Finding Your Financial Tipping Point

I’ve recently been reading Malcolm Gladwell’s book, The Tipping Point. It’s a fascinating read that in a nutshell, explains how messages, trends and behaviors “go viral”. How small acts and events build upon each other until they reach a critical mass (the tipping point) where they simply take off and become something much larger than the sum of its parts. In the book he uses examples such as Paul Revere’s ride,  the spread of a fashion trend and how a single person can start a “word of mouth” movement for a restaurant they’re a fan of.

As I was reading the book I couldn’t help but think of how the concept of the tipping point relates to our investing habits. We’re all aware it exists, and have probably read hundreds of articles mentioning the power of compound interest which is another example of the tipping point theory in action.

The Tipping Point For Financial Independence

Financial independence should be a goal for each of us in one way or another. Reaching a point in life where you can do what you want in life without having to worry about the financial aspect of it.

So the tipping point for financial independence would be the point where your investments are creating more income than you have in expenses. How much money do we need to reach that point? $1,000,000?! $10,000,000?!

You need much less if you listen to Berkshire Hathaway Vice-Chairman Charlie Munger. He’s famously quoted as saying “The first $100,000 is a bitch” (Which, in hindsight, would have made a much better name for this website)

To expand on that a bit, he’s quoted in the book Damn Right: Behind The Scenes With Berkshire Hathaway Billionaire Charlie Munger as saying:

Munger has said that accumulating the first $100,000 from a standing start, with no seed money, is the most difficult part of building wealth. Making the first million was the next big hurdle. To do that a person must consistently underspend his income. Getting wealthy, he explains, is like rolling a snowball. It helps to start on top of a long hill—start early and try to roll that snowball for a very long time. It helps to live a long life.

The historical dividend yield of the S&P 500 is around 3.26%. That means if you had $100,000 you could earn $3260 per year, or $9 per day from a simple index fund. Just for the simple act of waking up and not getting hit by a bus. If you re-invested  those dividends into more shares you’d really have the power of compounding working for you and be on your way to reaching financial independence.

So while I can’t argue with Mr. Munger that $100,000 is where you really start to be able to see the true power of your investments at work, I’m guessing most of us have yearly expenses totaling more than $3000 per year. So we’re still a way off from our goal of reaching the tipping point of having our investments create more income than we have in expenses.

The First Million is the Hardest

A portfolio of $1,000,000 would provide you with over $32,000 purely in dividends. The average American family spends about $49,000 per year, but the average American family is financially illiterate. If you have your sights set on financial independence and can’t get your yearly expenses lower than $32k per year, you’re doing it wrong. This is why I use $1,000,000 as a very generic tipping point for financial independence.

There are obviously problems with the number. For simplicity’s sake I’ve used the historic dividend yield of the S&P 500 for these numbers. No one (hopefully) has their entire portfolio invested completely in an S&P 500 index fund. Income investors, who are laser focused on creating income from their investments focus on creating a portfolio of stocks, bonds and other investments that will have a much higher dividend yield than the “average”, thus providing them with more income from a smaller amount invested.

Everyone also has differing expenses. Pete, better known as Mr. Money Mustache, was able to retire in his 30’s and had expenses of just over $25,000 for his entire family. If you’re single you may be able to live on less, if you have a family you’ll probably spend more.

This example also assumes the entirety of your portfolio income is coming from dividends. There are countless other ways to create both investment, and passive income. FI Fighter is well on his way to financial independence and retirement at the ripe old age of 30 by creating a small empire of rental properties to produce the income he’ll need.  Sam, at Financial Samurai has created a successful online business to supplement his investment and real estate income in early retirement.

The important thing is to have a firm grasp on how much money you’ll need to cover your projected living expenses. Tools like Personal Capital and Mint make this really simple, allowing you to analyze your finances from any angle you can imagine. Once you have a grasp on how much money you’ll need to generate, you can work on reaching the number at which your financial situation will “tip” and your investments will be creating enough money for you to live off of.

So while getting to $100,000 might be where you start to feel your investments taking some of the wealth creating burden away from you. Chances are, you’ll need much more money in order to reach your financial tipping point. The examples above show that there are numerous ways to get there, which one you choose is entirely up to you.

