“31 Days to Financial Independence” is an ongoing series that appears every Thursday on The Simple Dollar. You might want to start this series from the beginning!
The first three entries in this series started off in something of an unexpected place for people looking for solutions to their financial problems. Rather than digging right into the dollars and cents of the situation, we started off this journey by “zooming out” a little bit and looking at our lives as a whole. What do we want to do with our life? Why do we feel as though we’re spread so thin? What can we do about that?
The truth of the matter is that it’s very difficult to make any lasting change in your financial life if you’re spread too thin in the other areas of your life. Thus, the first step is to simply fix that state.
From there, now we can move onto the next steps, the foundational pieces of getting your financial life in order on top of a firm foundation.
It starts with your true hourly wage.
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So, what exactly is a “true” hourly wage? Most of us know what our hourly wage is for the work that we do, but what isn’t “true” about it?
While your hourly wage is how much you are paid for each hour you work, your true hourly wage is how much money you keep for each hour you devote to your work. That turns out to be a drastically different thing.
I first learned about this concept from the wonderful personal finance book Your Money or Your Life by Joe Dominguez and Vicki Robin, but over the years I’ve seen this idea pop up in my life in countless different ways.
The easiest way to demonstrate a “true” hourly wage is by example, so let’s dig into one.
Our friend John works 40 hours per week for 50 weeks a year. For that, he earns a salary of $40,000. So, if we do the math here, we’ll see that John works 2,000 hours per year (40 hours/week times 50 weeks/year), and thus earns $20 per hour at work ($40,000/year divided by 2,000 hours/year). That’s straightforward enough.
However, that doesn’t include the many other hours that John devotes to his job.
He has a half an hour commute to work and another half an hour commute from work, which adds five hours per week or 250 hours per year.
Once or twice a week, he spends two hours in the evening doing work-related tasks, which adds three hours per week or 150 hours per year.
Twice a year, he has to work an extra full day on a weekend, which adds 16 hours per year.
It’s basically mandated that he goes out to lunch with coworkers at least three times a week, which eats another hour out of his day, which adds three more hours per week or 150 hours per year.
We could add more things, but let’s just stop there. The truth is that instead of just working 2,000 hours per year, John actually devotes 2,566 hours per year to his job.
Now, what about that income? He makes $40,000 a year, right?
Well, he loses $4,000 of that immediately to federal income taxes and another $1,000 to state income taxes.
He spends $10 more on lunch three times a week than he otherwise would, which adds up to $1,500 per year ($10 times 3 lunches per week times 50 weeks per year).
He spends about $0.50 per mile during his commute for fuel, maintenance, registration, insurance, and depreciation. His commute is 15 miles each way, so he drives 30 miles a day for his commute, which means it costs him $15 per day. Multiply that by 5 days per week and 50 weeks per year and you wind up with $3,750 in annual expense.
He has to maintain a decent work wardrobe, which adds up to $250 a year.
Again, we could add more things to this scenario, but you get the idea. These extra job-related expenses are taking money out of his pocket – $10,500, to be exact.
Suddenly, rather than making $40,000 from working 2,000 hours, he’s actually making $29,500 from devoting 2,566 hours to his job.
His hourly wage on paper might be $20/hour, but his true hourly wage is $11.50/hour.
That’s painful to think about, and most people don’t want to think about it that way. The truth is that John is repeatedly trading away an hour of his life – his time, his energy, his focus – for $11.50. He does it over and over and over and over again.
(The truth is that the exchange rate is probably worse than that – we didn’t include nearly all of the factors that add “work time” nor did we include all of the factors that reduce the money that you actually keep.)
Knowing your true hourly wage is important for a bunch of reasons, but two really stand out.
First of all, it gives you a strong baseline as to whether something is worth your time. If John can spend an hour doing something that will save him $20, then it’s worth it to him. It’s far better than the true hourly rate he gets from the time devoted to his job. If he went just by his stated hourly wage, then such a task might not seem as good, but $20 an hour in his pocket is way better than the $11.50 an hour in his pocket that his real job gives him.
