When Your Income From Investments Covers Your Living Expenses: The “Crossover Point”

About a month and a half ago, I read Your Money or Your Life and found it to be a relevatory experience (check out my review of the book). One particularly interesting part was a discussion of a concept that the authors referred to as the “crossover point.” Since then, I’ve seen reference to this concept in other places under other names, but I’ll continue to use the same name here.

What is the “crossover point”? The crossover point is the point at which your investments begin to earn more money than the cost of your living expenses. The crossover point is usually reached by keeping your living expenses lower than your income and investing that amount for the long term.

Let’s use Joe as an example. Joe is 30 years old and has a steady job where he makes $30,000 a year with a 4% annual raise. He commits himself to spending only 88% of his income each year and investing the other 12%. He puts that investment in a balanced portfolio which earns an average of 9% a year. Let’s see how this works for him:

Crossover Point Illustration

As you can see, each year Joe earns an amout equal to the point represented in dark blue, but spends only an amount equal to the point colored in yellow. He invests the difference between the two. For the first several years, it doesn’t seem to be doing him a whole lot of good: the pink dot represents the return on his total investment for the year (which Joe keeps rolling over into future investments). However, around age 50, this return on investment really starts taking off and, even though he’s spending more money than he was before, he’s still sticking to a 12% annual investment. At age 65, it finally happens: his investments return an amount greater than his living expenses for the year. He can continue with basically the same “salary” in perpetuity and never work again.

For many people, the “crossover point” is a major goal. It’s the point at which your gainful employment has absolutely no impact on your ability to live your life; you can simply walk away and do whatever you want. For some, this literally becomes their life goal; although I haven’t directly discussed it with him, I would speculate that my best friend is making lifestyle and investment choices so that he can reach his crossover point in his early 50s (according to my estimate).

Let’s look at another example, that of Fran. Fran has the same job as Joe, but is a very frugal lady: she’s committed to only spending 70% of her take home pay each year. Let’s see how she does:

Crossover Point Illustration

Fran reaches her crossover point at age 48, but chooses to keep on working. She has a second crossover at age 53 where her investment income exceeds her salary, but she keeps working. By age 65, her annual investment return is more than double her salary; she could quit, live off of even 70% of this, and more than double her living expenditures.

Awesome! I want in! There are two major challenges to achieving a crossover point that render it highly difficult in the modern world. First, it assumes a reasonably steady employment without any major crises, a giant assumption in the modern era. Second, it assumes that an individual is willing to constantly live below his or her means; in our consumerist world, very few people are willing to do this. Adding the two together makes for a nearly impossible task.

Of course, if you’re really willing to focus on overcoming these two obstacles over a long period of time, the crossover point can come earlier than you think.

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58 thoughts on “When Your Income From Investments Covers Your Living Expenses: The “Crossover Point”

  1. Chris says:

    I responded to another post earlier (about savings) with exactly this as my goal. I am only 22 right now, so I have lots of time to plan for this. I have calculated that I can hit my crossover point somewhere around 40 if I am very diligent about it. Kids and house and such will slow the amount I can save, but not by too much.

    Once I have capital building on itself, I’ll be home free. Any work I do would be pure gravy, making my investments grow even faster. That’s my goal.

  2. I’m not sure it’s always a major crisis or a willingness to live below ones means. There are a lot of people living on minimum wage (one you had mentioned a little while back) who really can’t live below his means right now. His best plan of attack is to expand income to leave room for one to save.

  3. MidnightUT says:

    Hey Trent,

    Have you thought about attaching your spreadsheets to this type of post? I’m not trying to be lazy, but I often try to recreate your examples with my own data and am uncertain if I got the formulas “just right”. I understand that you put a good amount of effort into figuring this stuff out and it might take more effort making it “user friendly” than its worth, so don’t hesitate to decline.

    Thanks for another great concept to ponder.

  4. Trent says:

    I may include spreadsheets for complex calculations. I’m somewhat hesitant to do it, though, mostly because ~I~ never trust spreadsheets from random blog postings, so I just assume that no one else would either.

  5. EMF says:

    I was able to come very close to the results of your spreadsheet with a few minutes effort. My “crossover” was a couple of years later, but my compounding was only at a resolution of one year.