Readers: Have you reached either tipping point with your investments? Either where they’re really starting to take the work off your shoulders, or where they actually produce enough income to live from? If not, what’s your plan to reach your tipping point? 

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28 Responses to Finding Your Financial Tipping Point

  1. Great post! It’s amazing to think of everything that needs to go in to reaching that “tipping point.”

  2. Awesome post! And I agree that the “other” title for your blog would have be cool haha! In all seriousness though, I have taken notice to the “hyper-effect” of compounding as your portfolio grows. When you only have a little bit invested, you see very small gains over time. But once you reach a threshold of $100,000 you really see compounding and growth take off. I wish everyone would see that line in your post about $100K invested in the S&P generates $9/day in income. How motivating is that, knowing that essentially every day you are making $9 for doing absolutely nothing! That makes me want to invest more so keep growing that $9!

  3. Integrator says:

    Very interesting article. I feel like you come across a bunch of tipping points in a journey to FI. We’ve crossed a few of them. i think when our dividend income crossed around $15k/yr, I definitely noticed the annual increases in dividends that typically get paid by companies.
    I think the other tipping point is when your annual asset growth exceeds what you bring home from your wage income. We’re not at that point yet, but that would be pretty special!. I think the last milestone is when you can have passive income replace your wage income.

  4. FI Fighter says:

    Building that first $100,000 is excruciatingly painful, I will gladly attest to that.

    After that, progress gets infinitely easier as assets increase in value and cash flow re-invests.

    When I first started, I used to think that the path to financial freedom was through net worth… When I discovered dividend investing I realized that the name of the game is actually passive income (cash flow). That’s when the lightbulb started to go off.

    These days, that’s all I focus on. Whether you invest in dividends or rentals, these assets do provide a hedge against inflation, so your first goal should be to cover your monthly expenses.

    If I can get to that, and greatly exceed that number then I will know I am financially free. My net worth can do whatever it wants to…

    • I was the same way. You don’t need a giant net worth to achieve financial independence, you just need to build streams of income that will provide you with the cash flow you need to live. If you can keep your expenses low, you’ll need even less than you might imagine.

  5. Really insightful. I’m still in college now but I pay attention to personal finance and hope to be able to be financial independence as soon as I can. Now I have a side income business that I’m developing which I hope someday can bring me enough passive income for my expenses.

  6. Jef Miles says:

    Great post, how is Gladwell’s book? Worth a read from the sounds of it?

    A thing that you can also keep in mind, even with the 1 mill invested you can continue to earn an income either through self employment (probably my preferred way or working for the man)..

    • The book is definitely worth a read. I’m a big fan of his. Slowly making my way through his books on my kindle!

    • I highly recommend anything from this author and look forward to reading his most recent book: David and Goliath.

      I think I would say that my favourite was “Blink”.

      The books are entertaining and informative. And, as TFMITH said, it makes you think.

  7. Even 1,000,000 is not really enough, but it is getting there. If you can take the $1M, and get into the S&P, it’s currently about 1.89%. But you get some growth there too.

    What I found is that every time I reached the point that I equaled my salary, I would get a decent raise and have to get more passive income going. I have matched my ‘work’ income for a few years and am finally getting into the 2 year home stretch.

    While a family can live on $25K per year, if inflation takes off, it will be bad.

    • Jef Miles says:

      $1,000,000 for me would be plenty, when you think about it even being coservative you’d look @ around 8% return (before CPI I suppose) you’d have income of ~80K.. I appreciate this won’t happen every year but I am definitely an optimist and if you diverisfy your investments 8% I’d say is quite easily achievable..

      Plus what would you be doing with all of that spare time? If you had your own blog/business I’d add that income on.. A million is plenty unless you want to drive around in ridiculous cars and have fancy yahts..

      I’m brining the optimism to the conversation here :)

      • I am a bit conservative on this. I am only going to retire once. I am not coming back.

        I am planning on needing twice as much as what I spend, and having several income streams to support it, each with enough income to support my goal. I plan in retiring at 56.

        Rental income should be grossing ~125K. Investments, even at 4%, should be $50K at current values, Social Security and Pensions should be $50K. I will live in rental income until 65 or so. By then, investments should be close to double, and be able to support me.
        At 65, sell rentals or decide what to do, perhaps a 1031 to farmland or easy maintenance rental.

