Where did our wealth come from ? Part three

The aim of this third post is to draw deeper insights into how we achieved FIRE. So far we have established that the majority (approx two thirds) was derived from retained earnings, and one third from investment returns. This seems to tell you what we did but not really how we did it, i.e. what did we do differently than the average person/family to enable us to retire so much earlier. When I first conceived this post I intended to perform some kind of benchmarking analysis. For example, the average person earning X, spending Y, .... and compare this against our earning A, spending B, .... ; to try and build a bridge spanning the 27 year gap between our early retirement versus conventional (let’s say 65 years). Maybe I will still do this one day, but I can’t be bothered right now – sorry! Instead I am just going to try and list out the key things we did differently from most other people, and then try to judge which of these differences really made a difference. I hope this will be more useful and insightful than just stopping at the usual message: save more / spend less (although that actually is the crux of it!)

What did we do differently ?

Flying start (new car, no debt, no HECS)

Double Income No Kids until 30’s

Property Investment and accelerated loan repayment

Overseas “Expat” for 12 years

Carless decade

Frugal spending

High salary / career progression

Which differences really made a difference ?

To varying extents, all of the above strategies helped us reach FF in fast time. Some of them probably saved a year or two of work, others maybe cut a decade or even more. Some of them are also inter-related. Let’s go through them one by one...

·        Flying start (new car, no debt, no HECS) : This certainly was a boost, partly down to part-time work and saving while studying at Uni, and partly generous parents who wanted to pay off my Uni fees. I guess it’s not a silver bullet, but probably a year or two of head start versus the average person with a car loan / HECS debt.

·        Double Income No Kids until 30’s : I used to think this was a huge factor, but so far after 3 years of parenthood, I’m starting to wonder if the kid factor is not such a massive financial drain as what I had feared (perhaps its still too early to say). Also, I personally wouldn’t advocate making this life decision based on economics. For us, it took quite some years before we felt ready and excited to have kids, and there were periods when we questioned whether we would have them at all. The biological clock certainly played a role as a forcing mechanism and we are both extremely glad to have two wonderful children. Having said all of that, I think financially it is far more optimal to be DINKs and save/invest the surplus in your 20’s. I guesstimate this can be worth 5-10 years versus a couple who have kids in their early 20’s, and resultant impact on earnings (career break / slowdown) and expenses (childcare, kids costs, etc). Again, to reiterate I wouldn’t advocate deferring kids for financial reasons. If you know you want kids and are ready and eager to have them, then go ahead and do it !

·        Property Investment and accelerated loan repayment : I think the key factor is the last part. Our serial property investment was an effective forced saving mechanism. We didn’t overleverage. I feel our investment performance was neutral. We didn’t pick great properties but we didn’t pick lemons either. We had a good run overall with tenants over the years. It probably helped us get there a bit faster but I honestly don’t feel it made a huge difference versus if we had stuck it in index ETF’s and not used any leverage over all the years.

·        Overseas “Expat” for 12 years : The first seven of those years were on a traditional multinational company expatriate package, with lots of generous allowances and equalisations. This was a big income boost and enabled us to increase savings substantially. Not all expats capture the benefit, many spend or travel it away. In our case, I think we enjoyed ourselves but also tried to make the most of the financial opportunity. Aside from the salary aspects, there are factors like being a tax non resident of Australia. I think we didn’t capture this opportunity nearly as much as we might have in hindsight. In particular, with investment more in shares than property to capture greater benefit. As per the kids factor, I think key life decisions such as this, i.e. where do I choose to live, should be made holistically and not just based on economics. The opportunity to live abroad for us brought many positives to travel and experience different cultures, and the fact we could get ahead financially was the icing on the cake. I guess this helped us quite a bit, perhaps a 3 years short cut, off the top of my head.

·        Carless decade : We were lucky to live in big cities with excellent public transport systems (i.e. not places like Oz, US, where it’s hard to live without a car). Car’s are a financial drain and living without one for 10 years must’ve saved us a fair amount. Again it’s not a silver bullet, but would’ve contributed perhaps a year or two of avoided work.

