You’ll rev up your Money Machine – your well-oiled piece of equipment that churns and burns as it works for you, even when you don’t – by first creating what I call “dignity money.” This is the calculation of money you’ll need down the road in order to live a very minimal, luxury-free life each month. It’s your insurance, so to speak, against destitution – or ‘bag lady’. You can figure out how much dignity money you’ll personally need by determining the smallest amount that it will cost you to live each month. Add up what you spend each month for food, transportation, taxes, housing, telephone, utilities and insurance. Don’t include any frills.
One very important basic is your home. If you own your house or apartment, your mortgage or maintenance is likely to be one of your major expenses; it is perhaps your single greatest expense. Paying off your mortgage greatly reduces your monthly outlay and therefore reduces your total dignity-money requirement. For many women, eliminating mortgage debt is an essential step to achieving financial independence. Calculate your dignity-money needs both ways-with a mortgage and without. Depending on the current size and condition of your Money Machine, you may find that financial independence may arrive for you only after the mortgage is paid, whether that date is five, ten, or more years from now. Of course, the sooner the better!
Your dignity-money calculation can be a rough number; that’s okay. It might be $1,000 a month or $10,000. Each person’s sum will be different. In any event, your dignity-money figure is the target level of income for the first stage of creating your financial freedom. Your goal is to generate this amount of cash from your Money Machine each month going forward so you won’t have anxiety about the basic care of yourself in the future. If you already have your dignity money, then you can feel at ease. Knowing that you’re financially secure should give you a good feeling all over and relieve whatever stressful flutters you might have had about money. If you have yet to establish your dignity money, then it’s time to begin working toward it. Believe me, no outing, new trinket, or other toy is worth the cost of not taking this step.
How do you figure out how much your Money Machine needs in order to generate your dignity money? The calculation is simple. Multiply your monthly dignity money number that you’ve calculated by 12; then add a 0. This provides an estimate of how much money you’ll need to invest in order to generate the appropriate monthly income. For example, if your minimal monthly expenses are $4,000, then multiply $4,000 by 12 and add a 0. That means your yearly expenses will total $48,000. Your Money Machine will need $480,000 in order to provide you with dignity money. Why? At $4,000 a month, your yearly expenses will total $48,000. The rate of return on investments varies, of course, but history shows that a conservatively well-tended Money Machine should yield approximately 10 percent each year. This means that your Money Machine will need $480,000 in order to pay you an annual income at the rate of 10 percent per year, or $48,000.
The same formula-monthly expenses times 12, plus a 0-works for any expense level. If your minimal monthly expenses are $6,000, your Money Machine should contain $720,000: $6,000 times 12 is $72,000; adding a 0 brings it to $720,000. If your monthly expenses are $1,500, then you’ll need $180,000 in your Money Machine. Do your own calculation.
This calculation requires one important adjustment-deductions based on the inflation rate. Inflation gradually shrinks your money’s value. Therefore, whatever figure you compute will be worth less in the future. Consequently, the amount in your Money Machine will have to be somewhat greater to compensate for the effects of inflation. Unfortunately, no one can know for sure how high the inflation rate will be in the future. A high inflation rate, like the one we experienced in the 1970s, will have a strongly negative effect on the value of the money generated by your Money Machine. The moderate inflation we’ve had so far during the 1990s (averaging around 3 percent a year) isn’t nearly so powerful. The power of inflation grows significantly as time passes. If you are only one or two years away from the time when you plan to ease out of working, inflation will have little effect on your plans. But if you expect to work for two or three more decades, inflation will make a noticeable difference.
Let’s say you calculate your dignity money to be a whopping $600,000. That seems like a lot of money to feed to your Money Machine, and the thought of how to amass such an amount might be daunting. But if you save this $600,000 gradually, rather than all at once, it will be much less intimidating.
Consider Rachel Levine, Lynn Attwood and Betty Scott as they envisioned their financial pictures.
Rachel is the assistant museum curator who lives with her husband in a house they’re fixing up in Dallas. Rachel earns $30,000 a year. When I met her, with her discreet diamond earrings and self-assured air, I imagined that Rachel had already begun to build a financial future for herself. I was wrong. Once we warmed to each other in the hot tub at the Ranch, she easily confessed that her fiscal future was tottering a bit and asked what she could do at her age, starting with the $10,000 she and her husband had squirreled away in money market funds. Rachel and I chatted about the dignity-money concept, and she concluded that she and her husband would want to have $600,000 in their Money Machine. Here’s a closer look at how Rachel and David can accumulate the dignity money they’ll be looking for in later years.
Rachel enjoys museum work, and David enjoys his work, too. So they see themselves working into their mid-sixties. That’s about thirty-six years from today. Using the Rule of 72, we calculate that if their money grows at an average annual rate of 10 percent (a conservative average return on stocks), it will double every 7.2 years. In thirty-six years, when they reach sixty-six, their current $10,000 investment can double five times:
o $10,000 3 2 = $20,000
o $20,000 3 2 = $40,000
o $40,000 3 2 = $80,000
o $80,000 3 2 = $160,000
o $160,000 3 2 = $320,000 at age 66
So with their current savings of $10,000 alone, they’re halfway to their goal! Now all they need to do is squirrel away some money each month in order to meet the other half of their goal. It is likely Rachel’s income will increase with raises, promotions, and career moves, and David’s contracting business is expanding rapidly. This should dramatically raise his annual profits. As the Levines eventually accumulate more cash to invest, their Money Machine will gain more steam. Another plus: They have only about $50,000 left to pay on their mortgage, so they will own their house by the time they want to ease out of working full-time.
Lynn Attwood said: ‘To grow my own dignity money, I estimate that I will probably need to put $700,000 in my Money Machine. That means I’ll have $70,000 a year to live on.” To advance to the next step-to live more freely, to travel several times a year, and to entertain and frolic without guilt at some of her favorite stores-in other words, to maintain her present lifestyle-she will have to have more cash invested in her Money Machine – in excess of $1 million. And she likes to dream even bigger, and is inspired for several million dollars. The important thing to note is that creating the Money Machine begins with securing your financial necessities and then moving on. And the tools are at hand to make this process easier than our fears would lead us to believe.
Betty Scott figures she’ll need less dignity money than Lynn does. She earns $76,000 a year as an attorney at a small public-interest firm that specializes in environmental law. Betty grasps the principle of spending less than you earn and investing the difference and is prepared to do exactly that. Right now, her basic, no-frills monthly expenses total $3,500. That means her Money Machine will have to contain $420,000 to establish her dignity money. “If I cut back my expenses, I think I can eventually squeeze out $10,000 to invest,” Betty announced. “That means you have to really shave those credit cards,” I reminded her. But if Betty is able to commit $10,000 a year to her Money Machine, she’ll be in great shape by the time she’s sixty-five. The benefits of securing income from your Money Machine are pretty obvious. It’s possible to handle it all along the way and still have a good time enjoying life as you go.