When is it safe to leave your day job?

A few of my blog readers have asked for tips on when it is safe to leave their day job and concentrate on trading/investing full time. The decision should be based on several factors, both financial and psychological including:
1) How much you earned in your day job.
2) Your living expenses including access to health insurance.
3) Your age and life expectancy and general health.
4) Whether you have a spouse or partner that is still working.
5) Whether you have some other steady sources of income.
6) Whether you are willing or able to move to a less expensive area if necessary.
7) Your personal risk tolerances.
8) Your assumptions on future inflation.I think a good metric to use is the assets/salary ratio. The idea is that if your compensation is 100K it is much easier to leave your job than if you earned 250K.I’m probably older than most of you (I’m a baby boomer), and I’m very risk averse, so I didn’t retire until my assets/salary ratio reached 35. So if I were to earn a zero return on my investments, I have about 35 years worth of my previous salary available in investment assets. For most people, you can probably safely retire when your assets/salary ratio reaches 20, especially if you think you can easily get another job if you change your mind and want to “un-retire”. If your day job salary is significantly above your living expenses, you can use an assets/living expenses ratio instead of assets/salary, but this means you will not be able to save as much ADDITIONAL money every year to add to your retirement asset base.

I would advise everyone to have a steady income stream available to pay at least some of your expenses. This income stream should be completely separate from your main investments. A part time job that you enjoy, even if it doesn’t pay that much is great if it does not interfere with your trading or investing. A big advantage of a “retirement” job is that you can continue to fund a Roth IRA each year to further build up your retirement assets and give yourself a much greater margin of safety.

An alternative is to keep a certain amount in cash, or an annuity which generates a steady income stream. This is more psychological than anything else, and can take the pressure off of your investing. The worst thing is to get a big bill (say for property taxes) and you have been experiencing a drawdown in your trading account, and then have to withdraw additional funds. Keep your bill paying separate from your trading/investing.

I got an annuity quote for a 55 year old male living in New York. For a one-time investment of $1 million, you can buy a guaranteed lifetime income stream of $70K per year. If you use pre-tax IRA money, you will be taxed on the $70K payouts each year, but nothing up front. This can be a reasonable option if you don’t have a working spouse or any other dependable income stream to pay your basic bills.

If you are fairly young, inflation can be a concern. In recent years, money has been losing about half of its value every 20 years. A 60 year old has an average life expectancy of about 22 years. So if you retire at 60, your retirement assets would need to double by age 82 just to stay even with inflation. But most successful investors should be able to produce at least a 10% return per year, which would easily grow your assets faster than inflation if your assets/expenses ratio is 20 or more when you retire.

Of course the best way to insure a successful retirement is to achieve consistently high investment returns of 15% or more with the funds not devoted to providing a steady risk free cash flow. As time goes on, this portion of your retirement assets will grow large enough to easily cover your retirement expenses and provide more money for philanthropy.


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