YMOYL Chapter 8: The Crossover Point

For new readers: This is an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life that we're running throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

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We've got just two more chapters to go, and just a few transitions left to make in our thinking about money. And the key mental shift readers make in Chapter 8 is to change how we think about savings:

"Before FI thinking takes over, a 'normal' person might regard savings as earmarked for a splurge in the future--a down payment on a bigger house or a whizbang vacation towards the ends of the earth." (p. 236)

This quote is only partly right. Most "normal" people don't save any money at all, so when they "regard savings" it's an exercise in pure fantasy.

Your case, however, is different. Now that you're executing the steps of YMOYL, you're consistently saving excess cash every month. It's a regular habit for you.

But even people who have built a habit saving money can slip into being what I call vague savers: people who save money inconsistently, who periodically vaporize their savings on big splurges, or who save in an undirected way without clear and concrete goals. Don't get me wrong: vague saving beats not saving at all, but it's still a wage-slave based approach to handling your wealth. I want you to aim higher.

And that's why YMOYL uses a different word for that money you're socking away every month. They call it capital.

"Savings are funds put aside from time to time and kept unexpended. Capital, however, is money that makes you more money. Capital is money that keeps working for you, that produces an income as surely as your job produces income." (p. 237)

You're probably already nodding your head at the concept, so let's go over an example: Let's say that after months of patiently applying the YMOYL steps, you amass a savings cache of $20,000. Again, the proverbial "normal person" might see that money as a kickass family trip to New Zealand, or (slightly more responsibly) as a big step towards a down payment on a big new house.

As a financially savvy YMOYL reader, you might also choose either of those options--but only if that choice provided fulfillment and value in proportion to life energy spent. Furthermore, you grasp instinctively that neither a big new house nor an overpriced trip to New Zealand gets you any closer to freedom from work-spend.

However--and this is the important part--if you invested that $20,000 at a hypothetical 4% yield, you'd create $800 a year (or $67 a month) in brand new income. Forever.

In other words, YMOYL readers instinctively view sums of money using this formula:

Money   x   Yield   =   Potential Passive Income

Thus in our example of $20,000, we'd have:

$20,000   x   4%   =   $800 per year, or $67 per month.

One more important insight: when you piss away your capital on some splurge-related expense, you don't just bear the direct cost of the thing you splurged on. You also bear the opportunity cost of forgoing all future income you could have earned on that money. You lose out twice: you lose the twenty grand, and you also lose that yearly $800 in future passive income.

Train yourself to think about money this way. If you can make spending decisions with an eye to the opportunity cost of your capital, it is merely a matter of time before you become wealthy.

Problems and Pitfalls With The Long Term Interest Rate
Now, let's spend a moment addressing how Chapter 8 lays out the concept of "Monthly Investment Income." Remember, in this chapter you're adding an extra element to your Wall Chart: income from your investments. And to start off tracking this number, the authors give readers a shortcut: just take the capital you've currently saved, multiply it by 4%, and put that number on your chart. Next month, add in any new money you've saved, and apply 4% to that number. And so on.

If you've only just begun saving money, feel free to use this shortcut. But please recognize that this 4% is hypothetical. To paraphrase a Wall Street saying: you can't eat a hypothetical yield. At some point--soon, I hope--you'll want to begin making income-generating investments and earning actual income.

If you're a more advanced reader who's already earning investment income in the form of dividends, interest and so on, skip this step and just plot your actual earnings.

One other point. Some readers may consider the "4% shortcut" misleading. After all, there's no real explanation anywhere in the chapter about how to generate this hypothetical 4%--and worse, now that we're in a bizarre low interest rate environment, risk-free investments like bank CDs and long-term government bonds pay way less than 4%.

All true. Frankly, this is a flaw in the book's investment strategy: it simply isn't designed for periods of ultra-low interest rates. Fortunately, this flaw--which we'll discuss in much more depth next chapter--isn't fatal. It's still reasonable to earn a 4%-ish yield (or perhaps even better) with a diversified, conservative portfolio of dividend-paying stocks, preferred stocks, municipal bonds and bond funds. You'll have to take on some risk, but not a terrible amount of risk. More on this next week.

For now, just remember that interest rates fluctuate, and eventually, we will return to a more "normal" interest rate environment. Most importantly, don't let worries about interest rates sidetrack you from the central point of Chapter 8: Think of your swiftly-growing pile of savings as capital, and use it to generate income. This is the key step that will eventually free you from dependency on work.

The Crossover Point
Okay. The final concept of Chapter 8 is the Crossover Point.

You've already wrapped your mind around the strategy of making money from your money. Now, simply let the months go by while you patiently and relentlessly execute the YMOYL process.

What you'll start to see is rapid and accelerating growth of your capital as you steadily add savings each and every month. Start putting that money to work, and you'll begin to see similarly accelerating growth in income from your investments. With a combination of investment compounding and disciplined execution of the steps, your "Income from Investments" line on your Wall Chart will gradually and inexorably rise, until it approaches your "Total Monthly Expenses" line.

This process will unfold over time and, at first, things will move slowly. But you never know what the future may bring. You're highly likely to increase your job-related income. You might also drive your expenses far lower as you seek creative ways to align your spending with your values. Combine both, and this process may move more quickly than you ever imagined.