Just a process check, adding up the above I get roughly 12 years worth of avoided work. We reached FF approx 27 years earlier than conventional retirement age, so that leaves another 15 years to account for. And that brings us to the two generic early retirement “must dos” – earn more / spend less.

·        Frugal spending : I’m unsure whether we are really frugal people, but let’s go with the description nonetheless. As I’ve mentioned, we have never been in the habit of budgeting or tracking expenses. But definitely I would consider myself tight with money and someone who likes to bargain hunt, I’m sure I inherited that from my folks. Some of this has inevitably rubbed off on Mrs FFA too after hanging around with me for so long! We are not materialistic people and spend little on clothes or brands. The purse strings have certainly loosened a lot over the years, and definitely we have accumulated our fair share of useless “stuff” and made some stupid impulse purchases just like nearly everyone else does. That was a bit of a ramble but to cut to the chase I would estimate from a NW accumulation perspective, these “frugal” tendencies carved at least some 2-5 years of work versus the average. But don’t forget a lower spending level has the double whammy effect of faster NW growth AND lower NW required for FF. The latter is a much more substantial effect in our case. Our typical annual spend of $30-40k (including two kids) is far below the numbers I see for “comfortable retirement” which are of the order of $55k (and that’s for a couple without kids). If one’s spending is 40% lower than the average, then one can also accumulate 40% less in retirement funds. That is a huge shortcut; decade(s).

·        High salary / career progression : Without going into details, my salary has been above average and career progression relatively good/fast. I had a good run for 18 years. Benchmarking against an average income, I expect this is a big factor driving our early FF. It’s also the reason we managed to achieve such a high savings rate of approx 80%, which was more about high earning than extreme saving. I guess this was worth at least 10 years, probably more.

Summary

This post identified seven things we did differently from the average person and attempted to guesstimate how many years each of these factors contributed towards earlier FF. In our case, a successful career, an extended period as DINKs, and frugal spending are the key factors. As I have stated in earlier posts, increased earning and reduced spending are both very important but if I had to pick one I would target sustainable spending reduction as the most critical driver of FF (due to the double whammy and controllability). I hope this gives you some insight and ideas on how to plan your own path to FF.

Where did our wealth come from ? Part two

I sat down recently and tried as best as possible to figure out where we accumulated our wealth over the years. I won’t be posting any absolute numbers here but will talk in percentages, which still tell the basic story. This post will aim to estimate where the wealth was made based on the various buckets of Earning (net of Spending), Saving, Investing. This will be a good start, but I’m also interested to try and draw deeper insights on what really enabled us to achieve FF in accelerated time. That will be the focus of the next post, i.e. to identify what strategies we used to accumulate wealth faster than the average person, and which of these were the most effective.

Now for the hard work of backcasting the past 17 years and analysing where the money came from.

Let’s start at the beginning : As a 20 year old bright-eyed, Uni graduate. I must admit, I was lucky to be able to start from scratch (and not negative). Two things helped me get off to a flying start: 1) I had saved money from part-time work while in Uni to buy my first car with cash and 2) my parents had paid my Uni fees so I had no HECS debt.

So, from this starting point, the task is to make a bridge from – age 20 / 0% to age 38 / 100% net worth.

Despite being a relatively detailed person, I haven’t kept budgets and financial statements that will enable me to forensically calculate this, so we will have to make some simplifying assumptions. Fortunately, I have tended to buy and hold investments, and the majority of investment has been in a handful of residential properties, so I will start by back calculating the capital gain and approx. income derived from these over the years as a percentage of current net worth:

·        Property Capital Gains (after provision for CGT) : +20%

·        Property Net Income (after interest on mortgages) : +6%

I have also been a long-term regular investor in shares, but it has always been a small allocation versus property. Regrettably I don’t have good records of all the capital gains and income from these over the years, but my best estimate of the contribution is :

·        Share/Cash Investment returns (including Superannuation returns)  : +9%

Please note, the above are contributions to net worth from these investments, they are not asset allocations. My actual asset allocations are currently something like 55% Property (too much, I know!), 15% Shares, 10% Super, 20% Cash. The point of this exercise is to identify where the money came from, not where it has been invested.

