What does it mean to get out of the rat race?

Rat race. Source: http://thinkingnectar.com/2008/winning-the-rat-race/

To me, the phrase “getting out of the rat race” represents the desire and drive within most of us to live our passions and achieve our goals. If you are living the life of your dreams at a 9 to 5, then the rat race does not exist for you. If, however, you are simply working at a 9 to 5 (or 8 to 5, or 7 to 3, etc…), out of safety and inertia, not out of love and passion, then you could be looking to get out of the rat race, too.

I currently have it good for my stage in life, and compared to many other people and where I could be, I really have no right to complain. I do, however, still feel that I am leaving something behind. I don’t want to do 9 to 5 for the rest of my life, and I believe that something better is possible.

The keys here are to both increase income and reduce expenses.

What are your financial dreams?


Getting out of the rat race is one of my own financial dreams, and achieving it means having the ability and freedom to just pack up and take off anywhere I want, without wondering how I’m going to pay the mortgage next month. My job is pretty good for a 9 to 5, and I currently make a good living, but nothing is certain in life; I never know what can happen next year. Also, a 9 to 5 career does not intellectually nor emotionally appeal to me.

I don’t just want to sit on my ass in an office all day; I want to get out there, do things, and see the world. I do want to continue working, and hopefully begin generating significant income online.

There are financial barriers to just packing up and heading up today, but there are emotional barriers as well. Without a significant wall of savings, there is less security, and without that security, I don’t feel that I’m ready to leave the 9 to 5 just yet. I need to start working on my infinite portfolio before I can do that.

How do you start building up your financial scaffolding and leap over your emotional barriers?

Pay down debt

I believe that the primary source of insecurity is debt. Mortgage debt, consumer debt, student debt are simply some of the different types of debt that we can have. Debt is lurking around every corner, and waiting to take ahold of us if we are not careful.

Dealing with the largest debt of all: housing debt

In some situations, debt is unavoidable. In Canada, housing prices are on the high side, though not the extreme side. Higher housing prices necessitate taking on more debt, so unless you have a lot of cash sitting on the side or you are willing to rent for the next couple of decades, you will need to take out a mortgage.

You also need to ensure that you have adequate insurance, just in case something bad happens. You need to make sure that all your bills are paid on time, as you don’t want to end up like the man whose house burned down, with the firefighters just looking on because he hadn’t paid his bill!

I, for one, am not willing to rent for the next couple of decades. The rental stock around here is of inferior quality, and rents are not significantly lower than housing prices when discussing similar locations. I need to consider the quality of life, not only for myself, but also for my partner in life. Therefore, I do currently carry around mortgage debt.

My personal recommendations are that total housing expenses should not exceed 33% of net income, with some planning for future interest rate increases. Some leeway is acceptable, but if you find yourself in 38%-40% territory and beyond, perhaps you should reconsider your decision to purchase.

The important thing to understand is that debt is not evil nor objectively bad. When debt is used with caution, then it can be a wise choice. Ultimately, however, if one wants to speak about getting out of the rat race, then one has to pay down debt, supplant that debt with income, or use that debt to invest.

By doubling our mortgage payment, we could bring down the mortgage to a very small amount in 7 years time, and completely pay it off by 9 years time. We would be in our mid to late thirties by then, but with no mortgage debt.

Diversify income

In addition to paying down debt, the other key to getting out of the rat race is by diversifying your income. If I had enough side income to support a backpacker’s style of traveling, then I could conceivably take off for a year and just travel around the world. One of the ways that I personally want to focus on is building up online income.

What about the condo? Market rents in the area are high enough that it could be rented out at between a small gain and small loss in cash flow. At the worst case, the burden might be $300 to $400 a month.

Instead of renting the condo out and taking off, I could also use that side income to accelerate the down payment of debt and investment, thus allowing me to pay off the mortgage fully in 5 years instead of 9 while taking a nice vacation each year, or I can use that side income to expand and generate more side income!

Diversifying your income so that you are not solely reliant on your 9 to 5 opens up a new world of possibilities.

What is your rat race number?

Your rat race number is simply the amount of money you need to have in your investment portfolio in order to never have to work another day in your life. This is what I call the infinite portfolio. The formula for the rat race number is very simple: (expenses – income) / 3%.

