Most of you must have heard of the Marshmallow Experiment. Kids were put into a room and given one marshmallow by an adult. They were told they could eat it now or if they waited until the adult came back to the room they would get a second one. Follow-up studies revealed those kids who waited for the second marshmallow tended to have better life outcomes later as adults.
The lesson in the Marshmallow Experiment is delayed gratification. The point of waiting is to get a larger reward later. It’s the basis for saving and investing as opposed to spending the money on immediate consumption. Those who have the will and/or the means to wait end up better off.
We learn from the article Why Poor People Make Expensive Financial Decisions that if you must have cash from a $5,000 check today you’d have to pay a $100 fee whereas if you can tide over for only two or three days you would avoid the $100 fee. Those who prefer the here and now and those who are forced to prioritize the present pay a heavy penalty.
Contrasting the idea of delayed gratification is the concept of enough. It says when you have enough you stop looking for more. When it’s applied to early retirement and financial independence, practicing the concept of enough means you would become content and stop working for “the man” the soonest you have enough means to support your now content lifestyle.
It can be said the kids who ate the marshmallow without waiting for the second one actually practiced the concept of enough. One marshmallow was enough. They didn’t need a second.
Or it can be said those who declared enough early fell prey to instant gratification. They wanted it now at the cost of a larger reward later.
How do you reconcile between delayed gratification and enough? Wait for a larger reward but not forever. Smell the roses but not too soon.
Employment Income To Net Worth Ratio
Allow me to introduce the employment income to net worth ratio, EI/NW. The numerator in EI/NW is your after-tax income from working. It represents the percentage you can add to your net worth by working. It’s not just your annual savings. Living expenses are not deducted from your after-tax employment income because you will have living expenses whether you work or not.
There are two versions of EI/NW: the actual EI/NW and the required minimum EI/NW.
The actual EI/NW is how much you make after tax from working right now, relative to your net worth. If you make $100k after tax and your net worth is $200k, your actual EI/NW is 50%.
It in general goes down with your age and your net worth, in part because as you become older your net worth goes up and your income usually plateaus at some point. For instance, right out of college you don’t have much in net worth and your after-tax employment income is quite large relative to your net worth. As years go by, even though your income increases, your net worth increases even more. When you make $150k after tax and your net worth is now $1 million, your actual EI/NW drops from 50% to 15%.
The required minimum EI/NW is what percentage of your net worth you must earn to make you feel “worth it” for you to continue working. Right out of college when you don’t have a choice not to work, even if you make only 1% of your net worth you would still work. This 1% is your required minimum EI/NW.
The required minimum EI/NW in general goes up with your age and your net worth. All else being equal, the older you are, and the wealthier you are, working must offer a compelling addition to your net worth in order to keep you there; otherwise you’d do something else. With a $1 million net worth, 1% no longer cuts it. Maybe you require at least 10% now. At $2 million net worth, maybe even 10% doesn’t cut it, because now you have the choice to say no.
The required EI/NW goes up with your age and your net worth but it’s never infinity. When people say they have enough therefore they retire, it only means the offer in front of them isn’t sufficiently high. When you pay the asking fee you can get a former politician or CEO to show up at a corporate event. Even Warren Buffett auctions off a lunch for charity to the highest bidder. Given the right opportunity, a retired person can be convinced to unretire.
The required minimum EI/NW is also not static. If you identify with the work, you like the schedule and the people you are working with, you can set it low. If you hate it, you will set it high.
When you have your required minimum EI/NW going up with your age and your net worth and your actual EI/NW going down, they cross at some point. That’s when you retire!
This chart explains a lot of things we saw in the previous posts Early Retirement and Opportunity Cost and Staying In Your Job After Financial Independence. If you are still young, if you don’t have a large net worth yet, or if you like what you are doing, you set a low required minimum EI/NW. If you are already feeling the biological clock, if you already have a large net worth, or if you don’t find work meaningful, you set a high required minimum EI/NW. If you make a lot relative to your net worth, your actual EI/NW line will cross your required minimum EI/NW line later. If you don’t make much relative to your net worth anyway, it’s going to cross sooner.
The specific number for the required minimum EI/NW will vary by person, by age, by net worth, and by whether the person likes the work. Those who say enough simply have a high required minimum employment income to net worth ratio at their age and net worth. When their actual employment income to net worth ratio falls below the required ratio, they say they have enough. When they don’t make much anyway relative to their net worth, it’s completely understandable why they would quit. Many people who worked on Google’s self-driving cars quit even though they were paid very high in absolute dollars because the pay is relatively small to what they already have.
Those who stay on have an actual employment income to net worth ratio higher than their required minimum ratio. When they can double their net worth in three years for the next forty years and they enjoy the growth in their skills or the intellectual challenge, I don’t blame them for staying on.
If you are still working, what are your required minimum and actual employment income to net worth ratios?
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.