It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
—Mark Twain

Consider a series of coin flips. We’ll give heads a value of 1, and tails a value of 0. After 10 flips, we get an unsurprising result — 5 heads and 5 tails. The average value of each flip is 0.5, which happens to match the expected value, as statisticians would call it.

Of course you’d never actually “expect” any particular coin flip to have this value, for the simple reason that it’s impossible. It’s a simple example, but the point behind it is an important one — an average result is not necessarily a typical one.

If you recall, in part I of this series, we learned about the CAGR metric. It is considerably more accurate than the simple “average” return. But recall also what CAGR stands for: Compound average growth rate.

There’s that word again. Average. Does its presence arouse your suspicion by now? It should.

It’s Not so Easy to Be Average

It turns out there’s one pretty big problem with using the CAGR — it assumes the stock market has the same return every year along the way, instead of bouncing all over the place like it really does.

This all works out in the end if you invest your entire sum up-front, but that’s not how it works for most people. Most invest bit by bit over time. As the market moves up and down, you will buy some at higher prices, some at lower. The end result is that your final effective return over a given period is likely to be significantly different from the CAGR.

In the Long Run, We’re All Dead

The conventional wisdom is that this all averages out in the long run. The question is, how long is the long run? 20 years? 30? As it happens, it tends to be longer than most people think. Longer than you have, more than likely.

This can cut either way, of course. If you happen to spend much of the early part of your career in a down market, for example, and ride a bull market up for the final few years before you retire, you may well do far better than the CAGR over the period. This is because most of your investments were made at low prices, and most of your invested funds received the full benefit of the bull run at the end.

But what if, on the other hand, you buy all the way up during one of the greatest bull markets in history, but find that the market had a negative real return over the last decade of your career?

As it turns out, this is precisely what has happened to the baby boomers, who began turning 65 in 2011. So what would have happened if a boomer had followed the plan laid out in part I?

We cannot know precise figures without knowing the exact days our hypothetical boomer invested and the prices paid, but we can make a reasonable estimate by considering each annual $1200 investment separately, using the CAGR from the year it was made through 2011.

The figures are in the following table:

The final result for our unfortunate boomer is $128,463 — a good bit lower than the $149,806 he would have wound up with had he managed to earn the historical 6.26% CAGR, and growing ever more distant from the $1 million we were originally promised in part I.

Of course even these figures are suspect, since they assume the boomer in question invested their $1200 in a lump sum every year on January 1. What if he had invested $100 per month instead? Once again, it could cut either way, but the odds are the outcome would have been worse still. (I leave finding the precise answer as an exercise for the reader.)

Never Trust in Averages

I hope you are beginning to see the pitfalls inherent in relying on oversimplified figures and estimates based on historical results. Real life has a way of working out differently. Averages can be useful for making estimations and weighing alternatives, but they can hide all sorts of dangerous assumptions. You must never lose sight of their shortcomings.

Your plans must be tailored to the real world if you wish to have a realistic chance of seeing the results you desire. And if conditions change, you had best be prepared to adjust your plans along with them.

This is starting to get depressing, isn’t it? Well I hate to break it to you, but I have one more post of bad news to go. After that, we’ll start looking into actions you can take.

Note: This time we are able to adjust our contributions for inflation as well as the returns, as we know the time period in question. We must rely on the imperfect CPI for this, despite the warning in part II, as we have no real person for whom we can model actual cost of living, but it will serve for this discussion.

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
—Henry Ford

If you read part 1 of this series, and thought to yourself, hm, they didn’t account for inflation, congratulations. You’re right. It’s a pretty glaring omission, I know. Everyone knows you have to account for inflation.

I’m sure you know how this story ends, but let’s go ahead and go through the motions, anyway. If you recall, our contribution rate was $1200 per year, from ages 22 to 65. We found out last time that using the more accurate CAGR instead of “average” return, we wound up with a little over $600,000 instead of the $1 million we were promised. Now let’s factor in inflation. As it turns out, the inflation-adjusted CAGR of the stock market from 1900 through 2011 works out to just 6.26%. Heading over to the retirement calculator and plugging in our new 6.26% “real” return, we wind up with only $241,751. Ouch. So much for our million-dollar retirement.

No surprises, here, right? But there’s a problem. You see, this figure is pretty much bullshit as well. To understand why, we need to look into what inflation really is, and how it’s measured.

What is Inflation, Exactly?

Strictly speaking, inflation is an increase in the total amount of money in circulation. Rising prices are just a side effect, reflecting the loss of purchasing power you get when there is more money chasing after the same amount of goods and services.

Most people don’t think much about abstractions like the total amount of money in circulation, though. They think about the price they pay for milk at the grocery store. That’s why when most people think of inflation, they are really thinking of something called the “cost of living.”

What is the Cost of Living, Then?

So what exactly is the “cost of living?” When most commentators from the government or the business community use the term, they are referring to something called the Consumer Price Index, or CPI. This figure is published periodically by the Bureau of Labor Statistics, and represents the government’s official position on what the rate of inflation is. It’s also what’s used to generate all the “inflation adjusted” returns you’ll see reported all over the Internet for every sort of asset (including the “real” return for the stock market I quoted above).

The thing is, the BLS itself states quite plainly that the CPI is not intended as a model for the cost of living, and you should take that to heart, because the odds that the CPI accurately represents your cost of living are slim to none.

What’s Wrong with the CPI?

If you wanted to model changes in the cost of living, chances are you’d put together a list of products and services used by a typical American family. You’d then add up prices from one year to the next, weighted for how much of each item people consume on average per year. Subtract the previous year’s result from this year’s, and you have your rate of inflation.