To recap so far, we have accounted for a third of my net worth being generated from Investing, with 26% from returns on residential property and 9% from returns on shares/cash. Referring back to the FF waterfall (and ignoring the Savings bucket which is included in cash), so the balance two thirds must have come from the surplus of Earnings over Spending. It’s going to be difficult for me to break it down in any more detail except to say :

·        Earning (Salary/wages) less Spending : +65%                ( = 100 – 20 – 6 – 9 %)

I guess this reinforces my position regarding the preferred pathway to FF being to focus on the “Earning less Spending” part of the equation, moreso than the Investing.

The final piece of backcasting is to reconcile our historical after tax Earnings (based on employment contracts, bonuses, tax returns etc) versus the “Earning less Spending” contribution calculated above. Again I don’t have the full records of the past 18 years at my fingertips, so this involves some degree of estimation, but here is the figure I came up with…

·        Earning (Salary/wages) : +80%

·        Implied Spending : -15%                  ( = 65 – 80 %)

I must say that before doing the sums, I was expecting the Earnings to be a much larger multiple of net worth, leaving behind a huge amount of Spending that I would have no idea where all the money went. But this result is a pleasant surprise. So much so in fact that I am questioning the accuracy of my calculations and wondering if I’ve missed a chunk of income somewhere. The inferred “savings rate” is 80% ( = 65 / 80 * 100), which is at the high end based on this poll in the MMM forums:

 

source: http://forum.mrmoneymustache.com/welcome-to-the-forum/what-is-your-savings-rate/?viewresults

In conclusion, having gone through the analysis, it seems the vast majority of net worth came from our Earning (80%), i.e. active income from salary and wages accumulated over the years. Out of this, a relatively small portion was required for Spending (15%) on our basic needs and wants, leaving behind roughly two thirds of the net worth being contributed by “Earning less Spending”. The residual third has been generated from Investing, i.e. passive income and capital gains from property (26%) and shares/cash (9%).

This has been a useful exercise and only deepens my opinion that the key to achieving FF is at the top of the waterfall. Efforts to minimize Spending and maximise Earning will have the biggest impact for most people. Of course it is always beneficial to invest wisely and put your money to work effectively, but the impact is second order in comparison. If you are serious about FF, you need to focus your mind and effort where it will make the most impact. In part three (whenever I eventually get around to writing it !), I will dig deeper into this and try to benchmark the various strategies we used to reach FF.

Where did our wealth come from ? Part one

I was reading this recent MMM blog http://www.mrmoneymustache.com/2015/01/26/calculating-net-worth/ and it got me thinking... Where did our stash actually come from?

Of course, I have a fair idea that a large chunk came from salaries, out of which some was spent. And then we have had lots of investment primarily in property, which has made money over the years. While I have a good handle on our balance sheet, net worth and asset allocation today, I couldn’t definitively tell you where it came from, or answer questions raised in this post e.g. what was our savings rate?

In some ways it’s an academic question, but I’m kind of curious and I guess some readers will be too. Also I’m wondering to what extent I have practiced what I preach, about controlling spending and maximizing earning as being the two most important pillars to focus on. So this is the background to the following series, which will be in three parts.

1.      Our financial story

2.      Backcasting Net Worth into FF buckets

3.      Accelerated wealth strategies

Financial chronology

Here’s a brief summary of our main financial milestones over the past 17-18 years. Sorry I’m not including all the gory details of salaries, property prices, etc – they are private and I don’t think they’re required details for the basic questions I’m trying to answer here.

Year(s)	Milestone / Activity
0	Graduated Uni debt free. Used savings to buy new car. Moved cities to start work.
1	First year of work. Mrs FFA still studying. Company pays rent. Saving for house deposit
2	Bought property 1 (20% deposit) and moved in. Mrs FFA now working
4 to 10	Bought investment properties 2, 3 and 4. Roughly paid off each mortgage before buying next
4 to 6	Started some small share trading/investment, without huge success (or failure)
6	Expatriated overseas. Rent out property 1.
6-16	Regular monthly investment in retail actively managed funds (CFS, MLC, Perpetual etc)
10	Relocated to different country, still overseas
12	Paid off all mortgages properties 1-4. Switched from expat to local terms, paying rent again!
14	Bought property 5(overseas) and moved in
15	Parenthood ! Demolished property 4 and built new house (our intended post FIRE home). Mrs FFA becomes a SAHM.
17	Belatedly discovered ETF’s. Switched all mgd funds (2% fees) into low cost ETF’s and direct ASX blue chips
18	Quit job to return “home” to Australia!

