Day to day life after FIRE

I got this question in response to the last post " If possible, can you talk a bit about what you do in your day to day life after FIRE? "

Of course it's possible, so here goes....

Well, it's been a little over 9 months since we moved back to Oz and I quit my job. I guess there are many different versions of FIRE, depending on your life situation, age, etc. In my case, FIRE involved moving countries and returning to the place I grew up, but hadn't lived here for 17 years. The bigger transition by far has been giving up a cushy Mon-Fri office job to be a Stay At Home Dad. I guess that would be the four letter answer to this question - SAHD.

I severely underestimated how time consuming and exhausting it is to look after kids. I took a lot of things for granted before when I used to walk out the door to head to work. But just to catch myself in case I start whinging, it is completely a labour of love ! I wouldn't change anything. And I know it will only be the blink of an eye before my eldest is in kindy (well, a little over a year actually but the time flies), so I want to make the most of this time while I have it.

I think it would've been helpful though to have a more realistic expectation of Stay at Home Parenting before I started. It would've saved me some frustration in the first months, as I gradually re-calibrated ... Maybe something for you to consider Rob_S (?)

So coming back to the question, usually 5-6 days of each week I'm looking after two toddlers together with my wife. We have 1-2 days where grandparents help out with childcare, and those are usually bursts of productivity to do shopping, gardening, maintenance, errands, etc. I visit my great grandmother who's in an aged care facility.

And now to share a recent development for me, I've started some part time contracting work in the past months. I'll put this forward as my excuse for the infrequent blogging of late ! It's only one day per week, but has been a nice change for me. I guess I wasn't that successful at the "RE" part of FIRE !!

What else can I share ? We see plenty of family and the kids are developing bonds with their grandparents, uncles/aunties and cousins, which is the main reason we wanted to be back, so that is fantastic. Asides from family our social life has been limited, which I guess is not uncommon for parents with toddlers, but it's something we're keen to change in 2016 to reconnect with old friends (and make new ones too hopefully !)

Well, that's all I can think of for now. Maybe quite different to expectations, sorry no fairytale holidays or golfing to report as yet, but hopefully more of those to come also :)

Wishing you all every happiness in 2016 ahead !!!

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.

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.

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?



 

 

How much is enough ? (part one)

This is THE critical question for FF. Unless you can answer it, you will never know if you are there or not, and you will never have a concrete goal to aim for. Anyone seriously seeking FF should have a specific answer to this question, i.e. a net worth figure and a target date.

Source of image: theintentionallife.com

Initial research

I’ve spent a lot of time on this recently. Obviously before quitting the career and packing up everything to head home after nearly two decades, it’s important to be sure of what you’re doing. The 2008 Global Financial Crisis is still fresh enough in mind to factor in a safety margin.

While I was reasonably confident I had enough, I started doing some research to try and “make sure”. What I managed to find was various numbers on what it costs for a couple to retire, e.g. “The Association of Superannuation Funds of Australia releases a guide to how much retirees need for retirement. They reckon a “modest retirement” is $23,489 for singles and $33,784 for couples. Yet who wants to be modest in retirement? To have a comfortable retirement (holidays, nice wine, trips to the flicks), you’ll need $42,597, and $58,326 (couples). “ – Barefoot investor, 13 Jan 15

Here is another version with four lifestyle categories :

No.	Lifestyle	Single $ p.a.	Couple $ p.a.
1	Doing OK	22,500	32,500
2	Comfortable	32,000	44,500
3	Doing Well	41,000	56,000
4	Premium	54,000	71,500

(Source: Sunsuper, Suntracker brochure)

Of course, most of these guidelines are for the average single or average couple in Australia. You will be hard pressed to find general guidance for a couple in their late 30’s and with young kids, aiming to retire 25+ years before the typical age. And furthermore, it was only answering part of the question (i.e. how much you will spend, rather than the bigger question of how big a nest egg is needed to fund this spending!)

I also found some very extreme guidelines, e.g. “when you can live on the interest on your interest” –mentioned in “ The Rules of Wealth”, Richard Templar. And I thought I was being conservative! That’s an extremely stringent target especially in this recent environment of ultra low interest rates. Even assuming Australian interest rates of say 3% (which are very high versus other developed countries), that works out to 0.03 x 3% = 0.09%. Taking the modest couple requiring $33.8k p.a., they would need $38 million according to this ! And I didn’t even allow for taxes in the calculation!

Still searching for peace of mind before taking the plunge, I decided to take advantage of the free financial advice offered by my industry super fund. This was a worthwhile experience to get myself organized, but the complimentary financial check-up in no way answered my specific questions on early retirement, and I was not keen to shell out extra money for the personal financial advice offered.

