Not so long ago, a discussion with a coworker got into the early retirement subject, to be more precise: how much is enough. This is indeed a good question: when can you stop working and be sure? Honestly, this is a question that is in the back of my mind. There are so many variables to look at. So many events that can happen. What does the picture look like?
At a high level, I would split the problem into 2 parts: one being the numbers, the second being events that disrupt your freedom.
When making a plan, you need some numbers. How much do you plan to spend in retirement, how much do you think you can withdraw each year, what do you want to leave behind for the kids. I will stay to these 3 for now
How much to spend in retirement
Figuring out how much you need to live on is not as easy as I thought. I have a very good idea of my expenses now, yet what I would spend being free is difficult. As being free is about traveling a lot and still working on challenges, it is hard to find it out.Next to that, there are some benefits that the corporate job offers: health insurance, additional pension saving,…
Probably still too many questions to come up with an answer to that. What now?
For now, I just assume that my spending would stay the same, but we are mortgage free.
How much can you spend safely?
This is probably the point that scares people the most. How much can I withdraw and still be sure that I always will have money (Or, how do I avoid that I run out of money before I die – maybe a bit hard as question, but that is the real question I think)
Being an index investor, not having a rental property, all my spend money in early retirement needs to come out of the sales of assets. In order to see how much I would need, I can use simulators like cFIREsim or the 4pct (or 3,3pct if you like) safe withdrawal rate. This will help you to get a rough idea. Reading on this topic, there are many thoughts on this.
If you are a dividend investor or a rental property investor, then you need to make sure that your passive income exceeds your needs. Sounds simple? You need to factor in vacancies in your rental properties, drops in rental rates, dividends that are being reduced or suspended. So, it is not simpler…
Going for the 100pct sure rate is impossible. This would mean that your savings need to be sooooo big, that a normal person would not achieve FI before a lot of years.
Based on what I read and simulations that I made, going with a SWR of 4pct seems to be ok thing for me for an index investor.
What do you leave behind for the kids
Being a father with 2 kids, I think about their future and the future of my potential grand children. One thing I will be doing is teaching them values in life and making them smart about money. They should understand the power of starting early, having a plan, compound interest will be a mandatory subject during birthday parties (just joking).
Next to that, I hope to help them financially during college, when getting a first house and when having kids on their own.
This will take a big piece of the freedom fund. It will be given with great pleasure…
The disruptive events
sequence of returns risk
You have worked out your SWR. You are happy. You should not be: here is the sequence of return risk. This comes down to the fact that working with average returns on investments is wrong. Some years you make 10pct on your investing, the next year you loose 7 percent, the next year you are flat and then it booms with 15pct gains.In total, you have the gained 7pct per year return, but some years, you were actually loosing money.
How does this impacts you: In years of a downturn, you need to sell more assets than the calculated average to get the same amount of money. On the other hand, if the markets are high, you actually sell less assets. What is the worst case that can happen? At the start of your early retirement, your portfolio goes down, you sell more than average and by doing so, you cross the line where your portfolio can’t recover enough.
One way to deal with this is to withdraw each year 4 pct of your portfolio and not 4 pct of your initial portfolio. Do you have this flexibility? Imagine you had 1million when you start, that year you take out 40K. A nice life awaits you. Then the markets go down, you are left with 500K. You should not take 40K, but only 20K. Can you deal with this?
It looks like the first years of your retirement need to be the years where you earn more than the SWR on your portfolio. That could build in a buffer.
You have the future all planned out, then health issues pop up and you need to spend a lot of time and money on hospitals. What now…?
Making sure you have the right insurances in place is key. There is the health insurance that should cover for hospital and medicine costs. this seems to be a must have for me.
Next to that, maybe consider an income insurance. I am not even sure to what extend I am covered today. Should be an action point to find this out.
Should you take into account financial windfall. If your parents have a house and some savings, than it is not unthinkable to inherit at some point in time. I wish and hope that this happens as late as possible.
For my own planning, it is not part of the equation. It might happen late, they might have a disruptive event themselves, fights in families happen…
So, what is enough?
Reading FIRE blogs, it means having 300 times your monthly expenses. In this case the 4pct SWR applies and you could live for ever on this. It requires you to be flexible, to take out 4pct (or less) each year of your total assets, not 4pct of the starting amount.
A good proxy of monthly expenses are your todays expenses, maybe corrected foe the mortgage that you plan to pay off before FIRE. Maybe add in a personal health plan.
Next to that,make sure some black swans are covered, think health and income insurance. But also the bad markets: put some money away that you can use if the markets are so low, that taking out money of your fund would not be a smart idea. Ideas that I have read on this topic are very interesting: set up a bond ladder of 5 years, so you have the flexibility not to sell during 1 or 2 years in down markets, but you can also extend in booming markets your bond ladder to 6 or 7 years. Or, you could hold about 3 years in cash, so that in bad markets, you can skip a year of selling (similar to the bond ladder)
Other ways to protect your FI, is to be flexible and do some paid work when needed, or to build up extra security.
Applying the above, I was able to build a model with some numbers to calculate our FIRE date of 2029. The key assumptions for me are
- no more mortgage to pay
- Build in holidays in model
- build in university costs in model
- Current expenses cover the build up of an insurance health plan with an acceptance that already took place
what scares most people is that planning for FI is a big thing. There are so many parameters to take into account. That many assumptions to make. You are almost guaranteed to be wrong. Key to survival is flexibility. One of the things that I fear most is falling into the one more year trap. This means you require so much of security that it become impossible to start being independent.
How do you define “enough”?