What I’ve found over the years is that knowing my true hourly wage really makes frugal tasks look quite good in terms of dollars and cents. There are tasks that, at first glance, I wouldn’t imagine would be worth the time, but when I actually thought about them and then considered my true hourly wage in comparison, they actually seemed pretty good.
Second, your true hourly wage lets you see how many hours of your life you’re exchanging for various goods. If John buys a $1,000 television, he previously thought that was just a little more than a week’s wages – $20 an hour times 50 hours equals $1,000. Not bad. However, the truth is that he’s only getting $11.50 per hour of his time and energy, which means he’s trading 87 hours of his life away for that television.
Those kinds of comparisons are even worse for small things. If your “true” hourly wage is just $8, for example, buying a $2 slice of pizza and a $2 beverage means you’re literally trading away half an hour of your life for that stuff.
For me, at least, those kinds of comparisons are downright agonizing. I do not want to be in the business of trading away chunks of my life for small, forgettable things. If I’m going to work for a large number of hours to be able to pocket the money to pay for something, I want that purchase to be a meaningful one. I don’t want to trade my life away for an endless string of forgotten little “treats” and relatively meaningless splurges.
Let’s step back now and take a look at your true hourly wage.
Exercise 4 – Calculating Your “True” Hourly Wage and Putting It to Work
To begin with, figure out how much money you made in the past year. You can do this by looking at last year’s tax returns or paychecks. You’ll also need to estimate, to the best of your ability, how many hours you worked last year. Don’t worry about adding in extra work – just focus on the hours spent in the office working on tasks.
Got that? Now, if you take that annual income and divide it by the number of hours worked, you have your approximate hourly wage… but that’s not your true hourly wage.
To get your true hourly wage, you’re going to have to walk through your life a little bit in order to figure out where you’ve spent extra time and spent money on things directly related to your job. The time you spent increases the hours you’ve devoted to work, while the money spent decreases the actual amount that makes it into your pocket.
I’m going to break these things down into a few categories. I suggest taking out a piece of paper and tabulating all of the time and money spent on these things throughout the year.
First of all, how much did you pay in state and federal income taxes? That’s money taken straight out of your pocket, so you need to include it.
Next, let’s look at the general area of commuting, something that most employees have to do.
How much time do you spend commuting each day? This includes things like walking or riding a bike or even riding mass transit.
How many miles do you drive? Once you know the daily mileage to and from work, you’ll want to multiply that by $0.58, which is the AAA estimate of the per-mile cost of operating a vehicle (gas, maintenance, oil, insurance, registration, depreciation, and so on).
How much do you pay for tollways?
How much do you pay for parking each day (or each month or year, depending on how you pay for it)?
If you have to use mass transit to get to and from work, what’s the daily cost for that?
Multiply those things by the number of workdays in a week, then the number of weeks that you work in a year. You’ll quickly see how much those factors add up.
What about taking work home or weekend work? Make sure you’re including that when you include your total number of work hours.
What about work clothes? You should include the cost things like makeup and briefcases and extra grooming and other such items here, as well as the time spent shopping for them and the time spent actually using them.
What about meals? How often do you go out to lunch or dinner with coworkers or with professional guests? What about entertaining for work, like hosting dinner parties? How often does your job force you to eat convenience foods, and what do they cost (think of a vending machine or a fast food stop)?
What about hired help? If you have to have child care in order to be able to work, then you absolutely need to include that expense. Maybe you also hire people to help with other household tasks like cleaning or laundry.
What about decompression and entertainment? How much “down time” do you need to unwind when you get home? What do you spend on entertainment during that “down time”? Do you use entertainment or other things to “escape” from your everyday life – and if you do, how much does that stuff cost and how much time does it eat up?
What about extra lifestyle expenses – things that you buy because you think you should because of your salary or status? Do you go on excessively expensive vacations because you can “afford” it or need to “escape”? Do you have to use a gym to keep in shape because your job is sedentary (I’d probably count the cost here, but I’ll leave the time involved at your discretion)? What about owning a “summer house” that you “escape” to every once in a while – what does that cost? Think about the extra lifestyle expenses you have in your life that are far beyond what you’d need to do for basic enjoyment.