Over the long run, a 75% stock/25% bond portfolio with a maximum of a 3% rate of withdrawal appears to do pretty well, even through depressionary events. Going all-in stocks when the markets crash will simply increase returns. Being all-in stocks the entire time might also increase returns, but opens yourself up to more variance in income and long droughts, such as the last 10 years.

I recommend a maximum of a 3% rate of withdrawal because this allows you to build up capital reserves during the good years, which can then be drawn down during the bad years without having to drastically alter your standard of living.

So, what do different rat race numbers look like? See below:

Costs for a couple (examples)
Item Monthly Expense Rat race number @ 3% withdrawals
Internet $40 $16,000
Food $350 $140,000
Shelter (no mortgage or rented) $700 $280,000
Shelter (mortgage) $2,000 $800,000
Public transportation $100 $40,000
Transportation via used car $470 $188,000
New car $720 $288,000

So, once you have $16,000 invested, you’ll likely never need to work to pay for the Internet ever again. ;)

These numbers look large, but don’t succumb to sticker shock. While you carry a mortgage around and a new car, it will be difficult for you to exit the rat race. What about if you pay off the mortgage and go with a used car? Your base monthly expenses might be around $1600 for a couple. If you never worked a day again in your life, you would need a rat race portfolio of about $640,000 in order to accommodate your base expenses. Since the markets have historically returned more than 3% over the long run, your portfolio and income will continue to grow over time.

Wait a second, I am asking you guys to both pay off your mortgage AND save up $640,000? I agree, that is a tall order, but this is just what I consider the minimum number to be safe, if you never work a day again in your life. What if you do continue to work? Generating $2000 a month for a couple is very doable, and with a rat race portfolio of only $320,000 and an income of $2000, you would spin off plenty of income to travel and enjoy life with. One guy is already doing it and enjoying life with less than that.

The best way to exit the rat race might simply be to generate as much income as you can during the most productive years of your life. I don’t believe you need a massive income either; $60,000 to $100,000 for a couple is very reasonable and doable. Some familes have had success with much less than that.

Before you hit 40, focus on your career and on your side business income and generate as much income as you can. Aim for a savings rate of at least 25%, but 40% or more is even better. Don’t forget to enjoy life and take vacations, but build up your reserves and pay down that debt. Reduce your expenses as much as you can, and take advantage of ways to save money, like a tax free exchange. By the time you are in your mid 30s, you’ll have built up a nice war chest that should spin off dividends and that will continue to grow with time, and help you achieve your dreams of getting out of the rat race. This is what I’m personally hoping to do!

Further Reading

So, reader, what are your own dreams, and what steps are you putting in place in order to work toward achieving your goals?

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About

Kevin has left the office, and he is currently fighting the rat race by working on his own business. He enjoys exploring unvisited places around the world and gaining new experiences. He believes that by properly managing our energy and time, we can learn to invest our lives wisely.

109 Comments Kevin on Oct 5th 2010

109 Responses to “What Do You Need to Get out of the Rat Race and Achieve Financial Freedom?”

  1. [...] that. We invest our money not just to see numbers grow in a bank statement, but ultimately to have the ability to use that money to help us achieve our goals. To get there, we need to balance the need to spend now versus the need to spend in the future, and [...]

  2. Ravi Gupta says:

    As I sit here at my desk I agree with working a 9-5 or in my case 7-430. I reference frugality quite a bit because I believe that we live overcomplicated lives. Personally I never watch tv so why should I pay for a TV, the electricity for it and the cable? I wash my dishes by hand so I’ll never have to pay for dish detergent nor the maintenance on the washer nor the electricity. I rarely if ever eat out and I cook a lot of my food from practically scratch. I try to make my life more enjoyable by having a sense of accomplishment. I not only save money but I boost my self asteem. Besides that I think your article is great and I have a feeling that if more people chose the harder road they would have an easier time later on in life.

    -Ravi G.

    • Kevin says:

      No, this is a great point. A lot of it is about cutting out unnecessary expenses, not simply building up capital to live exactly as we live now because that might take longer than we expect especially with lifestyle creep. There is also nothing wrong with a 9 to 5 if you enjoy it, but I feel it’s even more enjoyable when you know you don’t need to depend on it to survive the next month. :)

  3. [...] to make a better life for ourselves. Everything we do should have an end goal in mind, such as getting out of the rat race so that we can spend more time doing the things that we really want to do. If you imagine [...]