Finally some answers

So I continued my search online, and it was a very rewarding and enlightening bonus to discover the world of FIRE (Financially Independent Retire Early). I never knew there was a community of bloggers out there writing about this, the very same thing I had set out to do all those years ago! And in particular it was very valuable to find Mr Money Moustache (MMM), which I have found to be an excellent resource and have been going through it in some detail these past few months. It was only on this website that I managed to find quality information that I felt was applicable to my circumstances, albeit with geographical translation needed from US/Canada to Australia.

So what does MMM have to say on this question :

“The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?

The answers you get to this question vary widely. Financial beginners (about 95% of the population) tend to randomly just throw out a number between 5-100 million dollars. Financial advisers who aren’t Mustachians will tell you that it depends on your pre-retirement income, (with the implicit assumption that you are spending most of what you earn) and the end answer will be somewhere between 2-10 million.

Financial Independence enthusiasts will have the closest-to-correct answer: take your annual spending, and multiply it by somewhere between 20 and 50. That’s your retirement number. If you use the number 25, you’re implicitly using a 4% Safe Withdrawal Rate, which is my own personal favorite number. “

(Source : MMM The 4% Rule )

It was a relief and gave me a lot of reassurance to find someone who spoke logically and specifically to my questions on early retirement. As I said before, nearly all the general information out there simply doesn’t apply to people still in their 30’s and with young kids.

Example

So how does one apply this? Let’s go through an example of how I would approach it…

1) Take current annual spending e.g. $44,500 (Based on a “Comfortable Couple” as per Sunsuper).

2) Assume a multiplier, let’s chose 40 (A safety margin over MMM’s preferred 25, but still within his suggested 20-50 range).

3) Do the multiplication: $44,500 x 40 = $1,780,000

[ Note: I didn’t consider income tax, but with an income of $44,500 split between a couple of two, the tax rate should be relatively low. Also considering I have been conservative in the multiplier assumption, any taxes should be covered by this safety margin ]

Just to be clear, what exactly does this “retirement number” mean? In my case as a home owner, it is the amount of net worth needed over and above owning my own home outright (mortgage fully paid off). Some might include their own home in net worth and that can be appropriate in some cases. But from a retirement perspective, your home is not an asset providing passive income, and so it does not contribute to this retirement number.

Potential Pitfalls

Please note that home ownership is not mandatory for FF. If you choose to rent, then the above process still works, you just need to ensure rent payments are included in your current annual spending.

The above is an illustrative example only. Obviously you will need to consider different assumptions fitting your individual goals, circumstances and risk tolerance. And accept that it will never be perfect. Of course you could use much more complicated discounted cash flow and statistical models. Please accept these will be imperfect too and I wouldn’t have much more confidence in them based on the track record of most economic forecasters who use such models. In the absence of a crystal ball, a simple and understandable approach suits me fine.

As with any model, it’s only as good as the assumptions and thinking which underpin it, and it can be open to both use and abuse. Try to approach it with an open mind and no pre-conceived outcomes. You will only be deluding yourself if you fudge the numbers. For example, say you are desperate to retire early, so decide on a 30% reduction versus current annual spending (e.g. $20,000 instead of $28,000) and assume the minimum multiplier of 20 to give a retirement number of $400,000. This might serve as a data point for reference, but it’s not prudent to go and quit your job and retire early based on this calculation alone. Before taking such a major life decision, it would be strongly recommend to test the robustness of the assumptions, i.e. 1) try living for at least 6 months on the 30% reduced budget and see if it is really do-able and sustainable, 2) check the average after tax returns achieved on your investments and see if it is in line with the 5% (plus inflation) implied by a multiplier of 20, 3) seek professional financial advice.

Another potential pitfall is the opposite scenario, where the retirement number calculated is so huge that people are de-motivated and possibly give up at the outset. If you experience this, I can only suggest breaking it down into smaller chunks. Every journey begins with a single step. It may seem impossible to reach $1,780,000 when you are starting from scratch. But if you look over 25 years on a straight line basis, that’s $71,000 per annum, which is already much less intimidating, although still a very large number. In reality, most net worth trajectories are far from straight line. Wealth tends to accumulate more rapidly in the later years due to compounding. Try to take a leap of faith and give it a shot. There is not much to lose – even if you don’t quite reach your goals, I’m certain you will still be far in front versus not having bothered about any of this.

Conclusion

The key takeaway message from this post is to spend the time and effort to calculate your specific “retirement number”. Once you have this, FF will no longer be a vague pipedream, but gets transformed into a concrete personal goal with a clearly defined finish line. And now the choice is yours, if you are ready and willing to commit or not ?