The Low Stability of High Income

A few weeks ago I read the following post on Reddit:

HENRY -> NENRY: A cautionary tale from FAANG-land

Imagine this scenario:

You’ve been HENRY (High Earning Not Rich Yet) for say two years and life is good. You feel successful and respected and have a fat stack of unvested RSUs. A few more years at this rate and you might be set for life!

Then you get laid off.

You are now Not Earning and Not Rich Yet (NENRY).

Your lifestyle crept up (and/or your partner isn’t working and/or you have kids). You have savings, but your burn rate suddenly feels quite high. That 6.5% mortgage felt manageable at the time, but now… woof.

You’ve been tracking your Net Worth the last few years (maybe too closely) and have been proud to see it grow.

Now it starts going down. Every week, every month, your FIRE number gets further and further away.

All those unvested RSUs you were granted before the stock price went up? Poof! Gone. You can delete the widget you added to your home screen then counts down the days until your next vest.

Even if you can find another job at the same level, which might take 6-12 months, your total comp might be half what you were making prior (given the difference in RSU value).

Moral of the story: Be grateful, keep your burn in check, and don’t count your chickens before they hatch.

Life comes at you fast. While such stories are rare, they illustrate the fickleness of some high income occupations especially in the tech industry. One day you are flying high and the next day you are trying to pick up the pieces.

The research supports this as well. A working paper released by the National Bureau of Economic Research (NBER) looked at earnings across peoples’ lifecycles and found that, “positive shocks to high-income individuals are quite transitory, whereas negative shocks are very persistent; the opposite is true for low income individuals.”

In other words, if you’re already making a high income, making more is usually temporary, while making less is usually permanent. If a company hits a rough patch or the economy goes into recession, highly-paid employees can be seen as a potential target for cost-cutting measures. 

This seems to be what happened to the Redditor in the post above. Layoffs came and their highly paid position vanished out of thin air. Though more educated individuals (who tend to be more highly paid) usually experience a lower unemployment rate than everyone else, the data suggests that it’s also more difficult for them to replace their income if they are fired or decide to leave.

According to a Pew Research Center study, “job mobility has declined significantly among high-income earners over the past few decades, with only 7.2% of individuals in the top income quintile changing jobs annually, compared to 13.3% in the bottom quintile.” Though high income individuals may be more likely to find a new job if they get laid off, this new position is also more likely to be a step backward in terms of compensation.

But the job market isn’t the only problem here, peoples’ spending is. As Scott Galloway once said, “Rich is having passive income greater than your burn.” Unfortunately for the Redditor above, they lived based on their active income, not their passive income. While getting enough passive income to cover your spending can take a lifetime, living an expensive lifestyle today based solely off your job is a choice.

And that choice is fraught with risks, even though it may not seem that risky initially. Let’s be conservative and say that the Redditor mentioned above was making $500k a year at their FAANG job before they were laid off. After taxes they took home $275k (in a place like California) and spent $200k. Therefore, they were saving $75,000 a year.

Most people will look at this and say “Wow, they are doing well. They are saving $75k a year, which is a lot of money.” This is true and a very logical conclusion to come to. But, I see this and think, “Hmmm, they are spending $200k a year and that’s all being covered by a single stream of income—their job.”

But here’s the rub. Even if their total compensation was $600k or $700k or $800k, I would say the same thing. Because their spending is so high, a replacement job may not cover it. For example, imagine our Redditor loses their $500k a year job but can only replace it with one paying $300k a year. Despite being a downgrade, this is still an incredible income.

Unfortunately, after taxes, that $300k only brings home $186k in a place like California. But their spending is $200k a year! Though they found a decent replacement job, they are still spending $14k more per year than they bring in.

This is the fundamental problem with a high burn rate that is linked to a single income source. It’s simply too risky. This explains why many retired athletes eventually go broke even though their spending wasn’t a high percentage of their income while they played.

For example, let’s assume that the typical professional athlete makes $2M a year (after taxes and agent fees), but spends $500,000 per year. That’s only 25% of their take home pay which is pretty conservative, right? But what happens when their income goes to $0 in 5 years while keeping their spending the same? Even if they earn 5% a year on the money they saved while playing, they’re still broke within three decades!

The issue here wasn’t their income, it was their spending. Trust me, I’m not the person to tell you to cut your spending. I truly believe that income is the foundation of building wealth. But, in the extremes, spending is the key to destroying it.

The problem is that once you get used to a certain lifestyle, it can be painful to take a step back. This explains why the Vanderbilts squandered their fortune so quickly. They couldn’t give up their life of luxury when times got tough, so it led to their downfall.

So, if you’re doing well now, find a way to diversify your streams of income and keep your spending in check. If you were to lose your high paying job, how much could you conservatively make in a replacement job? If you set your current spending based on that level of income, then you should be good.  

This might seem like overkill, but this is the kind of scenario planning you need to do so that you can avoid the same fate as the unlucky Redditor that started this post. Of course, no amount of scenario planning can prepare you for every situation, but keeping your burn rate in check is something that you probably won’t live to regret.

Thank you for reading.

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This is post 420. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data


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