 

Hopefully the above time-line gives you a good enough impression of our trajectory towards FF. A few key points to highlight :

·        We invested heavily in properties, but with moderate gearing and aggressive loan repayments. We did not cascade mortgages on top of each other. (Note : Just to make sure you have the right idea, these properties are villas or small houses, not McMansions !)

·        We enjoyed a lengthy period of expatriate living with company allowances for housing, etc

·        We invested consistently in shares over the long-term but at small scale and using high cost actively managed funds. At the end, our share portfolio was roughly equivalent in size to having another Australian property.

Data keeping

It has been an eye opener for me since reading FIRE blogs to see the extent to which people track living expenses. We have never really budgeted, let alone track how much we spend. Fortunately we are not big consumers or materialists, so I doubt the lack of these habits has dented our wealth too badly, but it is hard to say how much more effective we might have been over the years. One thing is for sure, the lack of such data makes it difficult to approach a task like this and figure out where the money came from. I will have to do my best to estimate and fill in the gaps.

Back in the early days, I did use to track Net Worth in a book. Initially I did it every month, but then after some years I regret I also fell out of this habit. I am trying to track down that book now, but it will take some more searching through boxes. Certainly it would be very handy for this exercise to have a timeline of our NW progress.

Coming up next

So that set’s the scene. In the next post I will analyse from our current NW all the way back to the beginning. While I don’t have records of how much we’ve spent over the past 17 years, I can estimate how much we’ve earned in salaries and the returns on our investments. From this data, I will infer spending and savings rate, as well as shed some light on what proportion of the NW was generated from active versus passive income.

Landing in Oz

We've been back for 6 or 7 weeks now and the time has flown!

This won't be a long reflection on having transitioned to FIRE, I'll save that for later. To be honest it has still barely sunk in yet.

Our FIRE is a jumble of several things - 1) quiting my "career", 2) relocating home after 17 years, 3) being a Stay At Home Dad.

[ Note : Points 1) and 3) only apply to me; Mrs FFA has already been for some years and I now empathise much better with all the things she has been telling me! ]

So far, I've felt the impact most of point 3). Being a SAHM or SAHD is a tough gig and must be one of the most under-appreciated and undervalued roles you could imagine. I guess you have to do it yourself to realise, that's how my eyes were opened.

From a practical perspective, the move has gone relatively smoothly, all things considered. We have had a lot of help and generosity from family which has made a huge difference. There's still many relocation issues to attend to, but I am hopeful some spare time will emerge to write some new posts here. The next plan is to put up a high-level analysis of how we generated our wealth, so stay tuned!

Taking a break, FIRE in progress.....

Please bear with me, there will be infrequent posts in the next month or two as we relocate back to Australia. Many thanks to all of you who have been reading and commenting - I promise to write more once the dust settles !

To RE or not to RE ?

First things first, sorry about the corny title. I just couldn’t help myself.

While I’m apologizing, sorry too for the heavy use of acronyms in this blog. I’m learning them too actually, I never knew about FIRE until a google search led me to the MMM website (oops another one) a few months ago. I hope you can figure them out. If not, please comment and I will happily explain.

 

Source of image: aidyreviews.net

Financially Independent Retire Early… it makes sense right ? The natural thing to do if you are financially independent is to retire… Or is it ?

Responsibility

We already covered some philosophical money issues in “How much is enough ? (part two)”, including my views against accumulating excessive wealth and the reasons for drawing a line in the sand called “enough”. But does it necessarily follow that you should retire immediately upon becoming FF ?

The answer of course is no. Being FF gives you more choices than the average person, but if you genuinely love your work and want to continue, there is no reason to stop immediately, or even ever. The important thing is to choose it consciously and intentionally, rather than just drift along because you don’t know what else to do, or maybe you feel uncomfortable explaining it to your colleagues, or other such questionable reasons that you will likely regret later on.