Makes sense, right? The trouble with this is assuming that there’s such a thing as the typical American family. If you don’t watch TV, for example, you don’t care if flat-screens are getting cheaper. If you’re a vegan, you don’t care if steaks are getting more expensive. This can mean that changes in your personal cost of living can vary wildly from what the CPI reports.

For some examples, let’s have a look at the weightings for 2011 in the CPI-U, which focuses on people who live in urban areas. “Food away from home” is weighted at nearly 6% of a family’s budget. I’m sure this is accurate on average, but what if you live a frugal lifestyle and rarely if ever eat out? Similarly, transportation is weighted at 17% of the average budget. What if you bike and walk everywhere, don’t own a car, and rarely take public transit?

Housing costs are especially troublesome. They are weighted at a whopping 41%, but price trends for these can swing hugely in either direction depending on which part of the country you live in. Housing prices in the DC area, where I live, for example, did not see anywhere near the decline that other parts of the country experienced during the subprime meltdown. Furthermore, you may well plan on moving to a much less expensive area when you retire. And naturally, if you have a paid-off home, your housing expenses are going to be very different than a renter’s.

In short, you should plan your retirement based on the choices you will make, and the lifestyle you want, not what the government estimates a “typical” household will do. Stay tuned to learn how to do precisely that.

Note 1: The real situation is even worse, for the $241,751 figure assumes you adjusted your contributions for inflation, which was not part of the original plan laid out in part I. The real result you’d receive if you didn’t adjust can’t be computed without knowing the particular years in question, but would be far lower.

Note 2: The original version of this article included a discussion of changes over the past few decades to the CPI calculation methodology due to the findings of the Boskin Commission. After receiving some feedback, I realized I had relied on some poor sources, and the discussion was thus overly simplistic and potentially misleading. The issue was ultimately beside the point, in any event, so I removed it.

Advice is what we ask for when we already know the answer but wish we didn’t.
—Erica Jong

Let’s say you’re just starting your adult life, and want to plan out your finances. First off, you are to be congratulated. Most people don’t put much thought into the subject until later in life, and in so doing, make things considerably harder on themselves. You plainly are much more clever than they are.

Let’s put together a plan based on the sort of generic, conventional wisdom you’ll find in endless personal finance books, Web sites, radio programs, and seminars. Let’s say you start your career at age 22, and want to retire at age 65. You’d like to earn $40,000 per year from your portfolio after you retire. Using the traditional 4% rule, that means you’ll need a nice, even $1 million to retire. How much should you save for retirement each year?

Well let’s head over to one of the many retirement calculators out there on the Web and find out. From 1900 to 2011, the average return of the stock market has been 11.37%. You can easily earn the average stock market return by buying an index fund, so let’s plug that into the calculator as your return, with $1,000,000 as your goal, and starting and ending ages of 22 and 65.

The result: you need to save less than $1200 per year! That’s the extraordinary power of compounding. Because you so wisely started out so young, time is on your side. So just start socking away $100 per month, stick it all in an index fund, and when you retire in 43 years, you’ll be all set.

That wasn’t so hard, right? There’s only one problem. It’s all bullshit.

The Devil is in the Details

Ok, so it isn’t quite all bullshit. After all, the most effective lies contain kernels of truth. The part about the power of starting young, for example, is absolutely true. Unfortunately, though, the very power it lends to your ability to grow your wealth also hugely magnifies the effect of all the other distortions, invalid assumptions, and fallacies of our little “plan” — and there are many. Layers upon layers of them. So many, in fact, that it would be almost impossible to cover them all thoroughly in a good-sized book, never mind one post.

Every one of these pitfalls is distressingly commonplace. While it’s true that few sources of retirement advice make all of the mistakes in the above analysis, almost all of them make some. Over the next few days, we’ll take a tour through some of the more egregious ones, and see what the results are more likely to look like in the real world for a hypothetical youngster who chooses to follow this plan.

Take a moment to reread the plan before continuing, and see how many problems you can spot.

Fallacy #1 — “Average” Return

This first fallacy is one of the worst. It’s also one of the most common. While it has long been a favorite tool of shysters and crooks, it also crops up routinely among many of the most respected sources of financial analysis available. Even the most knowledgeable and scrupulous commentators — people who really ought to know better, and are genuinely honest — frequently run afoul of it. Why? Because it’s so easy to overlook. This is especially troubling, since it can lead to some truly spectacular distortions. So what is it, precisely?

Let’s say you invest $100 for 5 years. You’re an awesome investor, so you earn an average return of 50%. How much money would you have at the end? A quick calculation says you should end up with $759. Nice work!

Expectation vs. Reality

But wait, your account only has $10 in it! How can that possibly be? You must have been defrauded. Time to call the SEC, right?

Well, not so fast. Let’s say you had a rough first year and lost 99% of your money. Your skills greatly improved in the other 4 years, though. You earned a whopping 199% in year 2, and 50% in years 3, 4, and 5. Your “average” return, then, is:

(-99% + 199% + 50% + 50% + 50%) / 5 = 50%

Run your $100 through those results though, and you will see that you in fact wind up with just $10. So you can see, your average return really was 50%, and you were not defrauded. Yet rather than greatly compounding your wealth, you lost 90% of your money.

Never Use Average Return

Let me be blunt. The entire concept of “average return” for an investment technique, index, or mutual fund is utterly useless. Worse than useless, in fact, because it is so easily misunderstood.

The figure you actually want to use is something called the Compound Average Growth Rate, or CAGR. This figure gives an accurate accounting of what would really happen if you invested a sum of money over time.

Taking another look at our above example, while the average return is 50%, the CAGR is approximately -37%. Plug that number in for 5 years, and you’ll see that it accurately predicts your $10 final balance. Quite a difference, eh?