        Keep up the great work. If you have rentals, check out my blog.

        • Jef Miles says:

          Hmmm interesting, different strokes for different folks but my goal is 40 (when I say retire, I mean be financially indepedent or have the choice to do what I’d like with my time)..

          This gives me a good solid 16 years to achieve it and I’d say with buying a few properties, a diversified share (stock) portfolio and gradually increasing income, with expenses staying relatively the same an 80K per year income stream is more than achievable..

          I’ve always aimed big so 80K a year is probably modest but I’d rather miss a high target than achieve a lower target, pardon the cheesiness but reach for the stars and if you don’t hit them you’ll land on the clouds :)..

          Will check out your blog as well, have a look at mine as well called mycareercrusader :)

          All the best and looking forward to hearing how it goes

  8. Gladwell’s books are really good, I enjoyed Outliers as well.

    Anyway, as far as my own financial tipping point is concerned, I haven’t reach that stage just yet. Really, I suspect that the tipping point where one can legitimately worry a lot less about money is something that is harder to obtain than many realize. Of course it can be done (and millions of people of course do it), so I’m working toward that point!

    • Outliers was the first book of his I read :)

      I’m working to that point too. Making progress, but not quite there!

      • Jef Miles says:

        I’m reading Never Eat alone at the moment (now that looks a great book for networking)..

        There’s also Thinking Fast and Slow as well.. Will have to get round to Gladwells books.. Need to be Financially Independent to have time to read more 😉 haha

  9. For me, the tipping point is psychological. How much money does it take to “feel” you have your financial footing?

    For some, it’s that first $100K, resting on the knowledge that your snowball starts to roll itself downhill in a meaningful way.

    For others, it’s that magic “7 figures”. I mean, don’t we all want to call ourselves millionaires?

    For me, it was knowing I had enough “FU money” to truly do the type of work I want to do for the rest of my days. It’s having the right balance between passive income and earnings that lets you flip burgers part time if that’s what you want to do for a living (or for kicks).

    Find that comfy blanket that is FI, whatever that magic number is for you. I highly recommend the awesome feeling that accompanies it.

    • Right on Free To Pursue! Well said.

      I’m with you. The thought of just having enough in the bank where I can transition to part time or move to a more fulfilling career is a big motivator in and of itself, knowing that eventually my nest egg will snowball on its own to cover my expenses and the extra time I may have to wait for that to happen will be pleasurable on its own.

      Then again I might get impatient and decide to tough it out a few extra years, but both scenarios are major motivators still.

    • Having enough “FU” money is the ultimate goal, but I think having enough “secondary” income coming in to cover the bills would be a huge step on that journey.

  10. Renee s says:

    Right now I am about to break 50k. It has been slow and steady, but I can’t wait to break 100k!

  11. I’ve recently found myself forced into retirement… Mostly due to market factors etc… However, I recently refined my option trading technique so much that it doesn’t matter that I no longer have professional income.

    If I said how much I’m making, on how little capital, people would dismiss me as a scammy/quacky/ponzi/liar. None of which I am.

    For those of you who care, I live-tweet the trades so I’m putting my money where my mouth is.

    Ok ok… dismiss me as a quack… But I am getting +50%/y returns no matter which way the market goes.

  12. Funny story, I was peeing in a urinal in HK once and Malcolm cozied up next door to pee as well. He’s a funny guy.

    My tipping point is about $500,000 where I started to BELIEVE I could do something on my own and not starve. A 10% return on $500K is $50,000, and that was where I knew I’d be OK.

    • Jef Miles says:

      Cool story there, I wouldn’t even know if I did bump into him.. Did you get into a conversation? How’d that go?

      500k is a nice little buffer, from there you could comfortably continue to build the online business, keep investing etc.. Will have to check out your site too FS, heard good things about you :)

      • He’s hard to miss due to his hair!

        My company actually invited him as a keynote speaker at our investment conference and we hosted a private dinner with about 25 of our top clients. Ah, the good old days.

        • Jef Miles says:

          Never actually seen a photo of him, suppose I should google him :)..

          Wow that does sound amazing, you don’t have them any more? If you ever head out my way (down under) would love to catch up for a beer (my shout). Sounds like you’d have some cool stories

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