A few months ago, I discussed the crossover point, the dollar amount you need so that proceeds from your investments exceed your living expenses. Here’s a visual example:
In the above graph, the person is investing 30% of their income each year and receives a 4% raise each year. That person reaches a crossover point at age 48 (crossing over living expenses) and a second one at age 53 (crossing over salary).
Why do I show you this? For some people, the crossover point makes a brilliant long term investment goal, one that can be broken down into smaller pieces over time. In fact, it’s a wonderful example of how to set and reach a long term financial goal. Let’s take a closer look.
First of all, define the larger goal. You want to reach the crossover point for your salary in twenty years? How much will that take? Take your current salary and multiply it by 1.04 times the number of years until you want to cross over – that’s the salary you need to shoot for. So, if you make $40,000 now and want to reach that crossover point in twenty years, you’re actually looking at a salary of $87,600 at that time. Assuming your investment will need an 8% annual return (you can figure higher, but this is a nice safe number to make sure you don’t start devouring your principal when you cross over), you’ll need to have $1.1 million in investments in twenty years to reach that crossover point.
Next, define the general gameplan. What percentage of your salary would you have to invest each year at that 10% rate to reach the crossover point in twenty years? It turns out you’d have to invest 36% of your salary each year, something that’s doable but very challenging. Can we break it down even more?
If you look at a month-long goal, you’ll have to save 3% of your annual salary each month, or $1,200. You can break it down even further to $300 a week. If you’re making $40,000 a year and have a low cost of living, can you sock away $300 a week? My best friend is actually doing something close to this, so I know it can be done.
Then, focus on the short term. One good way to approach this goal is to use nothing more than that weekly metric. Try to beat it every week by as much as you can so that during weeks where things crop up, you can deal with them. Each week, when you make that $300 (and especially when you blow by it), you can feel a sense of accomplishment.
How can I do that $300 a week when I’m barely getting by? Learn about frugality. Start cooking at home. Cut out unnecessary monthly expenses. Get out of all of your debts and don’t get back into debt. You also may have to define a different goal – look at a crossover point that’s further out, or simply define another goal entirely – perhaps a net worth of a certain amount by a certain birthday.
One big advantage to this type of goal is that it’s very flexible. If you’re moving towards this goal for five years, but then suddenly decide to get married and have children, you’ve got enough cash for a monster down payment. If you suddenly decide to start your own business, you have seed money.
A certain net worth is a great goal to have – it’s very tangible and lets you move towards it steadily, at your own pace. The way to make it work, though, is to make it immediate and stay vigilant.