Musings on How We Plan to Live off our Money
The question we are asked the most about financial independence — and especially the “retire early” portion of the equation — is how we plan to live off the money we’ve saved and invested. Are we even going to retire early? What will we do with our time? What if the market goes down? Sorry, that’s more than one question, isn’t it? The first critical aspect to address in a post-FI life is the safe withdrawal rate. Let’s take a look…
Extended Retirement Horizons
Many in the FIRE community are truly retiring very early — as early as their 20’s. These folks are looking at a solid 60+ years of subsisting on their investments. We’ve researched this ad nauseam, and I know the math works, but…
The 4% Rule
We’ve already hinted at this here, but for new readers, the 4% Rule is generally considered by many in the FIRE community to be the true safe withdrawal rate for long retirement horizons. In essence, an individual is financially independent once he or she can live off of 4% of their portfolio each year. Put another way, if you have 25x your annual expenses, working is optional.
Simple example: If your life costs $40,000 per year, a safe withdrawal rate of 4% means you can retire if you have $1,000,000 in assets. Importantly, the 4% Rule assumes at least 50% of those assets are held in stocks.
If all assets are held in cash the retiree would run out of money in the 24th year of retirement (with inflation adjusted spending). We reviewed here the immense power of compound interest and investing to keep your money ahead of inflation.
This pillar of the FIRE community is based on the Trinity Study, which studied retirement horizons of 30 years. Can we assume retirement horizons of 40-60+ years have the same rates of success based on historical market conditions?
Beyond the Trinity Study: The 4% Rule May Not Be a Safe Withdrawal Rate
Thanks to very smart people who actually understand the “real math,” Mr. and Mrs. CC have come to the conclusion that the beloved 4% Rule isn’t exactly extended from 30 years to 60+ years without increasing chance of failure. In the scenario of our life, failure is not an option.
I want to highlight the work that Karsten over at Early Retirement Now is doing. Full disclosure, I only understand about 25% of any given post he writes (kidding, sort of) 😉 , but I’ve gathered enough to know that unwavering faith behind the 4% Rule is perhaps misguided for the long-horizon retiree.
Karsten has written no less than 28 posts on safe withdrawal rates, which start here. Endless number crunching reveals that a “safe as possible” withdrawal rate likely lies in the 3.25% – 3.5% range. A difference of half a percent sounds insignificant, right? We’ll discuss the magnitude of this difference below.
So What’s Our Strategy?
Good question.
Our primary goal is to keep our withdrawal rate low (i.e. safe) and reduce our sequence of returns risk, especially in the first decade. If we can be careful over this ten year period, we’ll likely have plenty of spending flexibility later in life to live comfortably and provide for any increased cost of living (medical, etc.).
We are approaching 25x our future “expected” spending (yay?!). The problem is that “expected” spending is in a post-mortgage world. But right now we have a mortgage.
My thoughts years ago went something like this:
We’ll only have a mortgage for 5 or so years post-FI, and then our spending will be much lower. If we pick an expense level somewhere in the middle of what we spend now and what we think we’ll spend later, we’re good.
Wrong. By spending more than the safe withdrawal rate (let’s use 4% for easy round numbers) in any year — but especially in the first decade or so — you greatly run the risk of irreversible asset depletion. This is known as sequence of returns risk. Booo.
For instance, if we have $1,000,000 in assets and spend $50,000 for five years (5%) before dropping to a very safe $35,000 (3.5%), we could still be risking a potential failure scenario later in life. This of course might come long after we can be “flexible” and find work. Bummer.
Keep it Simple
Right now our withdrawal strategy involves a balancing act of:
(1) Keeping expenses low, and
(2) creating a very modest income stream.
A lot of folks might claim that by generating income we are not retiring early. You’re right! True retirement sounds pretty boring to me anyway.
Save More or Make More?