Here’s how another blogger describes it :

“While piling up net worth is a safe strategy, it is not necessarily an optimal strategy, given the fact that life is finite.  Once you have reached Financial Independence, you are now responsible for how you spend the rest of your life.  If continuing to work brings you joy, by all means continue, but remember to take more vacations and explore your alternatives. Bonnie Ware, a hospice nurse, listed the top 5 regrets people expressed on their deathbed:  working more or harder than they felt they needed to, not living a life true to oneself, not having the courage to express one’s feelings, losing touch with friends, and not allowing oneself to be happier.” - http://escapevelocity2020.com/about-me/

The bolded part was added by me. This is something I’ve been grappling with in the latter part of my career, as reflected in the “Evolving perspectives of FF” post. This might sound ridiculous, but in some ways it’s actually easier when you’re not FF, as you don’t really need to think too much about your life purpose and goals. For me anyway, I spent many years on auto pilot, toiling away purely in a quest for that “one day” when it would no longer be necessary. There was always a clear motivating force (money) and a clear goal (FF), even though these did not arise from much intentional thought on my part.

However, once you reach FF, or start getting close to reaching it, you need to find new source of motivation and fresh goals. As EV2020 says, the responsibility is now squarely on you. Auto pilot will no longer suffice. I believe the avoidance of this responsibility may well be one of the real reasons why FF people often choose not to RE, or at least delay it for extended periods.

Our decision / indecision

It’s difficult to say exactly when we became FF, depending on the criteria. I’d estimate based on a 3% SWR assumption and excluding any home equity in net worth, we crossed the line several years ago. So why keep going? In our case, I can deduce five factors that lead us to postpone RE :

·         Inertia : It’s natural to resist change and we are no different.

·         Geography : Having fun overseas…. “We’re going to spend the rest of our lives in Oz so why not one more year abroad, especially as we’re here and all setup now”

·         Re-employability (if needed): Being in a highly paid niche job makes you think long and hard before you quit. Especially in my case no such job exists in my home town. It is a completely irreversible decision. Perhaps this would not be such a big factor if you are in a more common field (e.g. accounting, teaching, etc).

·         Procreation : We had two babies in the past three years and it’s difficult to contemplate three major life changes at once (parenthood, retirement, relocating countries).

·         Greed / Fear : Let me expand a bit more on this one

Greed and fear are primal emotions that influence basically all money matters, so naturally they play a role in this too. Greed can somehow overrule the views you might have about excessive accumulation. Especially as your passive income starts to multiply and all of this flows back into more investments, the wealth starts to multiply quickly. This might become addictive in its own right. You begin to lose sight of the original plan and fall in love with your bank balance. Greed often works in tandem with his buddy Fear, who might also start whispering in your ear: “What if you run out of money, can you really cope without a monthly paycheck, markets might collapse soon after you quit work, etc.” I think you can imagine with the combination of these two goblins incessantly chattering away in the back of your head, it can invariably lead to…

OMY syndrome

One More Year. I confess we gave into this, but only once! We seriously considered pulling the trigger in early 2014. But we had a very good (and I would say valid) excuse in the joyful arrival of our second child in late 2013. Once the timing became apparent, we reassessed our plans. I was still keen initially to stick with the timeline. But as usually happens, Mrs FFA talked some sense into me. As already described above, it would be difficult for anyone to juggle three major life changes at once (newborn baby, retirement, relocating countries). In hindsight, even without this valid excuse, I am glad we took the extra year. We made the most of the bonus time overseas, and it has allowed us to mentally prepare for the big changes ahead. On the financial front it has enabled us to accumulate an extra buffer so our retirement economics are not delicately balanced.  

Therefore, while we did take OMY, fortunately we did not get trapped in OMY syndrome. In our case it was a conscious decision and not one that became ongoing, as some people seem to get stuck in.

Other considerations

I’ve been lucky to spend the latter part of my career in a good industry that pays well. A lot of people I work with have salaries and bonuses that are substantially above average. However, it also tends to be highly materialistic and for most of these people lifestyle inflation more than keeps up with earnings. Therefore sadly the majority get no closer to FIRE than the average person, despite having many times the earnings.