"The Crossover Point provides us with our final definition of Financial Independence. At the crossover point, where monthly investment income crosses above monthly expenses, you will be financially independent in the traditional sense of the term. You will have a safe, steady income for life from a source other than a job." (p. 241)

Do you see what you've been building towards? Can you now visualize your progression towards financial independence as you stay patient and continue to follow the steps?

If I know my readers, I'm betting there are some very bright lightbulbs going on and off in your brains right now as the reality of The Crossover Point sinks in. You don't necessarily have to start laughing and crying at the same time like "Steve" the carpenter (p. 245!), but be sure to take some time to enjoy the insights and implications of this process. You will be working for a finite time. Remember this, and remember how far you've come in your journey to take back your power over money.

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Appendix/Side Thoughts:
1) "I'll never get to the Crossover Point. This is just too depressing to think about." Some readers might feel like they're so far away from the Crossover Point that they dread even getting started. I empathize.

But indulge me for a moment and consider another perspective: You've allowed yourself to become pre-emptively depressed about something that you're too defeatist even to try. Reread that sentence and think about its hideous circularity.

Forget what's in the distance, and just start earning some money from your money. Just start. Don't worry that it's a small amount. Don't worry that your "Income from Investments" line is literally a mile below your "Total Monthly Expenses" line. And don't worry that the process might take a long time. That's all fear and ego. Forget all that. Keep it simple, keep doing the YMOYL steps, and keep plotting numbers on your Wall Chart. It all will happen in time. Don't get ahead of yourself.

One final thought: if you're still seriously getting depressed thinking about the Crossover Point, consider the possibility that you either haven't paid close enough attention while reading the book or you haven't sincerely done the exercises. Read the book again--and this time do the exercises. Commit to it.

And if I may offer a prediction: you'll be astonished at how much faster the process goes than you currently think it will.

2) On subjective reality and money: This point is related to Side Thought #1. Reality can be surprisingly subjective. If you believe you won't ever save up enough money to become independent from work, you're correct: you won't. However, if you believe you will reach this goal--and if you take steady and concrete steps to accomplish it, you'll also be correct: you will. Never permit pre-emptive defeat.

3) Scale benefits of passive income: The best part about passive income is its near-frictionless scalability. Consider two FI-ers, one with $10,000 in capital saved and another with $20,000. Both will do exactly the same amount of "work" investing their capital--yet the investor with twenty grand earns double the investment income from her capital.

This scalability exists at nearly every level of personal net worth: it takes about the same amount of effort to manage a diversified portfolio of stocks whether you have a million dollars or tens of millions of dollars. And this concept holds true in the institutional investment world too: oddly enough, it's actually somewhat easier to manage a multi-billion dollar stock portfolio than a stock portfolio in the $10-100 million dollar range. (Extra credit for readers who can reason through why this is true.)

Here's the point: Once you start saving aggressively and putting your money to work for you, you can earn surprisingly meaningful amounts of passive income for very little incremental effort. Get going, so you can take advantage of it.

4) "For those wishing to go all the way to Financial Independence" Note the nuance in this quote, which appears in the middle of page 245. Just because financial independence seems preposterously far into the future doesn't mean you can't use this process to achieve other important goals. You can use YMOYL to get on top of your debts, to find more breathing room between your income and your spending, to rethink your work and your life, and to put your spending and consumption in alignment with your values. And so on. It doesn't all have to be geared toward financial independence alone.

Moreover, as the book says, "financial independence is the by-product of following the steps. You don't need to have financial self-sufficiency as your goal in order to arrive there." (p. 247).

Most importantly, don't throw the book across the room and miss out on all the value in it just because financial independence seems too far off to bother with. That's no different from our acquaintance who threw the book away after some blurb about cutting her own hair set her off.

5) "This doesn't mean you must stop working for money." (p. 251): Yet another nuance: just because you earn enough money from investments to quit work doesn't mean you have to. In fact, you might keep right on working--and enjoy your work far more. After all, you're there by choice.

6) A personal note on re-reading YMOYL: I've mentioned before that when Laura and I first read YMOYL ten years ago [Edit: make that 15 years ago], the book had an enormous impact on us. But it's been an even bigger surprise to experience this book's impact on us now that we're reading it a second time.

I wonder if we got a little bit financially overconfident, and allowed some of the principles of this book to "wear off" and slip away over time. Certainly our spending slipped out of alignment with our values over the past few years, and--no coincidence--we've had more disputes and disagreements about money in the past few years than is normal for us.

But this re-reading of YMOYL is helping bring things back into focus. Our spending is now in far better alignment with our values. Laura and I have successfully hashed out quite a few money issues as we've re-read the book together. And we're back to saving money each month, nearly effortlessly--despite the fact that I'm now retired, and Laura's only working part time.

There are a couple of major takeaways here. One big one: YMOYL works over a vast range of income levels. It worked when I was making medium-sized money on Wall Street, and it works just as well now at a fraction of our prior peak income. Another key takeaway, at least for me: it pays to stay humble about maintaining a lifestyle that's consistent with your principles. Things can slip out of alignment more easily than you might think, especially since we're all literally surrounded by a culture of consumerism. It's all too easy to slip back into old, unconscious patterns and habits.

Hmmm. Something tells me we may want to re-read it again--in ten more years.


Next: The Fatal Problem with Chapter 9






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