My motivation and mission:
Google sheet that contains list of all WCD lessons and links to all content:
Lesson reviewing how to use Google sheet:
This lesson discusses how most people perceive retirement and rethinks how you should think about life, working, investing, and retirement.
What is retirement?
When should you retire?
What are the 3 phases of capital?
To understand the topics discussed in this lesson, you will need to understand the concept of time value of money (discussed in Lesson 001).
What is Retirement?
Most people have a very simplistic view of retirement. Effectively, they break life down into two phases:
Phase 1 - Work
This phase involves trading time for money.
Most people save very little and invest even less.
Most people adjust their life style such that they spend almost every dollar of their income.
Most people do this phase until the age of 65 when social security (SS) kicks in.
Phase 2 - Retirement
Stop working and start living off social security.
Typically people can’t sustain their old life style as the amount they get from social security is less than they were making at their job.
If the person was fortunate enough to accumulate any savings, this gets burned through in just a few years as people are slow to adjust their life style.
Most people sadly run out of money before they die and are living SS-check to SS-check and get forced to adjust their life style once their savings has evaporated.
Unfortunately, the model above happens to a high percentage of the population. My mission is to help educate people about money, finance, and investing such that they can break out of this model and begin thinking about life and retirement in a completely different lens.
How I Define Retirement
In order to understand how I define retirement, you need to first understand the 3 phases of capital. One of the key differences between the old framework and my framework of retirement has to do with how the phases transition from one another. The old framework has a cold-turkey switch between phases whereas my framework has a gradual transition and significant overlap between the phases.
So what are the 3 phases of capital?
The 3 Phases of Capital
Capital Accumulation
Capital Appreciation
Capital Distribution
Phase 1 - Capital Accumulation
Unless you were born with a trust fund, you start life with little to no capital. Many people actually start-off their career with negative capital (debt) from student loans.
“Capital Accumulation” is verify similar to “Phase 1 - Work” in the old framework as it involves trading your time for money.
However, there are some subtle, but key differences between these frameworks that make a huge difference in the outcome. The difference has to do with the objective of the phase; this objective isn’t a written rule but a mindset of the person in this phase of life.
Old Mindset - The objective of “Work” is to sustain your lifestyle until retirement.
New Mindset - The objective of “Capital Accumulation” is to aggressively save as much of your income as possible and begin investing it such that you can exit this phase as quickly as possible.
Phase 2 - Capital Appreciation
Capital Appreciation is the phase when you start investing your accumulated capital in order to capture the power of compounding. The earlier you can start this phase, the better off you will be.
Capital Appreciation can begin as soon as you start Capital Accumulation. Remember, there can be significant overlap between the 3 phases of capital.
However, most people will have debts that need to be paid off or other basic necessities (like a car) that they need to purchase in the early innings. So in reality, Capital Appreciation will typically lag Capital Accumulation.
If your are lucky enough to have no debt, then you can start Capital Accumulation and Capital Appreciation at the same time. However, your time, attention, and energy are limited and you need to allocate these accordingly. See image below to see how this transition could be made.
In the early innings of Capital Accumulation, most of your time and energy should be focused on earning more and saving more. It would be silly to spend a lot of time trying to squeeze out 12% ROI on your capital vs 10% ROI on your capital when you have little to no capital.
That said, there is a point in time where it makes sense to focus more of your time and energy on investing your accumulated capital, then it does trying to earn another buck. In Lesson 005 I will explore this determination in great detail.
Phase 3 - Capital Distribution
Capital Distribution is the phase where you begin utilizing your capital as the primary means of supporting your life style. Effectively, you are converting your capital into an income stream. At this point in your life, you are seeking yield and not capital appreciation. This can be done using any of the strategies below:
Purchasing dividend stocks (and not re-investing the dividend payment)
Purchasing fixed income investments (bonds)
Purchasing real-estate (rental properties)
Purchasing cash flowing businesses (E.G. laundromats and car washes)
Covered call options on securities
I will go into more detail about these different strategies in future lessons, but at the moment, all you need to understand is that these strategies convert capital into cash flow that you can spend. The rate at which this capital is converted into cash flow is called the “yield”.
If you have $1,000,000 of capital and get a 10% yield, then you will receive $100,000 in cash payments each year.
My Definition of Retirement
I like to say there are two retirements in life:
Active retirement
Passive retirement
Active Retirement
Active retirement happens somewhere in the middle of Capital Accumulation and Capital Appreciation. It is the inflection point when you start focusing more of your attention on growing your capital than trying to earn additional capital from an income.
Active retirement does not mean you stop working entirely. Instead it means you can afford to take a more flexible job, work less, hours, take a pay cut. At this stage, the marginal benefit of another dollar of income isn’t worth the time and energy because the opportunity cost is not focusing that time and energy on growing your capital or you family.
I am quickly approaching active retirement. I am 30 years old (in 2021) and have accumulated over $2,000,000 in capital. I will probably close out the projects that I am currently working on and seek positions that allow me to work remotely, are more engaging, and motivate me. I might have to take a large pay cut, but mismanaging my capital at this stage is more detrimental to my finances then losing my income.
Passive Retirement
Passive Retirement happens somewhere between Capital Appreciation and Capital Distribution. This is the point in life where your capital is now sustaining your lifestyle.
I would argue that you will always need to allocate some time and energy towards capital appreciation. However, if you have followed my principals and lessons, there will be a time when you realize that you have enough capital and you can live comfortably off a “conservative yield”. This is the point in time that I define as “Passive Retirement” and it’s when you start spending more time and energy trying to maximize the yield you are receiving on your capital.
In Lesson 006 I will do the math on calculating how much capital you need to have before you can reach passive retirement.
Summary
Retirement isn’t a single point in time. Retirement is a transition between “The 3 Phases of Capital.” There are two retirements:
Active Retirement (when more of your time and energy transitions from capital accumulation to capital appreciation).
Passive Retirement (when more of your time and energy transitions from capital appreciation to capital distribution (yield seeking)).
In Lesson 005 and Lesson 006 I will go into more details about these transitions.
Lesson 005 will crunch the numbers on when it makes sense to transition your time from capital accumulation to capital appreciation (active retirement).
Lesson 006 will address the important question of “how much do you need to passively retire?”. It will review how to calculate this number and provide context about how to think about passive retirement.
Reference Material & Social Media
In Lesson 030 I cover how to navigate and utilize the Google Sheet I have built for all WCD lessons. This Google Sheet contains a worksheet for each WCD lesson. Each sheet has all of the Excel calculations, tables, graphs, and charts that I have posted in the respective WCD lesson. Additionally, the Google Sheet has a master “Index” worksheet that has links to all of the content associated with each lesson.
If you found this post helpful, please like, share, and follow me on my social media channels!