    This confirmed what I had suspected — there is no consideration of inflation in this discussion. If you retire at the crossover point, your standard of living will erode away as the value of your constant earnings decrease.

    In order to keep up with inflation, a portion of the investment returns have to remain invested. If your investments return 9% but the inflation rate is 4.5%, one half of the investment return would need to remain invested.

    So Joe is not really ready to retire on investment income alone at age 65 even at a lower inflation rate of 3%, while Fran would be. Joe should hope that Social Security is still available so that he doesn’t have to use all his investment earnings.

    I suggest that the true crossover occurs when current income equals earnings decreased by the inflation rate times the value of your investment. Also to be considered is that when you retire you may want to allocate your investments more conservatively and the earnings rate will decrease.

  6. Trent says:

    Not true, EMF. If you are goal-oriented and you achieve the crossover point, you won’t be psychologically able to just sit there and do nothing. The point of the “crossover point” is that you’re suddenly free to just walk and do whatever you want with your time – and most goals that absorb a lot of time easily end up making money. For example, if I reach a crossover point, I’d walk out immediately and spend my time doing what I love to do most: writing.

  7. Tag says:

    “you can simply walk away and do whatever you want.” That’s the part I really like and the goal I am shooting for. Motivating post, thanks.

    Tag

  8. EMF says:

    Given the new information, I agree with you. At least in your case. Provided the income from your writing allows you to lower your withdrawals from your investments to compensate for the effects of inflation. Judging from this blog, could very well be the case.

    Hopefully the authors of “Your Money or Your Life” explain that adequately.

    It’s fortunate that I enjoy what I do, because while my savings are more than that of most people at my age, I’m still not at the crossover point, even the one adjusted not adjusted for inflation. A marriage to the wrong person set me back to zero in my 30′s and I’m still catching up.

  9. Leo says:

    @EMF: Actually, in a way, the graphs above are adjusted for inflation, although not explicitly … you can see that the income rises through the graphs, which would likely be partially due to inflation and partially due to lifestyle increases.

    The truth is that inflation is only a generalized statistic … if we are careful about our standard of living and our expenses, then our costs don’t have to rise at the same rate as inflation, as is explained in Your Money or Your Life. It’s all about careful choices.

  10. 60 in 3 says:

    Hey Trent, I don’t think relevatory is a word :)

    Other than that, I really enjoyed the article. Out of curiosity, have you calculated your own theoretical cross over age and if so, would you mind sharing that info?

    Gal

  11. Rick Dahl says:

    I created my own spreadsheet for this idea and found that the faster your wages rise, the more your investments have to return to keep the same crossover point. I did an example of saving 20% and using a 9% return. Assuming a 4% raise each year starting at 60K, the crossover point was 17 years after starting. Bump that raise up to 5% while not changing savings or returns and you have to work an extra 2-3 years. Makes you reconsider those extra nice raises.

    What I do when I get a nice raise, is to increase my contribution so my take home salary does little moving. If I get a 4% raise, I up my 401K contribution so I live off a 0-1% raise. While my standard of living doesn’t change now, it will definitely change in 30+ years.

  12. fubek says:

    I’m following that kind of plan for a couple of years now. I save about 43% off my gross income. And I don’t live below my “means”, I actually feel like I live like a king. I have everything I want, so actually I don’t sacrifice. Having a good income helps, though.

    I find that I spend significantly less than some worse-off people and still have a better quality of life than them.

    I had to find out what I get out of the money so I would not spend it stupidly, though. If something does not add to my quality of living, I don’t buy it.

    I’ll be at the crossover point in about 3.5 years. I’ll be 40 years at that time. I guess I will do some travelling afterwards and study the world. Sounds good, doesn’t it?

  13. Moneydork says:

    I’d love to have a copy of the spreadsheet. I’ve tried to simulate this myself but am a tool when it comes to spreadsheets.
    MD

  14. hnkelley says:

    @FUBEK: You make me sick, er, I mean, jealous!

