I'm back to thinking about those four questions that I battled with during my early retirement decision:
What would I do, would I be bored?
Might I be lonely?
How much would it cost/what would we spend?
How big an investment pot did we need to cover this spend?
This time, number four is on my radar, having been asked about it a few times in the comments recently. Here's what BobtBugle said:
I would love to know your perspective on Q4. That is the one I struggle with the most, having got myself comfortable with Q1-3. On Q4 I veer between worrying about running out having built up insufficient reserves and worrying that I’m being overly conservative. In other words should I be enjoying what I have now rather than building up more for a rainy day that may never come? I guess another way of articulating the “one more year” syndrome.
In early 2016, when I was trying to decide if early retirement was a possibility, this felt like an impossible question to answer. It seemed that there were too many moving parts. Working backwards, I figured I first needed to know:
How much I'd spend each year in retirement? and
What investment returns would be over the course of my retirement? and
What inflation would be?
I knew the answer to exactly none of these questions, which wasn't a useful starting point! Now, five years down the line, and with the benefit of hindsight, does the question of how big a retirement pot we need appear any easier?
How much would we spend?
The truth is that when I made my early retirement decision, I guessed this figure. There were some circumstances that made it more difficult for us (such as being an expatriate worker living in a country different from our retirement location), but guessing isn't the process I would advise!
My main issue was that I had no idea how much I would spend on the activities that would replace work i.e. how much would my new 9-5 activities cost. What I've found is that, on the whole, my early retirement activities haven't added extra cost to our lifestyle compared to when I worked.
My caveat is that travel can be an exception if you have some big trips planned, such as the four month trip we did to Australia and Asia and another three month trip to California, Costa Rica and Colombia. But unless you're doing these year in year out, then the odd year of higher cost could be compensated by some other lower cost years.
My conclusion - if I had to try to calculate what my spend would be, I would simply track my current spend and use that as a starting point. If there were any known sizeable activities, kids leaving home, going from two cars to one car, etc, then I would make an adjustment for these.
Fortunately for BobtBugle, he's already got himself comfortable with his spend number, which lets us move on to the next question.
In fact, let's take the next two questions together.
What will investment returns and inflation be over the course of our retirement?
I'm sure there are no prizes for guessing that I haven't got a clue, which surely puts me in the same position as everybody else, including the people who tell you that they do know! Because I don't and can't know the answer, it actually makes this question somewhat easier. Even if it has some flaws, my solution now is to look towards the 4% safe withdrawal rate as a rule of thumb, and flex it according to any personal preferences or perculiarities of my situation.
For example, I retired at 47, so it's possible that my retirement could last 50 years, so my money needs to last that long. I also err towards being financially risk averse too. Bearing these things in mind, I take the 4% as a rule of thumb, and then look to flex it to these circumstances, so maybe 3.25% feels right to me.
What size investment pot do we need?
Using this information, I can calculate what size investment pot I will need:
Our (Sally and me) average spend over the past four years has been 54,000.
To allow for tax, we need a gross income of around 63,000.
Using my personalised/flexed 3.25%, that indicates an investment pot of around 1,938,000 (if I'd stuck with 4%, it would be 1,575,000...quite a difference).
I can also sense check this from one of our actual investment streams, our rental property portfolio. Recently, this has generated a cashflow income of 3.8% per annum measured against current property valuations. Viewed another way, if we bought similar rental property for a value of 1,657,000 this would generate the 63,000 of before tax income that we need to fund our current spend. I find property relatively simple, because the income will track inflation, so it takes the inflation uncertainty out of the equation. My example is also very conservative because I don't assume any drawdown of the capital - if I did, then the rental property portfolio required might reduce down to, say, 1,500,000. I know that most people won't have such a significant chunk or their investment portfolio in property, but it's interesting, and perhaps comforting, that we're again dancing around that 4% withdrawal rate figure.
But is the question really about confidence?
I suspect it is, and I know that was the case back in 2016 when I was trying to make my decision.
BobtBugle is in a good place because he's already got himself comfortable with question 1-3. On the investment pot, he's veering between worrying about running out of money if he's built up insufficient reserves and also worrying that he's being overly conservative and working more years than he needs to. My gut feel is that if you have both these thoughts in mind, then you probably have enough in your pot to pull the early retirement trigger, if that's what you want. Most likely, it's not money that's standing in the way, it's confidence/doubt that's blocking the path.
So, what to do about those doubts? If it were me, I'd be thinking four things:
Our spending will reduce as we get older, so my calculations based on what I'm going to spend in the next few years will be overkill for what we're likely to spend in our sixties, even more so for our seventies, even even more so for our eighties, etc.
We could spend less if we had to. It probably won't be necessary, but if we needed to reduce our spending, we could and still have a great life. Although we spend an average of 54,000 per year, I recently calculated that this could be reduced to 34,000 (that's a 37% reduction!) by cutting down on some, but not all, of our discretionary spend. It's highly unlikely that our investment pot would be wrong by 37% - perhaps 10% is possible if we're unlucky, and I bet we could cut spending by 10% without a noticeable difference in lifestyle.
But what if my investment pot did have a shortfall? My thinking again is that it is unlikely that it would be massively out. Maybe there's a 10% chance that I have a shortfall of 10%. What does that mean? To me, it means there's a small chance that I might have to return to work a day a week, a few days a month, but probably not. If I wanted to retire while still young and active, that's a risk I'd be willing to take. And how likely is that really? As mentioned already, before I got to that stage, the natural reduction in spending as we age and the ability to cut my costs (while still having a great life) make this scenario less likely than we might imagine.
Perhaps this last one is a bit silly, but we haven't taken account of the fact that both Sally and I will be entitled to a state pension/social security when we are 67. If you have also left this out of your sums, that's a sizeable insurance policy. Maybe there are other things too, I'm not expecting an inheritance, and it's not a subject that one wants to think about, but for some it will be an injection to the investment pot some time down the line.
BobtBugle asked, "should I be enjoying what I have now rather than building up more for a rainy day that may never come?" Unfortunately, it's a question that we have to answer for ourselves. However, based on my early retirement experience so far, if I were trying to answer this question for myself, I'd vote for enjoying what I have now.
One last thing, I'm nervous about writing posts like this because I know I'm not a personal finance expert. Fortunately, there are others who are, and I'm sure you've found their blogs. The reason why I do write them is because I think the issues around making the leap into early retirement are just as much about confidence as they are about those four questions that I put at the start of this post. Again, looking back to my own decision, what helped was finding a few blogs that I could relate to, the ones where the person seemed to have some things in common with me, maybe in terms of background, geography or just their general outlook or interests. So that's why I venture into these posts that I'm nervous about, in case just one person says, "you know, that guy is a bit like me, he's doing it, so maybe...". If it can help just one person with their own thought processes, a little nervousness seems a price worth paying.