How much is enough ? (part two, going beyond the numbers)

Long post warning: grab a nice warm cup of coffee now, this might take a while to read!

Part one already covered the mechanics of calculating your retirement number, and how important this first step is to get on the path to FF. But there are some deeper, philosophical and mindset factors, which I feel warrant this “part two”.

Philosophical ponderings

On the first level, there’s the issue of money itself and what’s the point? At the end of the day these are pieces of paper or a bank account balance flashing on your phone. It has no intrinsic value by itself, but of course the value comes from your ability to pay for goods, services and experiences using these pieces of paper. So we accumulate money to enable us to spend for our immediate survival needs, plus some wants/luxuries on top, plus to provide for the future via savings and investment. In this case, what’s the harm in infinite accumulation, you can never have too much of a good thing, right ? Even if you go to the grave wealthy, you can always pass it on to your family, so it won’t be wasted.

It’s a valid view held by some, but not one that I subscribe to. For me, there is value to drawing a line in the sand called “enough”. The main reason is the opportunity cost of over accumulation, which is a fancy way of saying I didn’t need to spend so much time focusing on money and could have been doing other more worthwhile things instead. A further point is my skepticism on passing on too much wealth to the next generation. Like any parent I want the best for my kids, but I would rather them be motivated and self reliant, rather than spoilt and entitled. Finally, when I look at the ultra accumulators (Gates, Buffett, Carnegie), they seem to reach a point where they stop and reverse direction, trying to give back at least half (or even all) their wealth before they die. It just makes me think, was it really necessary to accumulate so much in the first place?

It’s also worthwhile to revisit the concept of FF itself. In one of the first posts, I have defined this in terms of the FF waterfall diagram. There comes a point where your passive investment income is generating enough water to fill up your spending bucket and the waterfall becomes self sustaining. It can flow all by itself without any contribution from your active income. In addition to this, it’s helpful to also consider FF from the simple perspective of being free from any money worries. You reach a point where you can make nearly all life decisions without money being a consideration. Of course that’s not to imply you should be wasteful or careless with your wealth, but surely you will have a wider set of options than most. A useful blog post I found that describes FF from this angle is here, written by a very inspiring young man: http://www.scotthyoung.com/blog/2009/04/02/financial-freedom/

Making the right assumptions for you

I think the “free from money worries” aspect is very important to bear in mind when calculating your retirement number. In particular, it might make a big difference in the assumptions you are willing to make regarding both annual spending and Safe Withdrawal Rate (SWR). There are plenty of things one can be concerned about in retirement forecasting. The level of uncertainty is so huge that it probably causes many people not to bother at all, which is a shame. Of course, the value is more in the planning process than the financial plan itself. The critical thing is to be self aware and develop a plan that you feel comfortable with, believe in, and have ownership over.

I do get concerned when I read forum comments about SWR such as : While 4% is a good assumption, you will probably not have enough if you encounter a bear market in the first decade after retiring, in which case you either need to return to the workforce or seriously cut your spending habits until the markets recover. For me, this is not something I’m personally comfortable with, so I will be more conservative in my plan and use a lower SWR.

Please note carefully I’m not saying it’s right or wrong, just that it doesn’t work for me. For other people, they might be fully confident in the 4% assumption and equally okay with the scenario of using a plan B in case of insufficient funds. They might also validly point out that my conservative approach likely leads to over accumulation and a loss of post FIRE time. Again, there is no right or wrong, but the key is to be self aware, ensure the plan fits your situation/needs and leaves you genuinely feeling comfortable and confident. Don’t quit your job based on the generic assumptions in a retirement calculator and a piece of paper saying you’re financially free. Only to spend your retirement years fretting over every share market wobble or RBA cash rate announcement. This does not sound like “free from money worries” to me.

Pop Quiz

·         Person A has Net Worth (NW) $1,000,000, Annual Spending (AS) $30k and is FF, she has quit her high flying job and is excited to be embarking on the next phase of her life.

·         Person B has net worth $1,000,000, annual spending $30k and is not FF but well on the way. He hopes to be able to retire sometime in the next decade.

Who is right, A or B ? Surely based on the maths, NW * SWR > AS = FF, shouldn’t they both be in the same boat. i.e. If A is free then B should be too, or on the other hand if B is not free then how can A be? Hopefully based on this post you can see that it’s important to go beyond the numbers. And FF is not one size fits all (or one SWR fits all in this case).

Let me fill in some further details not provided in the earlier synopsis :

Person A is a devout mustachian. She has done her own research on the trinity study and fully believes the 4% SWR can be applied to her situation. Therefore her $1,000,000 net worth will generate $40k per annum of passive income, which is adequate to cover her spending needs. She still has a reassuring 33% margin of safety ($10k / year); a handy buffer for inflation and other unexpected costs.