    Seriously though, this is great information. I just did a basic run through (no spreadsheet) and found I’m contributing less than half what I should. Oh, and already, I cannot afford to buy a home (Pasadena is danged expensive). On the other hand, if I go with renting and up my contribution to what I want, retirement will be relatively easy, especially if I go with my plan of retiring as an expatriate to Spain, Hungary, or some place with a lower cost of living.

    Oh, and I second the motion for including your spreadsheets, PLEASE. I’m just not that good at the compound type calculations. As for trusting random documents, I’ll DL them at work, run them through their scan, then my own scan. :) I’m very thorough and have a good track record with that.

  15. Marian says:

    Hi Trent, maybe you could put the formulas that you have used in the spreadsheets of this example.
    I can’t figure out the investment curve.
    Many thanks.

  16. stayfly says:

    reaching and exceeding the crossover point is one of my main goals.

    right now I am also focused on paying off my mortgage and helping my Mum do the same as this will;
    1. this will dramatically increase my expenses (by $200 a week or more)
    2. help my Mum be in a comfortable financial situation

    best of luck to anyone pursuing this goal!

  17. What also works very well if you can find a low interest loan (in my case it’s a student loan) and invest it real early. Also, there are certain mutual funds, such as the Bruce fund or some of the european business funds, which yield close to 30% each year. I plan to have an initial investment of about 20K, and add 10% of my income each year. I will reach the crossover point VERY early, and it’s all because of that initial investment, which gives me a several year head start. I should be able to reach the crossover point in my 30′s.

    Honestly though, I was happy growing up poor, so I’ll probably just save the money for my children.

  18. Jason says:

    There is a third giant assumption – that returns from your investment portfolio hold steady at 9% a year. That can be true for 9 years out of 10, but a big market correction in that 10th year can wipe things out.

    Couple that with the first giant assumption of continuous employment at ever-increasing remuneration, and the smooth curves are really quite bogus.

    On top of that, there needs to be a good gap between what you save and what you invest, because you must build up cash reserves. Thus, the graph needs a fourth curve.

  19. Jork says:

    Yeah, so where do you invest to get 9% a year? I think this is an overly optimistic interest rate. Are any of you out there getting returns like this?

  20. Trent says:

    Jork: the Vanguard 500 index fund has returned over 12% annually on average since 1976.

  21. Joel says:

    I love this post, but I am overwhelmed trying to re-create the spreadsheet. Would anyone send me an excel file that I could use as a template? joelsnewton at gmail.com

  22. I made a simple calculator that solves for several variables talked about here…I did this really quick so it isn’t perfect.

    http://www.stanford.edu/~msethi/calc.html

    The values are confusing, so I’ll explain what they mean (also put your percentage values in DECIMAL POINTS i.e. 10% = .10)

    1. How much your investment is worth ==> the current value of your investment, i.e. how much total you have invested
    2. Total money earned — how much money you’ve earned total from income alone
    3. Total money saved — how much out of your income you’ve invested
    4. How much you made last year — what it sounds like
    5. How much your investment grossed last year — the interest rate * your total investment value
    6. Difference — #5 – #4, how much more you need per year to break even.

    Note that when you start at year 0, it assumes you have already made 1 years income and invested it for that year. So take that into acct.

    There might be some bugs…any future updates will occur at the same file.

  23. overlyoptimistic says:

    Trent, ‘on average` returns won’t work past the crossover point, when you will literally be relying on a constant stream of investment returns to pay the bills. Dipping into the savings to pay bills for a few years when investments are loosing money will cause the house of cards to collapse since it reduces future returns. Better to keep working past the crossover point and have two sources of income- my plan.

