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Is Investing Art or Science?

Watching climate change documentary, a scientist drew a bell shaped graph, indicating the 2 degree global temp increase problem.  It’s assumed that 2% would trigger massive changes, setting off carbon emissions from plants, oceans, and mountains which would in turn raise temps by 6 degrees.  That would essentially wipe out most life on earth.  So , in order to avoid this we have to stop the present course we’re on because if left unchecked, we will exceed 2 degrees by 2050.  In order to get it under control by 2050, we have to slow the rate of increase (acceleration) enough so that by 2015 the graph flattens out  (stops accelerating) and begins to turn down, with the 2 degree level reached in 2050.

 

This got me thinking about investing.  If we use the same bell shaped graph to represent our financial health, what would it look like?  I came up with MASOL or minimum acceptable standard of living.  This is the baseline, below which we would become homeless and start to question our very survival .  if we draw a curve that starts at the point where we enter the work force (or leave home, leave school, or whatever suitable starting point) and ends when we die, we can calculate the masol that will keep us from being homeless.

 

This assumes that we keep working until we die, and don’t accumulate any savings.  Next step would be to start accumulating savings and then we can create a retirement period at the end of the graph.  Next we can start to draw additional lines that would represent increases in our standard of living.

 

The informative part of this exercise is being able to visualize, like the climate change graph, what the ‘tipping point’ is – in terms of how far behind the curve we are, and how fast we have to go in order to catch up.  This is a key question for almost everybody, but almost nobody knows how to frame the question, let alone ask the question.  Smart people like Colleen and Peder simply have a vague, uneasy feeling of worry, uncertainty, and dread about what the future holds for their nest egg.  I can answer this by defining it, representing it graphically, and presenting alternative solutions.

 

In a way this process is like thinking of your financial state of being as driving a car through life, and what you need to know is how fast you’re going now, what gear you’re in, how many gears does the car have, what’s the top speed, and what impact on your standard of living will result from changes in speed and gearing.  The point of this exercise is to find out where you are likely to end up at the end of your life.  Is your current speed and gearing enough to allow you to retire at some future date and enjoy leisure in your sunset years?  Or are you destined to work until you die?

 

The core of this approach is to ‘back in’ to the calculations by starting with the conclusion.  The question is ‘what will my monthly income need be in the future such that I can live comfortably without working?’  For illustrative purposes, let’s assume this number is $5000 per month in today’s dollars.

 

The next question is ‘how much capital will I need to accumulate in order to generate enough income to cover $5,000 per month in living expenses?’  That will be the topic of my next post.

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