Last week I was shaking my metaphorical fist at judgy relatives, and expressing my frustration about the consumerist culture here in the States. It’s hard for people to believe that we actually choose frugality, rather than having it forced on us. Despite our financial independence and growing portfolio we see little need to increase our spending. (Not everybody believes us though)
That post generated a ton of great comments… but one in particular stood out. A reader named “Joe” asked the following question:
“If you had a 10 million net worth, would you still keep your budget exactly the same? That’s the true test of whether you “have to be” frugal or “choose to be” frugal.”
What an excellent question Joe!
Sometimes the comments on personal finance blogs are absolute gold mines for great ideas. I thought the question would make a perfect topic for today’s post…
Life Will Spank You
So let’s imagine… instead of a net worth of nearly $3 million, the Tako family suddenly has a net worth of $10 million dollars.
Wohoo! Would we increase our budget and suddenly stop being a frugal family?
To give a simple one-word answer — No, we wouldn’t. The more important part of the answer is understanding why.
Today, our annual spending is approximately 2.6% of our portfolio. We live a pretty comfortable life — We have a nice older home, and go on month long vacations overseas. We eat tons of delicious food, and have plenty of friends to share it with.
Our general goal is to spend 3% or less per year, and so far that plan is working-out. Many people call this level of spending ‘conservative’ given the historical returns of the stock market, but if there’s one good lesson I’ve learned in life it’s that Life Will Spank You. Hard.
Just when you think things are going pretty well, life will reach-out and slap you down.
Feeling awesome because you got a raise at work? Fantastic! … except for that wacked-out Mercedes driver who just crashed into your Honda. Now you either ride the bus to work, or buy another car (essentially wiping out the positive effects of a raise). Then, that wacked-out Mercedes driver sues you for additional money.
How about another example — Has your portfolio done excellent the past few years? Don’t pat yourself on the back just yet! Everyone’s portfolio is doing fantastic. This doesn’t make you an investing genius.
Market downturns can happen at any time. Imagine the stock market crashes next week and erases 45% of your portfolio value. Market returns are ephemeral. They come and they go like the changing of the tide. (Which is one of the reasons why we focus on dividend income growth instead)
Even dividend income can get spanked during market downturns — Take a look at our dividends during the 2009 Great Recession:
Ouch! We went from nearly $19k in annual dividends to $5k. It took two years before dividend payments returned to normal. Our portfolio value declined by 45%. That’s no joke when you’re attempting to live off portfolio returns.
This is one of the reasons why we keep so much cash uninvested — In the event of a downturn we don’t want to be forced to sell assets to pay our bills. The losses to long term capital would be massive.
My point with these examples isn’t to be negative, but to illustrate that both good luck and bad luck happen in life. Many things are not under our control. Don’t over-extend. It’s important to stay humble.
So, let’s get back to the $10 million dollar question. Imagine for a moment that we did increase our budget — we bought a big house, a couple luxury cars, ate out every night, and forgot all of our frugal ways. What might happen?
Well, given my luck that’s right when a huge recession comes along. With that new high-priced lifestyle we could find ourselves in deep financial trouble trying to maintain it.
I don’t want to get stuck in the position of trying to maintain a “high class” lifestyle when it could be decades before the market returns to previous highs.
Setting A Good Example
Another good reason to NOT increase spending has to do with our kids. We want to set a good example for our children about what a good life looks like.
Notice I said “a good life”, not “a wealthy life filled with overabundant luxury”.
I don’t want my kids growing up in a “wealthy” household, being given everything they can imagine. That’s just a recipe for a spoiled brat! One who will overspend his income when he finally moves away from home.
This is exactly why we get nearly every piece of clothing and every toy used (and frequently free). Hand-me-downs are considered a gift to be appreciated in our household, not derided. This Christmas (like last year) our kids are getting used toys.
Some people might criticize this, but we’re attempting to live a realistic lifestyle. The idea here is that we’ll set a solid example for our kids. They won’t grow up having everything, and they’ll learn to live with imperfection.
The Hedonistic Ladder
I think the easiest way to capture my feelings on the subject is to visualize the hedonistic ladder. I started-out life near the bottom rungs of that ladder. This is the end with absolutely no luxury. You wear thrift store clothing, drive nearly-dead cars, and live in crappy ancient rental apartments with toxic lead paint (true story! I rented an apartment like that!).Most people go through life trying to climb that ladder… to move-up the rungs to ‘nicer things’ in life. With luck and hard work, most college graduates can expect to climb part-way up the hedonistic ladder and achieve “middle class”. This is a good comfortable position to be in life. There’s plenty of luxury in the middle levels of the hedonistic ladder, and it’s achievable with hard work.
Not everyone stops in the middle though. Some individuals are driven to climb higher for the rewards — The upper rungs are filled with fancy four star hotels, luxury cars, designer yachts, personal chefs, and gigantic mansions with ridiculous driveways. You know, all the trimmings of the rich and famous.
Very few people earn their way to these top rungs of the hedonistic ladder, but many try to imitate the lifestyle. This path is fraught with financial difficulty.
The problem with climbing the hedonistic ladder is that you get used to the lifestyle on the upper rungs. Any step down on the hedonistic ladder feels like a loss, and can lead to unhappiness or discontent.
Quite simply, once you’ve owned a Bentley, a beat-up Toyota just won’t bring you the same level of happiness.
This secrets is to not climb the hedonistic ladder any higher than you have to. Learn to find happiness on the middle rungs.
The Tako family is trying stay somewhere in the middle because we don’t desire to climb the ladder higher. We have enough. There’s plenty of luxury in our life, and we’re perfectly comfortable being ‘average’. Climbing higher would simply mean a more expensive lifestyle, NOT more happiness.
Having $10 million dollars wouldn’t any of change that.
Where Our Budget Might Change
While contemplating this $10 million dollar question, I was able to imagine one reason why our budget might rise… It was around location.
Mrs. Tako and I are currently considering new locations to move our family, but we haven’t yet decided on a location. If we had $10 million dollars this would open-up more expensive options we haven’t yet considered.
For example, we could move to Hawaii or California — the two most expensive states in the entire U.S. While we wouldn’t climb the hedonistic ladder, our expenses would need to rise due to more expensive housing, food, and higher taxes.
The same goes for expensive international locations — countries with higher taxes and a higher cost of living (like Australia or Japan). These countries have a very good quality of life that we would enjoy. Potentially it could even help us live longer.
Currently we spend WAY too much time indoors because of our local climate. It’s cold and wet in the Pacific Northwest 9 months of the year.
To live a healthy lifestyle, our family needs to spend a lot more time outdoors getting sunlight and exercise. That’s hard to do in the Pacific Northwest when it’s cold and constantly raining.
While I believe it’s possible to improve our quality of life without having $10 million dollars (there’s plenty of reasonably priced states), having more money would definitely make solving that problem easier.
Now I’ll pass the question to the readers — How would having $10 million dollars change your spending?
[Image Credit: Flickr]