Unfortunately, many people’s eyes glaze over when they see acronyms like CAGR scattered among lots of financial gobbledygook. It’s also much harder to compute than a simple average. The uninformed will often latch onto a simpler term like “average return,” since it is much easier to understand. Or so they think.

You know better, now, though. Next time you see the term “average return” or anything similar thrown around, your Spidey sense should go off immediately. Chances are extremely high that whoever is using it is either misinformed, misleading you, or misusing the term. You had best find out which.

The Fallacy in Action

Let’s see how this fallacy plays out for our hypothetical retirement plan. As it turns out, while the average stock market return from 1900 to 2011 was indeed 11.37%, the CAGR was only 9.49%. That’s still pretty good, though, right? Let’s plug that into our retirement calculator along with our $1200 in annual savings and see how we did.

Uh oh. Instead of $1 million, our hypothetical youngster has ended up with only $611,000. That’s right, this one mistake cost him nearly $400,000. Assuming this was his only mistake, if he follows the 4% rule, he’ll have to settle for living on less than $25,000, rather than the $40,000 he had hoped for.

Sadly, though, our poor youngster has run afoul of many more pitfalls. Stay tuned.

If I have the belief that I can do it, I shall surely acquire the capacity to do it even if I may not have it at the beginning.
—Mahatma Gandhi

I am a firm believer in 30-day challenges. They are an effective tool for making real, significant changes in your life, primarily because you’re more likely to actually do something if you put a fixed time span on it, rather than commit to a permanent change. After all, 30 days isn’t that long. No matter how onerous the change you have in mind may seem, surely you can manage it for that long, right? Yet 30 days is also long enough to get over the initial shock to your comfort zone, and to adjust to new circumstances. At the end of those 30 days, the change may not seem so onerous after all.

My first 30-day challenge this year is something I’ll call the Cheapskate Challenge.

A Month with No Income

The plan is simple: For the month of January, I’m contributing 100% of my income to my 401(k), and living off my emergency fund. The fund presently holds about a year’s worth of my regular living expenses. The challenge is to get through the month while depleting it as little as possible.

Of course for a one-month challenge I won’t be making the really big changes, like moving to a cheaper area, so I’m going to have to find my savings elsewhere. Every penny that goes out the door is going to be under even greater suspicion than usual.

Also, while I pride myself on having minimal clutter in my home (my mother called my place “austere,” which made me grin), there are a few items lying around the house which, in all honestly, I have been meaning to get rid of. I have been procrastinating because selling stuff is a hassle, but those few extra dollars will make getting through the month easier.

What’s my Motivation?

Why on earth would I want to do such a silly thing? There are a number of reasons. First of all, investing the money up front increases its total time in the market. Of course this can cut either way, depending on which way my investments go. Historically, though, a lump-sump investment in the stock market has resulted in higher returns than monthly investments about 2 out of 3 times. There are no guarantees in the investment world, but I’d rather have those odds on my side. (Note: if you’re considering trying this idea with your 401(k), be sure to check your employer’s matching policy, first. Some employers require monthly contributions to get the full match. My 401(k) has no matching, so this is not a concern for me.)

Practicing Stoicism

Second, you might recall my new year’s resolution to begin practicing Stoicism. Practicing adversity is a classic and highly effective technique of the Stoics. So this month, I’m going to practice being broke. I’m going to live this month as if I had suddenly lost all my income, and had to stretch my savings for as long as possible. I won’t be faking it, either, as I really will be losing my income (never mind that it’s to my own retirement account). From the perspective of Stoicism, the benefits of this are many, but first among them is a better appreciation for the lifestyle I’ve grown used to. There’s nothing like going without something for a while to make you see its true worth.

Hedonic Adaptation

Lastly, I can’t think of a better way to permanently ratchet down my lifestyle just a little further. Simply cutting back your spending by 5% may seem like a chore, but after 30 days of cutting back far more drastically, going back to 95% of your current level can still feel like a pleasant return to luxury. That’s how you put the old specter of hedonic adaptation to work for you, instead of against you.

Now I fancy my “frugality muscle,” as Mr. Money Mustache is fond of calling it, to be pretty strong these days — certainly much stronger than it was in my foolish youth. There is plenty of room for improvement, though. I am still a good long way from reaching Jacob’s level of mastery. A little challenge to root out complacency is good no matter where you are along the path to financial enlightenment.

The Upshot

So to sum it all up, when all is said and done, I’ll come out of this with:

• A better appreciation for my good fortune in life
• Less clutter in my house
• A 66% shot at better investment returns this year
• Some new frugal habits, at least some of which will hopefully stick
• A nice bump up in cashflow for most of the rest of the year because I’ll be maxing out my 401(k) much sooner.

Of course that raise I’ll be receiving from getting those 401(k) contributions out of the way will be going straight into my emergency fund until it’s back at a year’s expenses, then into my brokerage account. I’ll be saving more, and won’t even notice the difference.

Try The Cheapskate Challenge Yourself

If you want to try this idea out for yourself, but can’t swing a month without income just yet, you need not be so drastic. Ask yourself, what would happen if you had to take a sudden, unexpected 20% cut in pay? You’d hardly be the first in this economy. If nothing else, it’s a nice exercise in negative visualization.

It may be rough, but I’d be willing to bet you could find a way to adjust and make it through the month. Do you agree? If so, why not put it to the test? Take an extra 20% of your income one month and put it in a savings account. Force yourself to live off the rest. You may have to make some significant sacrifices, but it’s only 30 days, right? Surely you can scale back for that long. (Remember, the money will be in a savings account, so you can always get to it if you absolutely must.)

One of two things will happen if you try this experiment. You’ll find that you can adjust, or you can’t. If you can, awesome, you can rest easier knowing you’ve proven your resilience, and as a bonus, you’ve added a chunk to your savings. Now see if you can make some of those cuts permanent. I’ll bet after 30 days you hardly miss some of them, anyway.

