If I were to ask you how much money you make per hour, you’d probably come back at me with a smart-aleck reply that didn’t answer my question at all, because money is a very personal topic. But in your head you’ve probably got a pretty good idea. If you earn an hourly wage at work, that number is probably right on the tip of your tongue. If you get paid a salary, you’d have to do some quick math to figure it out. If you earn bonuses you might need help from a calculator.
But this number you’ve arrived at is not an accurate representation of what you make. You probably think of what you make in terms of a “gross” amount, i.e. “I make $12.75 an hour”. But there are taxes on that money that reduce your take-home pay. You might consider your take-home pay as being your “net” income. But I’m not even talking about that number.
Pretend you own a small business. Businesses exist to “make” money, which is defined as profit. When a business collects revenue, it’s entered into the accounting software under “income”. But that’s not profit. Expenses have to be figured into the equation. In order to figure out what the profit from the business was, you have to subtract the cost of running that business from the amount of revenue the business took in. When you think about whether to buy a new copier for your business, do you think about the total revenue your company brings in? Maybe if you’re an employee of the company who is managing the budget. But if you’re the owner, I guarantee you would think about how much that copier is going to eat into the profit margin, because it’s the profit that you’re going to take out as your income.
A “Valuable” Exercise
Warning! This section will require a little bit of number crunching, so brace yourself!
If you take the example above and transpose it over to your personal finances, you’ll arrive at an hourly wage that is much lower than your net income. How does one go about this task? Easy! Become an accountant!
Juuust kidding. All you need to do is grab yourself an Excel spreadsheet or a blank notepad and get started:
- Enter your gross hourly wage at the top of the list (for our fictitious example, we’re going to use $15/hour)
- Subtract your taxes (that leaves our hypothetical example at around $12.75)
- List all the categories from your budget (you DO have a budget, right?) that are required for you to maintain your job, like this:
- Commuting – Auto ownership, insurance, fuel, parking, repairs ($140/wk)
- Clothing – Clothing costs, cleaning, shoes, jewelry, etc. ($30/wk)
- Meals out – Eating out, convenience foods, vending machines, sodas ($50/wk)
- Starbucks/other coffee – Would you really buy this stuff if you didn’t have a job? ($10/wk)
- De-stressing activities – Relaxing in front of TV or internet, hitting the gym, happy hour, etc. ($40/wk)
- Vacations – Expensive trips to “get away” and “recharge” ($1000/year or $20/wk)
- Other – Housekeeping, yardwork, handyman, daycare, etc. ($25/wk)
- Assign a number to each in terms of weekly cost, add these all up, then divide that number by 40, assuming you typically work a 40-hour work week (for our example, that comes to $7.875 in our example)
- Subtract this number from your after-tax example above to get your REAL hourly wage ($4.87/hr)
Our Perspective Influences Our Buying Decisions
Many people go through life totally ignorant of just how much the “stuff” they own costs them. For example, if you knew that the next time you grab a Venti Decaf Soy Mocha Latte at your favorite caffeine store you would have to work for one solid hour in order to earn that money back, I’m guessing that it would influence your purchasing decision. Or, in terms of a larger purchasing decision, think about your mortgage, or your car, or the new golf clubs you absolutely can’t live without!
The authors of Your Money or Your Life, who first introduced me to this way of thinking, translate this “adjusted hourly wage” into the very useful term “life energy”, and it helps to think about it that way. When you work at your job you are trading your life energy for a salary, which is then traded for goods or services. Gaining an accurate perspective on just how much of your life energy it takes to obtain that next gadget or gizmo will aid you in making wise decisions on how best to use your hard-earned money.
This exercise also impressed on me how important it is to keep expenses as low as possible. That cable bill I’d been paying? It was costing me 16 hours of life energy every month! Nice restaurants for my wife and I? 6 hours of life energy for one meal! It was amazing how my mindset shifted overnight. Interestingly enough it didn’t cause me to resent the bills I continued paying, it actually made me appreciate them more, because I knew that those items were worth it for me to continue receiving them.
How This Number Could Affect Your Retirement
As you can probably imagine, if you weren’t working at a job at all, you’d have an extremely low income from said job (i.e. zero) but you would also be able to reduce several of the expenses that you currently have on the other side of the ledger. So when thinking about Financial Independence, it stands to reason that your target savings is probably lower than you might think. If you live on $50,000/year currently, then perhaps $30,000/year is all it would take for you to achieve FI, if you didn’t have to work the way you do now.
In my case, I don’t think I would be able to stop working entirely even if I did achieve FI, but I would probably tailor my work to be something I could do out of my house, keeping job-related expenses low. That side of things is still out in the future a bit for me, but I’d love to be making those kinds of decisions very soon.
What about you? Does this exercise change the way you think about, and ultimately how you decide to use your income?