What about other work expenses? Do you buy any books related to your career? Do you subscribe to any magazines or trade journals? How much time do you spend with these things because you think it’ll help your career (don’t count the time if it’s truly personal enrichment)?
As you can see, these expenses – both in terms of time and in terms of money – really add up. I strongly encourage you to go through each of these questions and think about whether those time and money expenses really exist in your life and, if they do, how much they add up to over the course of a year. If it’s a daily expense, multiply it by 5 (days per week) and then by 50 (weeks per year). If it’s a weekly expense, just multiply it by 50 (weeks per year).
Then, when you’ve calculated all of those numbers, add up the annual hours and annual expenses. Add the annual hours to the initial number that you estimated – the amount of hours actually spent at work – and then subtract the annual expenses from your annual income.
Then divide the two – take your adjusted annual income and divide it by your adjusted hours devoted to work.
That’s your true hourly wage. And it’s probably painful.
Most people don’t realize how little they’re willing to exchange an hour of their life for, yet over and over again you’re making that trade. You’re trading an hour of your life for that true hourly wage and you’re likely doing it 60-70 times a week (or even more).
That alone can be enough to make you strongly think about your career choices. Driving across town to make $10.50 an hour might be a worse move than working for $8 an hour at the gas station across the street, for example. It’s very possible that the gas station job across the street will leave more money in your pocket for each hour you work – in fact, I’d say it’s quite likely.
However, you might find an even bigger impact when using that true hourly wage to evaluate your purchases. This one can be a real life changer.
If you previously didn’t think about your true hourly wage at all, you might just see a $1,000 television as being a very expensive item, but one you’ll enjoy a lot. It’s bigger than that $500 television and would look great in your living room.
What if your true hourly wage is just $8 an hour, though?
That $1,000 television means you are devoting 125 hours of your life just to put that television in your living room. That doesn’t include the hours you’ll spend each month just to afford the programming on it – if you have a $100 cable bill, for instance, that’s 12.5 hours of your life gone just to have that cable package. Over the course of just one year, that’s 275 hours of your life that vanishes just to have this television.
On the other hand, maybe you stick with just that $500 television and, instead of cable, you just subscribe to Netflix for $9 a month. The television now costs you only 62.5 hours of your life, while Netflix is costing you only 1.125 hours of your life each month. This option is only costing you 76 hours of your life for a year of television.
The Big Follow-Up Question
The obvious question that people have from these calculations is what happens to the hours that I “save” by making better spending choices? In the example above, buying that less expensive television “saves” 200 hours out of my life this year, but in reality, we don’t directly see those hours. We don’t suddenly have 4 more hours of free time in a week if we make that choice.
So how does that pay off? It pays off in several ways that you don’t expect, actually.
First of all, it pays off in the form of reduced stress. Take that savings and put it aside for an emergency, like a car breakdown or a sudden job loss. Suddenly, you feel more secure about your day to day life – a little bit of the stress of walking the high wire is gone.
It pays off in the form of lower debts, which is the very first inkling you’ll get of the power of money over time. If you instead apply the hours you would have spent to get that big television and cable bill and instead apply them to paying down your debts, you’ll see that your debt payment gets smaller and the amount of interest you owe each month goes down, too. Your bills start to shrink, meaning you can devote fewer of your hours each month just to earning the money needed to keep afloat and you can spend more of your hours each month earning money for building the life you actually want.
In fact, that’s exactly how I like to look at my time spent working. I have to spend a certain amount of work time each week doing things to simply pay the bills and keep things going – my life expenses, in other words. The rest of my work time is spent earning the money I need to build the life I want. I want to spend less of my work time on merely paying the bills and covering basic life expenses and more time building the meaningful life I want – and I’m guessing you feel the exact same way. The easiest way to do that is to be conscious of what my purchases are actually costing me in terms of my working time.
Next time, we’re going to tie this “true hourly wage” concept directly to the life changes we talked about in the first few days of this journey. What are you really working for? We’re about to figure that out, and it will provide you with a rocket ship full of meaning and motivation for getting your financial life straight.