Person B is highly risk averse, being influenced by his father’s gambling habits which squandered large percentages of the family wealth in the past. He was also traumatized by the 2008 financial crisis when he supported several close friends who lost their homes as mortgages were called in by the banks. Person B is only comfortable assuming a SWR of 2% in line with long term government bond yields in the US. Based on this, his $1,000,000 net worth will generate $20k per annum of passive income which covers two thirds of his spending needs, but there is still a gap that will require 5 to 10 more years in the workforce to fill.

What to make of this now? Has person A acted recklessly only to later regret her decision to quit the highly salaried job that she might never be able to get back again? Is person B playing it too safe and will rue the lost years spent working when he could have been free to follow his other passions?

In my mind, both are doing the right thing and planning for early retirement in a financially sound way – they are self aware and following a plan they feel comfortable with, believe in, and have ownership over. This is not to say it will be smooth sailing and without regret, but they have done their best in the areas they can control to minimize the risk. The really interesting thing I find in this example, is that two people with identical net worth / annual spending and both having solid financial plans, can somehow be many years (or even decades) apart in retirement timing. How can this be?

Think and grow rich

Source : www.huffingtonpost.com

 



So then, should we all rush to the local library to borrow self-help books, and maybe even take a few sessions with a life coach or motivational speaker? It seems compelling if such a small investment of time and money might enable you to retire a decade earlier in this example of person A versus B. But is it really “between the ears” to such a huge extent?

Actually, I’m a big fan of psychology, self help, positive thinking, or whatever you want to call it. I’ve created a blog label called “mindset” and will tag all posts relating to this so they can be easily found. I am sure many will be skeptical that you can think yourself to FF and it’s true this industry does not really have the best reputation (i.e. hyped up motivational seminars). However I do believe it can work and make a substantial difference, not only for FF, but for life and general wellbeing too! Like anything worthwhile this takes ongoing effort and needs to be done authentically and sustainably.

What do I mean by this? For starters, leave the gimmicks aside, e.g. staring at a Ferrari poster above your desk for 10 minutes twice per day to magically “attract” this car into your possession; or repeating positive affirmations in your mind “I will be a millionaire by 30” “I will be a millionaire by 30” “I will be a millionaire by 30”..... I consider myself an open minded person, but even I wouldn’t bother with these shortcuts to nowhere.

I would recommend the following strategies to build a strong FF mindset :

·         Read a good self help book, and re-read it annually. Preferably around end of year / new years resolution time. Stephen Covey’s Seven Habits is one of the best IMHO, but you should research and find that one that works for you.

·         Become financially educated. Confidence can’t be entirely fabricated. No matter how good your mindset techniques, if you really don’t understand what you’re doing, they will come unstuck eventually. Build authentic confidence and comfort based on financial competence.

·         Avoid comparing yourself against others. Instead compare versus plan or versus last year.

·         Focus on the controllables. Covey is big on this. I like to remember the Serenity prayer. It’s an excellent summary of this principle. And it reminds me of a favourite Seinfeld episode as en extra bonus! A practical takeaway from this – avoid watching live share market prices !

·         Above all, try to lead a balance life and keep things in perspective. Practice gratitude. Be thankful for your health and all the other positives in your life.

I don’t know if I managed to convince any skeptics with this post. If you ask me to prove these mindset techniques work, then I have to openly admit that I can’t give you scientific evidence or explanations. If you want me to quantify how much wealth I have created from my mindset, I couldn’t really do that either. All I can say is I’ve tried these approaches and feel they have a positive effect for me. Maybe they can work for you too. And even if they don’t, I really can’t see much harm. You might spend $30 on a few books (or maybe not even that if you use the library). Rarely do you see such a cost-benefit equation where the cost/risk is negligible and the payoff is potentially immense.

Conclusion

The point of this post is to dig deeper into the retirement calculation and go beyond the numbers. You can make page after page of FIREcalc graphs, but I hope I convinced you to also focus on being self aware and developing a plan that you feel comfortable with, believe in, and have ownership over.

Don’t dismiss mindset factors and the subtle role they can play in accelerating or sabotaging your FF. Remember the other definition of FF as being free from money worries. Therefore another way to achieve FF faster is to learn how to worry less, or better manage the worries when they arise. This is not some kind of magic, you saw how person A’s mindset can tolerate a higher SWR, which enables her to FIRE much sooner than person B, all other things being equal. I am a believer in self help, which might well be the best investment you can make in terms of the cost incurred versus the potential payoff. It would be great to hear your experiences, and if mindset factors have helped or hindered your journey to FF?