How would you live your life if you knew you were the owner of a money machine that perpetually put out enough for you to cover your expenses, year after year without having to work? As long as you maintain the machine, it keeps pumping out money to cover what you need to live.
Pretty fabulous isn’t it?
The concept of the perpetual money machine is essentially the bedrock concept of the FI community. Your perpetual money machine is the portfolio of investments that will fund your retirement. With enough money, that’s invested simply (meaning, no genius level stock picking or speculation) over time, you can safely withdraw about 4% yearly and still maintain the machine’s cash regeneration abilities. That stockpile will have enough firepower as an investment to maintain itself since you will only be skimming a little bit off the top. Essentially, you live off of your investments and the machine can still feed itself to maintain it all.
So, how can you build your money making machine? First, calculate your numbers.
The money-making machine is unique to each person in terms of how big it needs to be. How much money will you need in the machine to ensure it runs properly? To calculate your money machine number, do your best to estimate your annual expenses and multiply it by 25.
The number you land on (25x your annual expenses) will make up the total portfolio value needed to build the machine for passive income building. This number doesn’t include the value of your home or anything that counts as an asset but doesn’t generate cash (like a car, jewelry or gold doubloons you have buried in the yard)–so, unfortunately, your machine is simply comprised of cold hard cash that generates more cash, usually by being invested in low-cost (meaning low-fee) index funds.
If you’re curious–many in the FI community are somewhat fanatical about the money-making machine being invested in low-cost index funds (VTSAX) with Vanguard. Though, if you’re not jazzed about Vanguard, you can also take advantage of lower expense ratios with Schwab and Fidelity.
Related: How To Calculate Your Savings Rate
Okay, Now What? Save & Invest To Build The Machine
After you calculate how much you’ll need to save, you can work backward to cut expenses and work your way up to a much heralded 40% (or more!) savings rate.
Your goal will be to cut your cash hoarding timeline down by being strategic about your expenses. Cut any unnecessary recurring expenses and any excesses you don’t need. The more you can put away early, the easier it will become for the machine to be fully operational and self-sustaining so you can retire and begin your withdrawals.
Take any cash you can save and put it into low-cost index funds and wait. While most people are tempted to touch their funds or move them around to try and guess the market trends, to time the market is futile. Don’t hit it and quit it, put your money in and sit on it–for years.
If that’s not enough action for you, you can do your best to find ways to get your savings rate up and your taxable income down with tax optimization strategies.
How Do You Determine How Much You Need In The Machine?
While 25x your annual expenses seems pretty straightforward, it gives most of us plenty to ponder over. How much do you really need to be happy? Figuring out your personal number and how you’ll get there is highly personal. What factors do you need to take into consideration to properly tool your machine in your post FI life? There can be a lot that goes into the math to help you arrive at your specific number.
Some factors to consider:
– Will your primary residence be paid off by the time you reach FI?
– How old will your children be when you reach FI?
– Do you have any special health considerations that could impact your number?
– Would you consider relocating to a cheaper location later in life? How could this impact the total amount you need to save?
– How will your taxable income change over time?
This is just the tip of the iceberg in terms of planning. Nobody can anticipate every factor that could impact their finances in the future, but it shouldn’t keep you from getting started in building your own perpetual money machine that will fund your post-retirement life.
As your money making machine becomes more powerful, you can begin to explore other levers to pull and hacks to power your growth to save more and spend less. Tricks like tax optimization, geo-arbitrage, side hustling will help you build your machine faster and reach a point you can let it work its magic to fund your post-retirement life.
- Vanguard Vs Fidelity–Which Company Is The Right For You?
- Beginner’s Guide To Reaching Financial Independence