How Do I Get My Cross Over Point?

Posted by Fitz Villafuerte under Guest Posts, Personal Finance on July 4, 2012

How much do you need to invest to be financially free?

That’s the question that our guest blogger for today, Anthony, tries to help us with.

Below, he gives us an illustration of how you can calculate the amount you need to save, and then invest, so you can live a financially independent life.

A stage that he calls, “Cross Over Point” – Anthony gives us a pretty interesting theory and formula on how you can give “financial freedom” an exact value.

Let’s now read what he has to say:

I really like writing articles about the “Cross Over Point” because it reinforces my drive to achieve it as soon as possible.

I’d like to share what Jepi and I talked about reaching our own respective Cross Over Points. It’s a nice thing for a couple to set a goal like this independently because it provides more chances for learning new techniques, implementing old or used strategies to saving, investing and spending.

I first shared with her the basic formula to determine one’s Cross Over Point (COP1):

Average Annual Expenses = 0.08 x COP1

where: first Cross Over Point (COP1) is your income from your assets and investments

Note: 8% is the average annual growth of assets and investments in Mutual Funds/ Stock Market. I know this is “lower” than what most people know, but if your money grows more than 8% per year, then you won’t hate me, right?

Like what I said in my blog article, Cross Over Point = Financial Freedom, I can determine the point when I’ve already achieved Financial Independence when I reach COP1 (and then do a lot more after that).

What are the essential ingredients you need to determine how you’ll reach this Cross Over Point?

Consider Eric as an example. Let’s say he wants to hit his COP1 in 15 years (be financially free in 15 years).

Eric’s Time Frame: 15 years or 180 months

Next, let’s say:

Eric’s Expenses: Php 50,000 per month or Php 600,000 per year

This amount covers Eric’s needs and wants, and a little extra. The values are different for every person. A very frugal person can spend less than Php 10,000 per month, or someone with a more upscale lifestyle can spend around Php 100,000 per month.

As a last step, let’s determine Eric’s Cross Over Point by dividing his annual expenses by 8%, the annual average interest growth of investments in mutual funds and the stock market.

COP1 = Average Annual Expenses / 0.08

Since Eric’s Average Annual Expenses is PHP 600,000, then his first Cross Over Point (COP1) is PHP 7.5 million (divide 600k by 0.08)

The result shows that Eric only needs to save and then invest PHP 7.5M to be able to live comfortably with a PHP 50,000 per month of expenses (Php 600,000 per year) for the rest of his life.

Of course, the assumption here is that he does not spend over his budget and that the annual growth of his investments is always more than 8%.

Once you have your first Cross Over Point (COP1), then you can calculate how you can achieve it:

Eric’s COP1: PHP 7,500,000
Eric’s Time Frame: 15 years or 180 months

Divide the COP1 by the time frame and you get your required income rate per month:

Savings and Investments Income: PHP 41,667 per month (PHP 7.5M / 180 months)

This means if Eric wants to get to his first Cross Over Point, then he needs to save PHP 41,667 per month for 15 years. Too high or difficult? Not really because this equation does not yet include the power of compounding interest.

If you compound 8% per year, then Eric actually needs to only save Php 40,000 per month for 11 years to reach his first Cross Over Point:

 Annual Growth Year 480,000 1 998,400 2 1,558,272 3 … … 6,953,550 10 7,989,834 11

Some people may argue that achieving your Cross Over Point is the best possible way to be financially independent.

Moreover, some people will say that the time frame is too long and they can’t wait 10-15 years. For this case, the Cross Over Point becomes a limiter which hinders your potential of achieving financial freedom faster.

Meanwhile, some people will say that the amount needed to be save and invest is too big and they can’t put aside almost 80 to 100% of their monthly income. For this case, the Cross Over Point is not a S-M-A-R-T goal FOR NOW.

But personally, I think setting a Cross Over Point and then working hard to attain it is a good financial goal. And I believe there’s a great satisfaction in being able to achieve this.

This guest post is contributed by Anthony Dones. You may visit his blog Each Peso Counts to learn more about Cross Over Points and other personal finance tips.

Personally, I find this one very interesting. And the only criticism I have with his calculation is that he did not take into account inflation, which at current is around 3%.

However, factoring in inflation can be as simple as adding subtracting it to the 8% which gives us a new constant for the formula, which is 5% (or 0.05). (Thanks to ForsakenOne for correcting me here.)

In any case, I understand that the values in the calculations are not absolute, and in one’s journey towards financial freedom, you need to constantly adjust your income, expense, savings and investment rates so that you stay on track with your goal.

I guess that’s it. I hope you liked our post for today. Do share your thoughts, and if you have any questions regarding this article, just ask them below in the comments section. Anthony and I will try our best to clarify anything about the formula and calculations above.

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Photo credit: mlhradio, fkehren and trekkingrinjani

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15 Responses to “How Do I Get My Cross Over Point?”

1. ForsakenOne says:

Awesome article!

Fritz, i tried out your method for factoring inflation. but I got 4.6M (amount i needed to save) instead of a larger amount (as you would expect).