  4. great angle and way of presenting the cash needed for the various expense line items. i like the way you concluded your post. i agree with this. many choose to expedite the journey by starting side gigs and working hard on them during their most productive years so they can reap the rewards later on. that is exactly what i am partly doing as well

    • Kevin says:

      You’ve shared a lot of great information on these side gigs, and I appreciate it! This is something I’m moving into over time as well.

  5. [...] up savings and investing it, and it can also be done by starting side businesses and building up side income. This is easier said than done (if I had a magic formula then I’d already be independently [...]

  6. Alex says:

    we all sometimes feel a little bit under the weather but… these days passed fast… most important is in this time, that you stop and think for a minute – think about how short life could be and what you want to make of it. think about beeing 60-70 years old… and do you think, that you will regret a lot of things that you have done in your life? would you change anything? Dont forget, that we should enjoy in life and smil as much as we can. These woul b great memmories.

    Thanks for the article and good tips. We need good advices all the time.

    Alex

    • Kevin says:

      I agree, and that’s why I don’t see the “work your ass off until 60s and then don’t do anything” mode as ideal. The earlier I can hit financial independence the better! Thanks for the comment.

  7. [...] but at the same time, while times are good, I am building up a buffer that will help lead to financial independence down the [...]

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  10. [...] $50,000 on the side to cover all expenses for the year so that me and the girlfriend can focus our energies on our passions, and see how far we can go with that. This amount should be more than enough to live a normal [...]

  11. Choodeelown says:

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  13. Timberlake says:

    I stopped the rat race and started a new live with new non-business goals with the help of a special income increasing investment method I had tested and studied over years just in the hope to stop the rat race without having to reduce to much of the expenses of my family. I just recently published in my website the investment strategies which I found to be helpfull for many to increase income, build quicker capital or rebuilt battered savings and require only small investment funds. The results are great, if you always remain within your risk tolerance levels und don’t invest but a few thousand dollars to build up your capital reserves and your risk capital over some years.

    • Kevin says:

      Thanks for stopping by! I’m happy to hear it, and I also agree that one doesn’t have to be a millionaire or deploy massive capital funds to get out of the rat race. It just depends on where you are, and if you want to do it the “easy” way or the “hard” way!

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  18. You know, I was almost the same a few years ago – promising myself, that one a have enough money I will travel the world, buy BMW and see the world.

    You have everything to realize your dreams, if you do not do it now, no money could help you.
    I do have money to take 10 years off, should I want it but I do not do it… The reason I want something else. Albeit, I visited 4 new countries last year.

    I do like how you presented the rate race number. However, I have recently added two other factors – inflation and administration fees. Both of them could add up to 4%, it means that at current stock market & bonds performance it means negative returns.

    • Kevin says:

      Enough money to take 10 years off definitely sounds like financial independence to me. :)

      The rat race number is a useful concept, but I personally don’t think I would stop working at all. You could use it more like “well, if I have X amount, then I don’t need to worry so much about being tied to my day job if I can make Y doing this. If it doesn’t work out, well I can still survive because I have enough to cover the base expenses.” Just being there would be pretty amazing.

      I definitely agree about inflation/admin fees too. I recommend index funds to reduce those fees, as well as the taxation aspects from active investing.

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  20. [...] up your savings isn’t the only way toward financial independence. Building up side income is also a great way of closing the time gap and striving toward financial fr…. I believe that diversification is important when it comes to wealth, but I also believe that [...]

  21. [...] I currently have it good for my stage in life, and compared to many other people and where I could be, I really have no right to complain. I do, however, still feel that I am leaving something behind. I don’t want to do 9 to 5 for the rest of my life, and I believe that something better is possible. – Investitwisely [...]

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  26. Just in case anyone was wondering, to figure out the multiplier for any given rate of return, simply divide the rate into 12.
    So, 3% return = 12 / 3%, or 12 / 0.03 = 400
    4% return = 12 / 4%, or 12 / 0.04 = 300
    8%return = 12 / 8%, or 12 / 0.08 = 150

    Take the multiplier and multiply the monthly cost of a given service (i.e. Internet @ $40/month), and multiply by that.
    $40 * 400 = $16,000 (since we’re using the 400 multiplier it’s 3% rate of return)
    $40 * 150 = $6,000 (or at 8%, you’d only need $6,000).

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