What if You Didn’t Manage It?

If you couldn’t make it, then you need to take a long, hard look at your finances, and make some big changes. You can’t afford to wait for an emergency — in fact, you’re in an emergency situation right now.

In our modern economy, there simply is no such thing as job security anymore, and being so dependent on your present job that you can’t even survive a 20% cut for one month means you’re at serious risk. It may be an unpleasant realization, but at least you know, now. Hopefully that knowledge will spur you into action.

You can start by signing up at Mint.com and tracking every penny — and take heart. As the saying goes, anything that can be measured can be improved. So measure, and then get to work improving.

It’s a Win-Win

As you can see, you win with the Cheapskate Challenge no matter what the outcome. It can also be a lot of fun, if you approach it with the right attitude. I personally am looking forward to flexing my frugality muscle this month.

If you’re playing a poker game and you look around the table and can’t tell who the sucker is, it’s you.
—Paul Newman

I just completed a little game of Poker with my local broadband Internet monopoly (who shall remain nameless). It all started when I had to cancel one of my credit cards due to some fraudulent charges I discovered (Hooray for Mint.com!). I had a number of auto-bill arrangements set up on the card with various companies, and updated my info with most of them, but, regrettably, I forgot about the cable company. When monthly bill time rolled around and their automatic charge failed, they were kind enough to inform me of the oversight, but not before slapping me with a $50 “returned payment” charge.

Why would they do such a thing to a loyal customer of several years, who had always payed his bills on time? The simple answer: because they can. They’re a monopoly, after all. If I want cable Internet service, I’ve got a Hobson’s Choice. (Sadly, FiOS is not available in my neighborhood.) So, I might as well just suck it up and pay up, right? After all, they hold all the cards.

Or do they?

Déjà Vu

The thing is, I had been down this road with the big, mean cable company before — several times, in fact, most recently when they tried to charge me $100 for a service visit when both the person I spoke with on the phone and the technician who visited my house repeatedly assured me I would not be charged. It has always followed pretty much the same script.

I called them up, and got a representative on the line. Here’s how the conversation went:

Rep: What can I help you with today?

Sean: I see a returned payment charge has been added to my bill. I’d like to have it removed, please.

Rep: Let’s have a look. Yes, I see here your credit card company rejected your last bill payment, so you incurred a returned payment charge.

Sean: Yes, I understand. The thing is, I had to cancel my credit card because of some fraudulent charges. I will be happy to update my billing information as soon as this charge is removed.

Aha! It seems I had a card or two after all. If they wanted to collect my outstanding balance, they’d have to work with me. Unfortunately, what followed was no surprise.

Rep: I’m afraid I’m not authorized to do that, sir.

Sean: I see. Well may I speak to someone who is authorized to handle this?

Rep: You can speak with my manager, but he will only tell you the same thing. He isn’t authorized to do bill adjustments, either.

Sean: So there is no one I can speak with who can help me with this?

Rep: No, sir, I’m afraid not.

Horse hockey. I happen to know for a fact that this is false (as you will soon see). All I could think was, “Oh geez, they’re not going to make me go through this song and dance again, are they?”

Sean: Ok. Well please put me on with your manager, then.

Rep: Ok, sir, just a minute.

(2 minutes of Muzak later)

Manager: Hello, sir, how can I help you?

I then proceeded to have pretty much the exact same futile conversation with the manager that I’d had with the rep. Hopeless, right?

You Have More Power than You Think

Let’s pause for a moment here and consider. I don’t watch TV, so we’re just talking about my home broadband Internet service. But that’s pretty much an essential service nowadays, right? After all, the Internet is where I earn my living, get most of my entertainment, and keep in touch with my social circle. I need my Internet connection, right? Just imagine how awful it would be if I lost it.

Well let’s actually imagine it. I could take my laptop to the local library or coffee shop and get free access there when I need it. It would be inconvenient, but it would also get me out of the house. Not so terrible. Or, I could get satellite Internet. Slower and more expensive, but it’s an option. I could even talk my neighbor into sharing her connection with me in exchange for splitting the bill (Hmmm! I might just have to consider that idea, current situation aside!)

So when it comes right down to it, if I’m going to be perfectly honest with myself, I don’t really, truly, strictly need cable broadband service. And do you know what that means? That means the big, mean cable company can take their monopoly and stick it.

Back to my conversation:

Sean: Let me ask you something. Let’s say I had accidentally pulled out my old, canceled card and tried to use it at the gas station. Do you think it would be reasonable for them to charge me $50 for the failed charge?

Manager: Sir, our subscriber agreement says…

Sean: Never mind the subscriber agreement. I’m sure you’re correct. I’m just asking you a simple question. Would it be reasonable for them to charge me $50?

Manager: It depends on their policy, sir. I can’t comment on other companies’ policies.

Sean: Well I don’t think it would be reasonable at all, and I don’t believe it’s reasonable for you to do so, either. I don’t do business with companies with unreasonable business practices. So if you’re going to insist on charging me this fee, I’ll pay it, but it’s the last $50 you will ever collect from me.

Manager: I’m sorry, sir, but I’m not authorized to remove the fee.

Sean: Alright, then cancel my account, please, effective immediately, and send me my final bill.

There’s a mountain of chips on the table, and I’m all in. But I am confident knowing that I don’t truly need these guys. They, on the other hand, do need reliable customers who pay their bills on time every month for years on end. That’s why I know precisely what’s coming next.

Manager: Very well, sir, if you wish to cancel, I will transfer you over to the retention department.

(More Muzak)

The retention department? I just asked to cancel my account! I should be transferred to the cancellation department, not the retention department! But of course I knew this would happen. Like I said, I’ve played this game before.