I’ve also seen a few others like myself who capitalize on the opportunity and exit at a young age to start a new life... Hooray!

But there’s another minority I observe who genuinely love what they do and will keep doing it long after they no longer need the paycheck. Other possible reasons for these folks not to RE include:

·         Not ready to take responsibility for what to do next (as explained earlier)

·         The power/status of their working persona

·         The social benefits of work

The power/status factor can be a big one. You might enjoy a high level of authority (official and/or unofficial power) in your workplace, where everyone looks up to you and respects you. Will you be prepared to give that up to be a stay at home parent and get bossed around by toddlers all day ? It’s hard for a “somebody” to accept being a nobody. Although this depends a lot on your ego of course.

Conclusion

FF doesn’t necessarily mean RE, although it is a prerequisite. The RE decision extends well beyond financial readiness into many other factors, not least of which the question “what do you REALLY want to do with your life, now that you fully own your time and don’t need more money?” Surprisingly, this question is not as straightforward as one might think, and if you don’t have the answer it might be tempting to roll on with the status quo. But frankly speaking, such avoidance is a cop out… FF is an amazing privilege that so many others would love to have, please don’t waste it! Tackle the challenges of RE head on, face up to any fears and accept full responsibility for your life ahead.

More about this blog

This is to elaborate on my welcome post, after making progress in the past five weeks to get some content up here. I hope this will make it easier for you to search for posts in particular subject areas, as well as further clarifying the intention of the blog.

Structure

As you probably noticed I am a beginner at blogging so the structure and layout of this page is very basic. I have decided to use the following labels to categorise each post :

·         Financial Freedom

·         Earning

·         Spending

·         Saving

·         Investing

·         Mindset

·         About me

·         Start here

The first five labels should be self explanatory. So far I posted a lot about FF and there will be some further posts to cover my basic thinking on this. After the overall FF framework has been covered, I intend to dive deeper into the four buckets of the FF waterfall and share some of my experience and tips on how best to handle each one : Earning, Spending, Saving, Investing. The Mindset label will capture posts about the psychology of FF. About me is also obvious and will capture self reflections and other posts that give some personal background (albeit vague/non-descript as I already explained this is an anonymous blog). Finally the Start here label is for these introductory posts and any other key articles which are the foundation of what this blog is about.

Content

All of these blog posts are original content that I’m writing myself. When I quote or take inspiration from another source I will always try my best to reference it accordingly. As I start to read other blogs, I noticed a few times very similar content as what I have already put up, e.g. FF water buckets on Living My Rich Life’s blog, and the Shawshank redemption analogy in livingafi.com’s Fear of Freedom post. I guess this can easily happen as most FIRE bloggers are like-minded people and have similar influences. Where possible, I will edit my post and make a cross-reference especially if there is a close similarity. Please accept that these are purely coincidental and unintended occurrences. Meanwhile I intend to stop reading other blogs for a few weeks, at least until I type out the next 3 or 4 posts to complete my basic thoughts on the topic of FF (there will be more to come after that, don’t worry!). Hopefully this way I can avoid contaminating my own ideas and/or subconsciously copying content from others.

Not for profit

I mentioned in the first post my intention is to be honest and transparent. I’m sure readers might wonder if I plan to “monetize” this blog, and if you might soon be seeing google ads, amazon links, etc. I know it’s one of the criteria I sometimes use to screen if I want to follow a blog or not, especially as (with most things these days) readers are overloaded with choice and need to prioritise.

To answer the question: This is a Not for profit blog. I have no intention to monetize it in any way. If that ever changes I will inform you beforehand, but I really can’t foresee why that would occur. By the way, no disrespect to those who have profitable blogs, I think that’s fantastic and an excellent achievement too! But it’s not my purpose here, which is really about the objectives I already stated - to have a space for some self reflection on the transition to FF, and to give back to others by sharing the benefit of my experience, in the hope it might help those at early stages of the same journey. Of course this could be presumptuous on my part to assume this blog will ever be widely read, but I wanted to make it clear nonetheless.