Let’s say we want to stay at a 3.5% safe withdrawal rate. Operating under the assumption that our yearly expenses are $40,000, we would need assets of approximately $1,150,000.
A 4% safe withdrawal rate would only require $1,000,000, so raising the additional $150,000 could mean a rather extended horizon with your current employer (dependent on savings rate and market conditions). You might not want to do that.
Another way to look at this and perhaps fast-forward the path towards financial independence is to secure a very modest stream of supplemental income. In the scenario described above, a combined income of only $5,000 (yearly) could mean the difference between a 4% and 3.5% safe withdrawal rate. However, by choosing to go this route you are committed to having this very modest income stream, at least in the early years.
If the market is drastically down and there isn’t flexibility in spending, additional income is required to cover the difference and not expose yourself to sequence of returns risk. In dark economic days, increasing income is not always possible.
The CC Family Post-FI Life
What is our plan after hitting financial independence? We honestly don’t know. Lots of folks seem to have this direct path, say, “I’m going to move to X house in X town”. We’re not that lined out. Here’s the top 4 scenarios we’re considering to live the life we want and reduce our sequence of returns risk.
1. Keep doing what we’re doing.
By almost any standard, we have a good life. Our jobs pay well, and we have a reasonable amount of freedom to travel, climb, etc. We could keep on our current path and make our financial situation as close to bombproof as possible, ensuring a very low safe withdrawal rate.
2. Grand road trip
After following Chuck and Maggie Odette, I’ve been inspired to hit the road and experience the “dirtbag life” I’ve envied but never lived. This plan involves traveling for a year and renting out our house, exploring other areas around the country that might be candidates for potential relocation (see #3). If we love it, we’ll keep doing it.
3. Relocate
Based on our current estimates of equity in our home, we could sell now and purchase a property at a lower price, putting us over the threshold of financial independence. The Front Range of Colorado ain’t cheap though, so this plan likely involves moving to another town or out of state.
Geoarbitrage is the practice of reducing expenses by relocating to an area with a lower cost of living. We’re not opposed to this idea, but we want to spend some more time in the towns we’re considering (see #2).
4. House hack
I really don’t like the use of the term “hack”, but it’s all the rage these days. If we could do it again, we’d buy a townhome or duplex and rent out the other half. Getting paid to live in your home is pretty cool! Plus, I can’t imagine a better scenario to ease into being a landlord. Again, based on local real estate values, this scenario would also likely require us to relocate.
We’re total newbies in this regard — any success or horror stories about this scenario?
What About When the Market (inevitably) Tanks?
I can say with absolute certainty that there will be market corrections and even recessions in our future. Hell, we might be heading for one right now! We clearly got dinged in October, as discussed here.
What if the market falls 20% after you’ve left your job?
Good question my dude! This is a critical concept to understand. I want to dive in a bit more on this in the next post. For now, the short answer is that you either must have flexibility in your spending, or you must have income to cover the difference. Do we?
Summary
The takeaway message here is that we don’t quite have our next phase fully sorted. We know we want a financial model with a very safe withdrawal rate (ideally 3.25% – 3.5%), but there is a colorful array of pathways to get us there. Primary questions floating around in our heads:
- Mortgage: How do we account for a mortgage that will only exist for a small portion of our “retirement”? Do we work longer? Do we secure income to cover the additional expense?
- Income: Do we want a model that is based on having a modest stream of income? Income greatly hedges against sequence of returns risk, but can we secure a recession-proof income stream?
- Risk vs Reward: Should we start our new life now, following the Fully Funded Lifestyle Change model? Or maybe we could work in less-than-desirable jobs a couple years longer to bombproof our plan and perhaps put us in the FAT FI category.
- Geoarbitrage: We could pull the plug on our current home now and fast-forward our path to financial independence. In all likelihood though, we would need to move far from our current location to significantly lower our cost of living. Are we ready to move??
What are your thoughts? Have you weighed similar options in your lives? Hit me!