The retention representative came on the line, and like always, she had a much more soothing, friendly tone of voice than the others, and was far more helpful.

Retention rep: Hello, sir, I understand you have requested to cancel your account. May I ask why?

Sean: Well I was assessed a $50 returned payment fee. The thing is, I had to cancel my credit card because of some fraudulent charges. I don’t think charging me $50 is reasonable.

Retention rep: That’s perfectly understandable, sir. I can have that removed for you.

No one is authorized to remove the charge, eh? Like I said, horse hockey. I still wasn’t quite done playing my hand, though.

Sean: Well that would be helpful, but I’ve had to spend nearly 20 minutes on the phone, here, and this is the third time I have had to waste my time having unreasonable or mistaken charges removed.

Retention rep: I’m sorry to hear that, sir. You’ve been a very good customer. I see you’ve been with us for three years, and kept your account current the entire time. How about I credit you for one month’s service for the inconvenience?

Sean: Alright. Remove the charge and credit me for a free month, and I will update my payment details.

Retention rep: Ok, sir, that’s done. Is there anything else I can help you with?

The big, mean cable company folded in the end.

Don’t Let the Bastards Grind You Down

There are two lessons to be learned, here. First, apathy is expensive. That’s why it’s essential to track every single penny of your spending every month. That used to be a serious hassle, but nowadays, with free services like Mint.com, it’s quite easy. You need to watch your statements like a hawk, not just for fraud, but for sneaky hidden fees. That goes double if you use automated billing.

Second, you really do have more power than you think. Lots of companies will treat you poorly if you let them get away with it. Don’t. Just about anything is negotiable if you’re willing to make the effort, so don’t lie down for unreasonable fees from your cable company, bank, brokerage, or anyone else. If a company absolutely refuse to remove the fees, take your business elsewhere. There’s almost always an alternative, even if that alternative is simply doing without.

Of course, don’t expect this sort of result if you have a habit of paying your bills late. Chances are they’ll call your bluff.

Lost time is never found again.
—Benjamin Franklin

Time is money. You’ve heard it a thousand times, and it makes sense. But have you ever considered it the other way around? After all, if time is money, then money must be time. It may seem like an odd concept, but as it turns out, the analogy holds up quite well. More importantly, thinking of money in terms of time is one of the best ways to adopt a more healthy attitude about spending vs. building wealth. Read on to find out how.

Your True Hourly Wage

If you presently work at a job, the best way to begin thinking of money in terms of time is to figure out your true hourly wage. I was first introduced to this concept in the classic personal finance book Your Money or Your Life, by Vicki Robin and Joe Dominguez (which I highly recommend you read). The idea is to figure out how much income your job is really bringing in, once you factor in all the costs both in time and money of having a job in the first place. I must warn you — you should prepare to be shocked by the answer.

Figure Out Your Real Working Hours

First, figure out how much time you really spend on your job. The rule to follow here is to factor in every last thing you currently do that you wouldn’t do if you didn’t have to work for a living. Here’s a partial list of some things to consider.

• All hours spent at or around the office, including time actually working, unproductive “face time,” lunch breaks, overtime, etc.
• Your commute
• Time spent shuffling kids back and forth to daycare
• Business Travel
• Job Training
• Time spent shopping for work supplies, clothes, etc.
• Seminars and conventions
• Time spent working or thinking about work at home
• Time spent “unwinding” from work at the local bar

Remember, this is just a partial list to help you get started. Your real list will likely be longer. Average out everything on a weekly basis to figure out how much of your precious time your job is really costing you.

Add Up Your Work Expenses

Now, figure out how much money you spend on your job. Again, include every last penny that you wouldn’t generally spend if you didn’t have to work for a living, and average it out per week. Here are some possibilities to consider:

• Commuting costs
  • If you drive, the IRS mileage deduction of 51 cents per mile is a reasonable approximation that includes gas and maintenance costs.
  • If you wouldn’t need a car if it weren’t for your job, include the cost of the car itself as well, along with taxes and insurance.
• Parking
• Daycare costs
• Happy hour
• Licensing costs
• Training expenses
• Restaurant lunches
• Coffee
• Work clothes

Compute Your Real Hourly Wage

Now take your weekly take-home pay, after all taxes. You can add back any 401(k) contribution you may be making, but be sure to subtract taxes from that as well. Now subtract all the expenses you computed above. This is your real weekly income.

Now divide your real weekly income by the number of hours you computed earlier. The result is your real hourly wage — the real amount of money you’re receiving for all the precious, irreplaceable time you put into your job, week after week, year after year. Like I said before, prepare to be shocked by the figure.

A Typical Example

To illustrate how you can put this knowledge to use, let’s consider a typical American worker. Let’s call him Bob. Let’s say Bob earns a near average income of $40,000 per year. Assuming he works 50 weeks per year, that comes to an even $20 per hour — or so he thinks.

The average federal tax burden for such a worker is about 14%, and the average state tax is about 7%. That comes to 21%, or about $162 per week.

Now let’s add in the commute. The average U.S. worker’s commute is about 15 miles, taking about 25 minutes. Using the IRS mileage cost of 51 cents per mile, that comes to about $38 and 4 hours per week. Let’s also add in $5 per day for parking.

Now let’s factor in food. Let’s say a restaurant lunch at $10 and 1 hour, one gourmet coffee at $3, and one weekly happy hour at $20 and 1 hour. All very typical.

Finally, let’s assume he works 45 hours, as the current prevailing trend among salaried employees is to work more than 40 hours per week.

Taking his weekly wage of $769, that gives Bob a real wage of only $8.36 per hour! That means that each dollar Bob spends costs him more than seven minutes at work.