I think you subtract the inflation instead of adding it. so .08 becomes .05 (instead of .11)

2. Claudine says:

Cool! I was looking for something like this to figure out how much I should at least have for my retirement. It’s not a perfect formula as it didn’t include inflation as well as other needs that may arise in the future (i.e. getting married, kids). Moreover, the unpredictability of the market may affect the computation and the money you may spend in a year if you were already to achieve this.

3. Lyn-Lyn says:

Very informative and helpful post, Kuya Anthony and Kuya Fritz! 😉 I agree with the comment above that the inflation rate should be subtracted as this is a deduction from our income growth rate of 8%. =)

4. Hi ForsakenOne and Lyn Lyn, I was able to come up with 8% growth annually since Philippines’ inflation rate is currently at 2.9% (since May).

Since for a long term investment like stocks or mutual funds, 10-12% is the average, I came up with just 8% growth even with inflation.

8% keeps your investment on top of inflation.

But if your money grows over 8%, that’s all well and good. The advice of keeping your investments diversified will cushion any blow (to the economy/ growth of investments) in years to follow.

5. I’m also curious how people with varying annual realized incomes think of what they can do with the Cross Over Point.

6. ForsakenOne says:

@Anthony – funny you ask. looking at my monthly expenses, i found that my crossover point is remarkably similar to your example. And the prospect of me getting 7.5M is very daunting. factoring inflation and some downturns in the market (after all, who can say we’ll have a bull run for the next 30 years?), It will take me roughly until the day i retire to save up such a huge amount – and that’s considering that i will be able to maintain an aggressive saving habit even after having kids, paying tuitions, and other life events that might happen.

Safe to say I’m now considering the concept that i was not meant to be financially free, but instead i am meant to be the deliverer of financial freedom to my offsprings.

I will be relaively-free, but not really free.

Of course, i did not give up without a fight. I looked at my monthly expenses again and realized i can take away rent money as I plan on owning a house in a few years. But i left something for house repairs, and – to be realistic – some spending money. I came up with 40K permonth for a COP1 of 6M, which is more achievable, but will still take me into my white-haired days – assuming i still have hair.

Nice to know I can achieve it. I just wished it would happen earlier.

7. Fitz says:

Hi ForsakenOne,

Thank you for sharing your thoughts. It really hits close to home.

Personally, my parents have failed to plan for retirement, and I can say that it’s not easy to be “sandwiched in between” – that is, having kids (below) and parents (above) who both depend on you financially.

It’s really hard and difficult work. If it was just me, I can bravely say I’ll be financially free within the the next 8 years. But the reality is that, it won’t be that way.

So like you, I also see myself more as a deliverer of financial freedom to my offsprings (and siblings); which I believe is a legacy that I will be very much proud of.

But hey, we’re still young… and the future is still upon us; and who knows what it could bring? Even J.K. Rowling didn’t expect she’ll be richer than the Queen of England when she was writing Harry Potter, right? 😀

8. ForsakenOne says:

Ha! Yes, that is the X-factor.

Was it you who said you can’t manufacture luck, but you can put yourself in a position to get lucky? or something like that…

I’m seriously thinking of a second income stream now… I think i like writing, maybe I’ll try that and hoepfully get lucky too! 😀

9. Fitz says:

@ForsakenOne
Yup, that’s my personal belief… we all have opportunities to set ourselves to be lucky. 😀

And writing can be a very good income stream… if you like writing novels, consider joining the Amazon KDP and write ebooks for the Kindle.

I’ve read a lot of independent writers and novelists earning good passive income from there.

10. ForsakenOne says:

Thanks Fritz! 😀

11. ForsakenOne says:

Haha!

I just read a comment on the latest blog apologizing for getting your name wrong. I just realized I’ve been getting your name wrong for months now!

12. giggles says:

Hi! fitz

just curious, what do u think is best age to retire or a least how much savings we need before considering retiring???

13. Hi Giggles. Please let me share what I think of your question. It’s a great question, something a lot of is don’t usually like. Same goes for me before. But when I read about the Crossover Point, I realized that I would be able to retire as soon as I’m able to hit my crossover points. At the Point, COP1, I won’t need to worry about money and survival.

So about the savings, building the continuous (active, passive or semi passive) income that will target your Survival and some Comfort or Luxuries is a good point.
How much do you spend in food, travel, rent/mortgage, clothing, for fun in a year?

For retirement, again, when you hit your COP1, you’ve eliminated worry for money and can focus on living. Honestly living the life you want. Statistics say people set a goal to retire even before 65, others want it even sooner. For me, it all depends on what you want. You can semi retire too (great option), you love your business, still want to work even if your financially free? Go on ahead too.

Just some simple thoughts on your question.

14. frugal expat says:

Thanks for sharing this.. At first, my initial reaction too is not factoring in the inflation but glad that you have it at the bottom part..

Cheers

15. Jorayma Salvan says:

very helpful.. I am a budding financial planner and i am just learning all this. and i get a lot of realizations…

sana marami nakaka basa ng blog mo para marami din maka realize at maging eye opener sa knila ito.

in my advocacy to help filipinos to be financially free, one peso at a time, i will share your helpful blog…

more power and God Bless sir fitz!