  24. Anders says:

    I guess the Crossover Point is closely related to what Neal Stephenson termed Fuck You Money in the novel Cryptonomicon – the point where you can safely say the F-word to your employer without fear of finanicial destruction…
    A lifelong dream of mine, by the way, but not one I’m at all close to making real…

  25. noko says:

    I’m quite shocked that most people don’t save at least a quarter of their salaries. I did this when I was making $25k and now pull mid six figures. I spend more of course, but not that much more and certainly not half of what I make. My portfolio has returned 10-11% averaged over the past 15 years with a diversified asset mix aimed at smoothing returns. I’ve also found that having solid investment returns has allowed me to take time off for training and turn a few bouts of bad luck into benefits. Its the main reason I’ve been able to double my salary four or five time over the past 10 years. Oddly enough, I don’t even own a house. I found a great rental deal for a beautiful home and have been there for years “throwing my money down a hole” as they say. Oddly enough, my net worth has nearly tripled during that period. I run the numbers a few times a year and when its cheaper to buy than rent, I’ll do that. I bought my first new car this year from dividends. I’m pretty average and not even close to a high flier, just steady and value-conscious. It does help to have a wife of the same ilk. I am curious, what could people possibly buy that would be better than financial security?

  26. Nate says:

    Trent: Maybe just share up the spreadsheets as Google Docs? People can get the formulas and such without worrying about random .xls from the internet.

    Also, while the VFINX has had 12% return annually over it’s lifetime, it is possible for it to have a bad year like anything else. I just looked it up and it looks like it’s been kicking butt over the last 1,3 and 5. However, on the 10yr it didn’t clear the required 9%.

  27. Owen says:

    Is it realistic that your spending will track your earnings as a direct proportion? I guess it would for some people but in my case as I earn more I don’t eat more or move to more expensive properties, or buy a less fuel efficient car. OK – maybe I go on more holidays.
    Nevertheless I think a major way of reaching the crossing point a little bit earlier would be to increase your lifestyle budget at a lower rate than your rate of increase in your income.

  28. noko says:

    Just thinking: one peculiar aspect of building a solid seven-figure portfolio is that generally you become extremely adverse to touching it. I’ve seen this in our friends as well. If you spend it, you won’t have it. If you spend the interest, you lose the compounding effect. This probably fades above $5m, but we’re not quite there yet. Also, to build it, you need ingrained habits: you must be value conscious; and you must always hold spending lower than revenue. At the same time, having the money to buy a Ferrari makes having one seem less desirable since having one would chisel away at the portfolio you’ve built (and oh my god, the upkeep on those puppies is ferocious). My wife often points out that she doesn’t feel wealthy. We’re not really. But, one thing is clear, we never worry about how we’re going to make a payment or anything else to do with money (not true, actually: we regularly sweep our spare cash into the portfolio and feel poor until cash builds up in the current account – just our habit). Generally, though, it feels like we control money rather than it controlling us. And when I think of money, I’m generally smiling.

  29. stretch says:

    If you are looking to make more than 9% on your investments check out “Start Late, Finish Rich” by David Bach. He does a great job of detailing how to achieve this.

  30. Brady says:

    You could import your spreadsheet to Google documents and make it public. Google does a good job importing, and then nobody has the fear of downloading it.

    Happy investing!

  31. Joel says:

    Another request for a spreadsheet. I’m trying to make my own, but it’s just not coming across right. Even a few tips at your calculations would be handy. Thanks! Motivating post. (especially for someone like myself who works for a non-profit and doesn’t get those nice 4% raises every year.)

  32. Doug says:

    I posted an example spreadsheet on google spreadsheets. It had an excel chart but apparently google documents can’t understand it, so you’ll have to recreate that part.

    It’s fun to play around with salary and contribution amounts to see where you stand.

    http://spreadsheets.google.com/pub?key=p6wV11QA4JWJINVZv–s7YQ

  33. Shawn says:

    I see one problem here (maybe someone already mentioned it).

    The moment you stop earning income and start spending investment income, you’re investment income stops growing.

    That pink curve stops going up the moment you tell your boss to f-off.

  34. Jonathan19 says:

    Other commenters are correct: You can’t just stop working at either crossover point. That 9% return just cannot be assumed. I would keep working for a couple of years, assuming decent returns, just to be sure I would have the income I wanted.
    Also, I think this assumes either very heavy investing (pre-crossover) or a very meager lifestyle (post-crossover). Difficult choice. With my family of 5 (soon to be 6), there’s not a lot of extra beyond our emergency savings. We could cut corners in places, but we do live what seems to me a pretty frugal life. Does anyone really want to tell their kids they can *never* go on vacation (etc).?
    On the flip side, I don’t really want to eat dog food in my retirement.
    Interesting concept, not sure how practical it is.