A New Perspective

Now let’s put some of Bob’s expenses into perspective. Bob knows that eating lunch out costs a lot more, but he does it because it “saves time.” But does it really? That $10 lunch costs him over an hour of time on the job. He could prepare lunch for an entire week in less time than that — never mind that he could save upwards of $40 in the bargain.

Similarly, that daily coffee costs him about 22 minutes on the job. I’ll bet making coffee at home would take a lot less time, and he could put that $3 back in his pocket as a bonus.

How about that weekly happy hour Bob attends to unwind? That costs him almost two and a half hours, week in, week out. Perhaps Bob should reconsider this expense. Perhaps he will, when he sees it in this light.

Now let’s say Bob decides he wants an Xbox 360. He’s wisely waited a few years since they were released, so the price has gone down to a mere $199. The thing is, that $199 will cost Bob nearly 24 hours, or almost three full days of work. That’s three more days away from his family, friends, and the things he loves — three more days before he becomes financially independent and can spend his days any way he likes.

Imagine spending three days at the office, and being handed only an Xbox at the end — not a dime toward rent, food or anything else you truly need. You’d have to spend another 7 hours on the job just to buy your first game.

Keep Your True Hourly Wage in Mind Whenever You Spend

Now you can see — money really is time. So next time you’re debating whether or not to buy something that you may or may not really need, try thinking about the cost in terms of time. Think about how much longer you will have work to get to your goal of financial independence if you make this purchase. Now decide if it’s really worth it.

We all have finite time and energy. Any time we spend whining is unlikely to help us achieve our goals. And it won’t make us happier.
— Randy Pausch, the Last Lecture

Over the past year I have read a number of inspiring articles and books on the classical school of Stoicism. What I learned was surprising — Stoicism may be an ancient philosophical school, but it is extraordinarily well suited to modern life. It offers an eminently practical path to a life of happiness and fulfillment, and while growing material wealth is not the primary focus, it is a near inevitable side effect. Let’s take a brief look at the central tenets of Stoicism, and their benefits.

What is Stoicism?

For people who are unfamiliar with the Stoics, the term may invoke images of curmudgeonly, joyless old men who greet triumph and misfortune with equal levels of grumpiness. After all, that’s pretty much what the dictionary definition says:

sto·ic [stoh-ik]
noun
1. One who is seemingly indifferent to or unaffected by joy, grief, pleasure, or pain.

Of course this bears little to no resemblance to what the ancient Stoics were all about. The Stoics were not out to rid themselves of all emotion, nor were they ascetics. Stoic thinking is focused on conquering the negative emotions in your life, such as fear, anger, envy, and greed. The goal is a state of serenity which cannot be shaken by the inevitable ups and downs life will bring you. Many find that that this fundamental tranquility is interspersed with moments of pure joy from all the good things life has to offer.

So how does it Work?

How can an ancient philosophical school help to bring about this extraordinary change in mindset? After all, as anyone who has taken any philosophy in college will attest, much philosophical writing is arcane and inaccessible, dealing with abstractions like the debate over the existence of absolute truth.

By contrast, the writings of the stoics are quite accessible and practical. Rather than delving into arcane abstractions, the stoics present a collection of principles and techniques for living well. Many of these techniques revolve around grappling with what modern psychologists call hedonic adaptation. This is the tendency of humans to adapt to their circumstances, whether positive or negative.

This adaptability is one of humanity’s greatest strengths, but it can also be a terrible liability. It can lead to what the Stoics call insatiability — the utter inability to be satisfied with what you have, no matter much much that may be. As soon as one desire is satisfied, it is replaced with another desire.

In a modern context, you may get a brief rush from buying a 50″ plasma TV, but it soon wears off, and when 60″ plasma TVs go on sale a few months later, you find yourself wanting one of those, and of course you need nice new speakers to go with it, the latest XBox, a nice new stand to match, and so on. It’s never enough.

Conquering Hedonic Adaptation

If you look, you can see insatiability all around you in our ultra-consumerist culture. It’s one of the greatest sources of human misery, and the Stoics set out to conquer it. They developed a number of mental techniques to help cure insatiability, and in so doing, train yourself to be happy with what you have. The most prominent of these are called Negative Visualization and Practicing Adversity.

Negative Visualization

Negative Visualization is one of the most powerful techniques in the Stoic’s arsenal. It’s also one of the easiest to practice. It boils down to this — pick a blessing in your life, preferably one you normally take for granted. Good candidates that might not come immediately to mind are having people in your life who love you, or a roof over your head, or simply the ability to walk, or see. Now imagine what your life would be without it.

Let’s focus on hearing, for example. Imagine what it would be like to be deaf. You’d have to deal with endless daily inconveniences with communication. You’d never hear music again. You’d never hear the voices of the people you love. Your life would be more dangerous as well, as you wouldn’t be able to hear honking horns or shouted warnings.

In the end, though, you’d be able to adapt. You would learn sign language, learn to read lips, and keep in touch with friends over email or text rather than the phone. Chances are you’d get along just fine in the end.

But wait — you have that perfectly fine life now, except you also have the extraordinary gift of being able to hear. And what an amazing gift it is. You are truly blessed. Now put on your favorite music, and see if you don’t relish it just a little more.

Negative Visualization can help you turn hedonic adaptation on its head so it works for you instead of against you. “Get used” to going without one of your many blessings in your mind, and all of a sudden you will see it for the blessing it truly is.

Practicing Adversity

You can take negative visualization a step further by actually choosing to experience adversity in real life. The ideas behind it are much the same. You can actually make a fun game out of it. Challenge yourself, and see how long you can go without turning on the air conditioner in the summer, or the heater in the winter. You’ll find you quickly get used to conditions you’d have found intolerable before.

The benefits to this are manifold. At the very least, you’ll learn to appreciate the modern comforts you used to take for granted. Even better, you might decide you don’t need to keep your house at 75 degrees in the the winter time. You can be perfectly comfortable at 68 degrees. So you can turn down the thermostat and save a bunch of cash (not to mention the planet).

