balence shifts. Better to simply decide what allocation works best for your situation and then implement and maintain it.
2. You have a 50% chance of it working against you. If the market rises while you are DCA you’ll be paying progressively more for your shares. Of course, it could work the other way and by choosing DCA you are betting it will. So basically you are predicting the direction of the market in the short-term. That’s market timing and market timing is a loser’s game.
3. Since you are in the wealth building stage, as you invest new money over the months and years you are in fact stuck with a de facto DCA situation. This one you can’t avoid, but no sense adding to it with your cash on hand.
Make sense?
Lars:
I’ve never heard that reasoning against DCA, but it helps me feel better about dumping the money into VTSAX as a lump sum. It’s basically a bet that the index will be higher in 20-30 years than it is now. I’ll take that bet.
Thanks A TON for your help.
jlcollinsnh:
Yeah, DCA is one of those popular things designed to make people feel more comfortable without fully understanding the implications. This might help: Investing in a Raging Bull
It is far better in my view to take a little time to understand the market and how it really works.
Addendum #1: For more on luck and good fortune….
You make your own luck by JD Roth
What poker, basketball and Mike Whitaker taught me about luck