  35. Scott says:

    The guy that wrote “Rich Dad, Poor Dad” (Robert Kiyosaki (sp?)) made a board game called Cashflow that illustrates this principle. It’s kinda hard to find and tends to be a bit expensive, but is great fun.

    The goal of the game is to reach that crossover point where your “passive income” surpasses your expenses. He calls it escaping the Rat Race. It’s less investment based and more real esate based (a lot of buying rental properties and being silent partners in businesses), but the concepts are very similar. You get a pre-made set of debts, income, and expenses based on your “job” in the game, but the real point, once you grasp the mechanics, is to use your actual income, debts, and expenses and see if you can still escape the Rat Race, and in how much time.

  36. Pedro says:

    @Shawn: Yes, the pink curve stops going up the moment you tell your boss to f#$% off… The way our of this is to way a little longer so that your investment interest gives you the amount you spent plus an extra (which you will keep reinvesting). If you do that, the pink curve will never stop growing but it will just grow slower now. It will always keep above your spening curve since your interest is greater than the inflation (9%>4%).

  37. Owen says:

    Here’s my stab at Doing something like this with Google Spreadsheets. The graph looks ropey but the figures are fine.
    http://spreadsheets.google.com/ccc?key=pPXrdSQ5U4ZqBWecC01H8VA&hl=en_GB

  38. Dave says:

    So this is looking at the return of investment as income, not growth. So wouldn’t that be factored back into salary for the year?

  39. I like it. I think its quite right to have your long term goal to achieve this crossover point.

    I realized after reading this article, that this is actually my long term goal itself in someway. The crossover point basically requires high amount of stability in all terms though – basic and side income, which I believe is the only challenge here.

  40. Jeff Caylor says:

    Excellent post. Del.icio.us’d. Hopefully I can get out of debt soon enough to use this…

  41. I read “your money or your life” some 17 years ago. I followed what it said, and I have been living off my interest from my investments for ten years now! No job to go to, I do what I want when I want. It works and I am a good example of it.

  42. Oh one more thing! When you stop working, you stop driving to work, you stop spending the money it takes to support your having a job (jobs can be very expensive to maintain). You don’t have to live in commuting distance from a job anymore; I moved to area where it is less expensive to live (in a desert community) that I call “Home Base” and I can travel from there to where I wish. You have really got to read the book to understand the concept!

  43. McS says:

    “You don’t have to live in commuting distance from a job anymore; I moved to area where it is less expensive to live (in a desert community) that I call “Home Base” and I can travel from there to where I wish. You have really got to read the book to understand the concept!”

    Two things;

    1. The concept is very basic and barely okay. It only happens in very ideal situations. What if you had invested in the boom eras and not in the lows? Same is critical to when you withdrawal your funds. Do it at the wrong time and you will be broke 15 years ahead of schedule.

    2. Do you really want to live in a sandbox with the winner above me? Make your money work for you… really work for you…

  44. Yes most folks invest in boom eras, I invest when folks are selling. I went to the website from the above post “Wesabe” and it looks mighty nice and useful. I might even give it a go (I still have money to invest that I made following the advice in “Your Money or Your Life).
    As for living in a “sandbox” I live in the high desert of California in a place called Joshua Tree, where you can still see the stars at night and the air is clean. And I’m loving it!
    I write a column for a small newspaper there in my “spare time” (you can read it on my website). There are a lot of new things you can do when you don’t have a job and don’t need one.

  45. Scott says:

    EMF is right… this “cross-over” point is no “F U” point. If you quit at your cross-over point:

    + You now need to pay the capital gains taxes, so your spending must decrease by ~25% to avoid eating away the nest-egg, even without inflation.

    + As EMF pointed out, you can’t escape inflation…. the only way to keep your nest egg indefinitely is to keep actual dollar spending constant for the rest of your life, which means that every year your standard of living will decrease as inflation rises.

    Of course, you could avoid this by continuing to work at a lower paying, more fulfilling job…. or you could live with the fact that your nest-egg will erode, as long it outlives you, which may be the point of the article, after all.

  46. Trent says:

    However, at that point you no longer pay income tax. All you pay is the capital gains on your investments.