Stoicism and Financial Independence

Cutting down the thermostat is not the only way stoicism can help you grow your wealth. The central goal of the philosophy is learning to appreciate what you already have. When you can continue to get joy from your many blessings, you’ll find that your endless desires for more of everything subside. Cutting back on non-essentials becomes easier. Resisting the relentless temptation to spend money on things you don’t need becomes easier.

In fact, you may find the temptation melts away entirely. You may find yourself wondering how you could ever have wanted all that stuff in the first place. The most natural use for all the money you save as a result is paying down debt and growing your wealth.

The Rebirth of Stoicism

Stoicism enjoyed a wide following in ancient Rome, but eventually fell out of favor, and was long considered a minor intellectual side alley, even among philosophy majors. It has recently resurfaced, however, driven in no small part by William B. Irvine’s extraordinary book, A Guide to the Good Life: The Ancient Art of Stoic Joy. If you are interested in Stoicism, and want to learn more, this book is an excellent place to start.

I have personally experimented with Stoic techniques over the past few months, and seen remarkable results almost immediately. That’s why my New Year’s resolution is to become a full-fledged practicing Stoic. I will be assigning myself a course of study including Seneca and Zeno, and daily practice of negative visualization and other Stoic methods. I am looking forward to the challenge.

With so many people struggling in vain to find fulfillment working in miserable jobs to fuel endless consumption, Stoicism is a philosophy of life whose time has come again.

A hundred million dollars in New York and twenty-two fish-hooks on the border of the Arctic Circle represent the same financial supremacy.
—Mark Twain

I hosted Thanksgiving in my home for the first time this year. In a rather pleasant reversal of roles, my mother assisted me in the kitchen as I prepared the feast. She spoke admiringly of my All-Clad roaster, my Le Creuset enameled cast iron pans, and my Gunter Wilhelm knives, among other things. She seemed far less impressed when the time came to set the table, though, as I pulled out the mismatched plates and silverware I had bought at Goodwill in 1998, and glasses from Dollar Tree. What’s behind this apparent contradiction?

A Real Life Lesson from Video Games

The term “min-maxing” is most commonly used nowadays by video game enthusiasts. No, I’m not going to suggest you take up World of Warcraft, but a common strategy used in such games can be useful in real life as well.

Stated simply, a min-maxer tries to get the best results possible by putting maximum resources or effort into what’s most important, while investing as little as possible into things that don’t really matter. Given limited “points” to spend on his abilities, a min-maxing wizard will maximize his knowledge and intelligence, while making little to no effort to improve his strength. A min-maxing warrior will do just the opposite. It’s a common strategy in gaming, because it makes the most efficient use of limited resources.

Uncommon Sense

This idea may seem obvious, but few people apply it to their spending habits. Most middle-class people buy middling quality across the board. If a middle-class couple decides they need some pots and pans, for example, they’ll head over to Target or Bed Bath & Beyond, peruse the 3 or 4 sets of reasonable looking non-stick pans there, and most likely choose the mid-priced one. They’ll do the same when shopping for their “regular” dishes (they probably got their “fancy” dishes as a wedding present, and never use them). When the non-stick coating on those middling quality pans wears out in 3 or 4 years, they’ll replace them in the exact same way. They’ll follow roughly the same strategy for everything from cars to tubes of toothpaste.

Let’s think back on my Thanksgiving feast. I have a great love of cooking, and I do it every day. So when it comes to cooking gear, I buy the best. It’s all about the food for me, though. I couldn’t possibly care less about fancy china, silverware, or glasses. So while I have no regrets for paying upwards of $200 for my enameled cast iron Dutch oven, which brings me joy every time I use it, I can’t fathom paying more than fifty cents for a plate, and then only if one of my current ones breaks.

That’s why I have thrift store dishes and Dollar Tree glasses, but the same pots and pans as my friend who owns a major construction company and is worth $100 million or so. The funniest part of this is, I spend less money than our hypothetical couple in both cases. My “expensive” pots and pans will end up costing me far less in the long run, because I fully expect every one of them to outlive me, while those nonstick pans will likely need to be replaced every few years. The replacement costs adds up, especially when you factor inflation into the picture.

The next time you choose to buy something, whatever it may be, don’t just follow your regular habits and shop on autopilot. Put some thought into each purchase, and see if there may be an opportunity to min-max. There almost always is.

What to Maximize

Are you going to use this item every day? Can you truly and honestly tell the difference between the best version and cheaper options, and if so, will it really make a difference in your life? If so, then don’t hesitate to buy the best. Seek out goods of the highest quality that will last you a lifetime, and then take care of them. (In fact, a good way to tell if you truly are feeding your passion is if maintaining your tools is a pleasure rather than just a chore.) If woodworking is your passion, go ahead and pay more for the DeWalt router. If you spend hours every day playing the acoustic guitar, then by all means buy a Taylor.

It’s critical, however, that you be honest with yourself. Is woodworking truly your passion, or is it just an occasional hobby that you might well abandon after a few months? If it’s the latter, think twice about purchasing tools at all. See if you can find a tool lending library, or borrow them from a friend instead.

Also, be sure you really can appreciate the difference. For example, if you’re a cooking enthusiast, you might shell out a few hundred dollars for an excellent set of knives. Chances are, though, that you won’t truly appreciate the difference between these and the several-thousand dollar set a professional chef would use (and spend many hours maintaining).

Get it Used, if You Can

Even if you decide to get the best, there’s no need to be in a rush about it. Have some patience, and see if you can can find it used. Getting the best used is like minimizing and maximizing at the same time. Chances are you’ll pay less than for a new mid-range model, for something that will last longer and bring you more pleasure. It’s a big win.

