I’ve been using a model that assumes static wages over 30 years, and while that is unrealistic, it is useful to observe the how one’s financial status changes due to the investing strategy and not due to any other variables. But I have put together models that take the perpetual concept and apply it to different situations. Since everyone is going to have their own unique financial situation, I again have to simplify the model to a degree that isn’t going to be directly applicable to your own situation, but these models do assume incremental increase in wages.
For these models, they start with annual wages at $30k and increase by $15k every 5 years. Again, that doesn’t perfectly reflect reality, but it helps account for increase in wages over time due to better paying jobs as we gain more skills, along with inflation pushing the nominal rate of wages up over time.
I set up 4 different models here:
2% Contribution Rate, 3% Contribution Rate, Tiered Percentage Method, & Target Income Method.
The 2% & 3% Contribution Rate Strategies:
The first two are primarily the same and most reflect the model we have been using: they start with a contribution rate of 5% of wages and increase by either 2 or 3 percent each year. The 2% method is basically the same as the static income model, but it now accounts for the increases in wages and starts off at a lower wage amount. Since the increase in wages tops out at $105k for years 26-30, this means the nominal amount of contributions increase over time and thus at year 30, we’re contributing $66k of our $105k, but we’re also starting the year off with $61k and have an annual budget of $100k. We also still have an investing balance over $1.3 Million as well. Again it’s not too much higher than the static model since the first 10 years, we were making less than $50k like we were for the static model.
The 3% is directly comparable to the 2% method; choosing between the two is determined by what you value more: more money today or more money in the future. The 2% slowly increases the contribution rate so you don’t feel the pinch of investing as hard and requires minimal effort to sow the seeds that help establish long-term sustainability. But if you’re willing to take it up a notch and want to fuel the perpetual engine forward, then just increasing the contribution rate by 1% annually can have a notable impact. For instance, at year 30, you will now be contributing 92% of your income, $96k, into the fund, meanwhile you start the year off with almost $87k and a total budget of $95k, which means you start out with 91% of your annual budget. The 3% method not only gives you more of your wages upfront over the 2% method, but also gives you a higher investment balance. At year 30, you would be projected to have $1.9 Million in investments. Over those 30 years, you would have earned $2 Million in wages, and would have spent $1.7 Million with the 2% method and $1.5 Million with the 3% method.
Tiered Percentage Method:
This method takes out the annual increase in contribution rates, but waits until the years with wage increases. It can start at any rate you like, but I chose this as a method for those who want to jump in at a higher contribution rate and are willing to sacrifice early to have higher benefits in the future. Thus the contribution rate starts at 40% and stays at that rate until year 6 when wages bump from $30k to $45k. When that happens, the contribution rate increases by 10% to 50% and again stays there from year 6 to year 10. Once wages increase to $60k, contributions increase to 60%. Through this method, the hardest year we experience is year 11 when we get that pay raise but also increase our contribution rate. In that year we have a budget of $35k, which is 58% the value of how much we made in wages that year, but while it’s the lowest percentage of our wages that we get to spend over those 30 years, it comes during a pay raise, so we still have a budget increase of 9.89% over the previous year when we were able to spend just under $32k.
As we move to year 30, we’re making $105k in wages, of which we’re investing 90% of our wages, but we’re starting the year off with $118k! That $118k plus the $10.5k we keep in wages means that we have an annual budget of $129k even though our wages were $105k, a 23% increase over how much we actually made in wages that year. Not only that, our investment portfolio sits at just under $2.6 Million. Over those 30 years, we got to consume $1.65 Million, thus it sits in between the amounts we could spend in the 2% and 3% methods, but still have more than $500k in additional investment funds than the 3% method. That is because this method trades short term consumption for more consumption later on. This could appeal to those who are trying to achieve the “Financially Independent, Retire Early” (FIRE) goal.
Target Income Method:
The final model I’ve created so far is one that is probably most suited for reality. The Target Income Method switches the contribution amount being dependent on the quantity of wages to being dependent on how much is left over after achieving a predetermined budget amount. Like the Tiered Method, you can adjust the numbers to your own preference, but I have the model currently set up that it starts with the target budget value being 75% of wages, and then increases the value by 3% annually along with 15% bumps when wages increase.
To demonstrate, in year 1, we make $30k in wages, and thus 75% of $30k means we are aiming to live on $22.5k. Since we are set to spend $22.5k, that means we’ll have $7,500 to invest that year. For year 2, we’re going to increase our budget by 3% and thus 103% of last year’s budget is $23,175. We still started the year cashing out $396, so our budget is comprised of $396 from investment returns and $22,779 from wages. That leaves $7,221 to invest for year 2.
When we jump to year 30, we’re aiming to live on $82,395 while making $105k that year. But here’s the interesting part: we are set to cash out $112k. Since this exceeds what we’re planning on spending that year, what that means is we don’t even need to cash out the whole 5% and instead just leave it in the investment fund. This not only leaves more money in the fund to continue to grow exponentially, but that also means less capital gains tax we are incurring.
By preserving more of our portfolio, this could also be observed as technically our contribution is not only 100% of our $105k, but also $30k from our own investment returns, with a total investment of $135k for the year. That high rate of contributions later on means that we would be sitting on an investment fund of $2.5 Million.
Why I think this is best suited for reality is that it doesn’t matter what happens in the economy or stock market, as long as you’re not out of a job, you have a sliding scale of where your money comes from. In years where the market was doing well, we get to cash out a higher percentage of our budget from returns and get to put more of our wages into investing. When the market is down, we hold more of the investment while we consume more of our income. The target income stabilizes our life in that we know what we’re going to have in a given year regardless of what happens in the world around us.
Comparing the methods
Here is a breakdown of year-by-year the value difference between the 4 methods:
I’ve invested a lot of time laying the groundwork for this theory of perpetual value generation, but I had to simply the model to make it easier to explain. We can now see that once that basic understanding of how money can have sustainable life cycle, we can shape it to our own unique preferences and needs. We can keep most of the benefit today and not worry about trying to build up a huge nest egg, or we can sacrifice a little bit more today for more stability down the road. We can make the progression consistent, or we can make jumps ahead when it’s more convenient, or we can just define what we want to live on and invest what’s left over and provide ourselves with complete stability. It doesn’t really matter which path you take, they all move you forward to transitioning you out of a single-use consumption of income to a perpetual state of value generation.