  47. Daniel says:

    I couldn’t understand some parts of this article o.us poetry, but I guess I just need to check some more resources regarding this, because it sounds interesting.

  48. Komissar says:

    Financial independence does not mean sitting like a vegetable staring at the wall with 0 income because you’ll soon go crazy if you do, watching the crap that passes for entertainment in the media.

    Financial independence means NOT DEPENDING ON A PAYCHECK TO SURVIVE FROM MONTH TO MONTH and put you in a position where if you miss two paychecks you’re living in a car. It buys you TIME to SELECT OPTIONS free from PRESSURE in your OWN DUE TIME. It liberates you from FEAR which is the whip the capitalist system uses to force you to do things you don’t want to do.

    Your savings income doesn’t mean if you quit working your work income will fall from 100% but rather from 100% to say a part time, writing, tutoring, hobby related income or something you like to do, which generates say 20% of your ex-full time income. Added to your investment income, this supplementary income can then compensate (or reduce) the gap between inflation and capital erosion since it can be capitalised.

    Likewise, costs will decrease since, you don’t need to throw money away buying Armani Suits, SUVs and gas to fill the beast in order to avoid being labelled a loser and ostracised by your fellow workers.

    This is why the purely statistical model doesn’t hold water. It indicates the BROAD CHOICES AVAILABLE to make broad lifestyle decisions.

    Finally you can live with a minor erosion effect if income dips below the crossover point when you are say 124 years old (which in other words means you still leave a nice fat inheritance for your “children” who will only be 76 ;).

  49. no says:

    I’m 30 years old and I’ve assumed for many years now that I’d probably be dead by 35. If I’m lucky, maybe 40. So these long term plans are not relevant. Even if I were to manage to live until the average lifespan of 72, what would be the point of reaching financial independence at the age of 60?! By the time you have reached this point, you’re too old to do anything BUT work. What are you going to do, retire and spend your final decade of life staring out the window of a motor home or playing bingo?

  50. @Owen, Nice work on that Google Spreadsheet.

    @no, Everything seems to change once you hit about 39. Just wait and see.

  51. phil says:

    what is in columns H, I and J.

  52. JR says:

    Owen – or someone else looking more deeply at this spreadsheet… Shouldn’t the first row formula for “TOTAL INVESTED” add both the “Initial Investment” (from cell M9) AND the “Money Invested” from the first year (in that same row) ? Looks like there are two solutions:

    1 – If you want to include the “money invested” in the current year – as the rest of the spreadsheet seems to do – than you can fix the “Total Invested” in F2 to be “initial investment” + “money invested” – that is M9 + E2.

    2 – If you want to include it in the following year , you could just change the formula in F3 to add in the “money invested” from the first row/year.

    I took option 1 in a copy that I made of this spreadsheet:
    http://spreadsheets.google.com/ccc?key=pO3Ze62OAU2GZyk-E9ar4fA&hl=en

    I also made some format fixes (changed ages to not be a currency field ;) and I added links to credit both the book and this blog… Owen should speak up if he wants a link back to his site ;)

  53. andrew brunsch says:

    I am a 14 year old investor just starting out! I made a spread sheet and calculated my “crossover point” to be when I am 32. Of course this is whle having the stock market going up 15% a year and everything buy I think it s very reachable. I am pumped about the idea. Good Luck to everybody with this dream!

  54. Dave says:

    What happens when a year or so after passing the cross-over point, the market drops 12-13% in a year? What if it does this 3 or 4 times over the first 10-12 years of your “retirement”?

  55. Kfish says:

    Not to harp on the point, but if you read the book, it explains that when you do make the shift, you need to get out of high-risk, high-growth investments into something with a lower, but guaranteed return. A lot of questions that people are asking here are answered fairly thoroughly in the book, which outlines the consequences of ‘crossover’ in great detail.

  56. Robert Taylor says:

    I created a template on Google Docs that will enable anyone to calculate their crossover point very easily.

    http://docs.google.com/previewtemplate?id=0AtDm4XtWaYwEdEhLZ3JiTmI0cDh3MkZyYm5SWTFYWXc&mode=public

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