What to Mimimize

One place to think long and hard about minimizing is things you only do occasionally. For example, I love scuba diving, but I only go about once or twice a year. When I first got into the hobby, I followed the standard script and bought a bunch of decent-quality gear. This was, in a word, stupid. I’d have been far better off renting than storing a bunch of scuba gear in my closet for the other 51 weeks of the year.

Another great opportunity to minimize is with everyday consumables. Can you really tell the difference between different brands of dish soap? I sincerely doubt it. How about laundry detergent? I doubt that as well. So why on earth would you ever consider paying a penny more than $1 for either, when Dollar Tree carries both?

Trust me, LA’s Totally Awesome detergent will get your clothes every bit as clean as Tide, which costs over 1000% more per load (not a typo). A few switches like that can free up a lot of room in your grocery budget for more healthy and delicious organic veggies, and I’ll bet you can tell the difference when you buy those.

Ultimately, if you can’t justify maximizing it, chances are you should minimize — or better yet, don’t buy it at all.

Give it a Try

Min-maxing will let you eat like a prince on a peasant’s budget. What does it matter if it’s off a pauper’s plate?

My problem lies in reconciling my gross habits with my net income.
—Errol Flynn

Building wealth and losing weight are both simple in theory. There’s really only one step to each. To lose weight, simply burn more calories than you eat. That’s it. If you do that consistently, day after day, you will lose weight. You may not lose as much as you’d like as quickly as you like, but you will lose weight. Period. Nothing can change this fact — not your metabolism, genetic profile, family history, or any other excuse or rationalization you can come up with. No one can escape the laws of physics.

Similarly, if you consistently spend less than you earn, you will get richer. Again, perhaps not as quickly as you’d like, but your net worth will grow.

Simple, right? So why do so many of us struggle with both? Why are Americans the worst savers and most overweight people in the developed world?

Simple, but not Easy

The first thing you need to realize is that “simple” and “easy” are two very different concepts, especially when addiction dynamics enter into the equation. After all, to quit smoking, all you really need to do is never light up again. Simple, right? But as any smoker who has tried to quit will tell you, it’s anything but easy.

Our collective addictions to consumption in general, and overeating in particular, likely come from a common source. Humans evolved in an environment where food was scarce, without any effective means of preservation, and resources were limited. It’s only natural in such an environment to eat more than you need to survive when the opportunity presents itself, building up stores of fat for the inevitable lean periods. Similarly, it makes sense to hoard whatever resources you can get your hands on whenever possible.

Neither of these behaviors make much sense in our modern world of effectively limitless food and access to resources, but in the grand evolutionary timescale, humans have been living under these conditions for a blink of an eye. Our natural tendencies have yet to adapt.

So if you’ve gotten into trouble with your spending in the past (as I certainly have), or if you’re in trouble now, first off, give yourself a break. You are human, and succumbed to human nature. Beating yourself up about it will accomplish nothing.

At the same time, there’s no excuse for continuing the pattern. Realize that you and only you are responsible for your spending, and take action. There are many natural tendencies responsible adults must suppress to live healthy, productive lives. (I, for example, must constantly suppress the perfectly natural urge to assault anyone who plays Nickleback in my presence.) You’re just going to have to add one more to the list.

I’ve been rich and I’ve been poor. Believe me, honey, rich is better.
— Sophie Tucker

If you were to survey a random group of people, chances are most would agree that, all else being equal, being rich is better than not being rich. Ask that same group of people what being rich actually means, however, and you’re likely to get a wide variety of answers. So ask yourself before you continue — what does “rich” mean to you?

What’s Your Number?

Most would say some number of millions of dollars. Of course these numbers are nonsense. If you were to win $10 million in the lottery tomorrow, you might well feel rich, but imagine if Bill Gates were suddenly stripped down to his last $10 million. Chances are he wouldn’t feel wealthy at all.

You might not feel much sympathy for poor Mr. Gates having to learn to get by on a mere $10 million. I wouldn’t blame you. Consider, however, that the average middle class American who is “just getting by” lives like Bill Gates compared to much of the world. If you’re having trouble making the payments on your SUV, I doubt a subsistence farmer in, say, Somalia has much sympathy for you.

If you’re Reading this, Chances Are You Already Live like a King

In point of fact, the average American lives a more luxurious life than a king would have not so many years ago. Don’t believe me? If you live in America, or any other first-world country, you have affordable access the electrical grid, highways, the Internet, vaccines, reliable sanitation, antibiotics, year-round fresh fruit and vegetables, natural gas, a nationwide cellular network, and a thousand other things I could name. A medieval king may have had lots of money, servants, and status, but he had none of these. Traveling to another continent would have taken him weeks instead of hours. And if he happened to catch, say, dysentery, well he was out of luck.

It’s staggering how much we take for granted, isn’t it? Isn’t it fair to call these things wealth? How about access to national parks and museums? Or simply being able to walk down the street in relative safety? And let’s not forget what’s most important — good health and strong relationships. Is anyone truly wealthy who lacks these?

Your Attitude is Everything

There’s a fundamental truth to be learned here, and that is that being rich has more to do with your mindset than your salary. You’re probably rolling your eyes when I say this, because it sounds like one of those “there’s more to life than money” platitudes, but it goes deeper than that. I don’t just mean feeling, rich. Your mindset is the key to becoming rich as well, in all senses of the word. This is fantastic news, because you have the power to change your mindset. Unfortunately, it’s also difficult for many people to accept (If this is true for you, then I hope you in particular will keep reading).

This site may be focused on growing your net worth, but that is only a means to an end. The true goal is living richly. That’s what real wealth means to me, and I am here to tell you that it requires a lot less money than you might imagine.

So how about you? What is wealth to you?