Our draw-down plan for Financial Independence

The “Physician on Fire” started a blog chain talking about draw-down plans for early retirement. (chain anchor)

Here’s my two cents. It’s not part of the chain itself, as so far I’ve managed to escape the clutches of Twitter and most other “social” media. I tend to be less social the more I use social media. ūüėČ

Set-up

I think of my portfolio in three parts.

First comes the “floor” portfolio. This covers the non-discretionary living expenses: food, clothing, shelter, transport, and the like. Though they aren’t actually fixed, they might as well be: I’ve been tracking for over two decades now, and the household inflation rate on non-discretionary expenses is slightly negative. (!)

Second comes the “upside” portfolios, one for me and one for my wife. These cover the discretionary expenses we each have, plus our own shares of joint travel as a couple or with the household.

Last comes the “cache” portfolio. This covers specific earmarked expenses, such as a certain amount for the daughters’ undergraduate education.

Before FI transition

Floor

We accumulate equity index funds in 401k and IRA and Roth-IRA accounts, and dividend-bearing blue-chip stocks in a taxable account at a large conservative broker. What goes where depends wholly on what we can get our hands on. Preference to Vanguard (when available) in 401k (when employed), and stocks with dividend yield above 4%.

Our current broker has an upcoming mandatory conversion of our accounts from semi-self-directed to advisory with high commissions and ongoing fees. Bad mojo, those fees. We’ll transfer these to Vanguard as a low-cost broker, which will open up VTSAX and ETFs for the tax-deferred accounts.

Upside

For ease of tracking, we each accumulate into a different mutual fund, held directly at the mutual fund provider. One of us uses Pax World Balanced Fund (PAXWX), the other one of Vanguard’s dividend-focused mutual funds (VDIGX).

Cache

These are in municipal bonds held at a large conservative broker, a relic of past living in a high income-tax state here in the US. Selling them all at once would incur a very large capital gain hit, which I would prefer to avoid or at least spread across several years.

After FI transition

Once we transition to Financial Independence, each portfolio draws down differently. To be ornery, I’ll take them in reverse order this time.

Cache

Cache will draw down as expenses are incurred. Since the cache is sized to the expense, and those all will complete in ten years, this portfolio will draw down to zero within the next ten years.

Upside

My wife and I will spend from our upside accounts when we want. I target what would effectively be a bog-standard “25 times annual spending” 4% safe-withdrawal-rate regime for each account separately. Again, with two decades of records, I feel confident on my projections.

Floor

This one’s the odd-ball, which is probably enough of a clue for you to guess why right now. Ready?

No draw-down at all, in true rentier manner. I target the floor portfolio to cover our non-discretionary expenses by dividends alone.

Well, really, not quite “no draw-down at all”. Since it’s aimed to over-cover our needs with a noticeable margin of error, we expect it to grow exponentially. We’ll prune occasionally by gifting chunks of it to our children once dividends exceed 150-200% of our stable baseline of expenses.

Side note: the dividend yield I target is higher than the safe-withdrawal-rate I’d target were I going with a pure depletion strategy. So I’m perfectly happy to be ready to transition sooner as a rentier than as a depleter.

Conclusion

My wife’s insistence on how much to fund colleges and relatives delays the transition until we can empty the nest and downsize the current house. (My discontent elided but you could guess it’s there.) We’re ten years out from transition, yet everything’s in place. We’d need a sudden quarter-million-dollar windfall to transition earlier, thanks to the house.

And that’s how we expect money will flow in and out after we transition the household to Financial Independence.

Pivot on the financial plan

The wife and I sat down not long ago to talk about finances. I spent most of the time listening, as it is rare she sits down to talk *with* me — it’s usually a “talk at” session.

As usual, she talked around lots of things, as an attempt to think them through. The only clarity arrived at was that she’d changed her mind several years ago on “how we must fund” the daughters’ college years, forgot to tell me, and was assuming I’d been acting on the changed agreement the past decade or so.

The first daughter’s already taking college classes. *shakes head*

I’m repurposing the municipal bonds (capital and coupons) to fund undergraduate educations. This will be a full liquidation. Finally, I can shift us from overweight bonds to a more appropriate stock-heavy asset allocation (40% stock to 90% stock).

Throw out a third of our capital?! BBQWTF! That torpedoes the *fourth* run at FI. If I’m going to have a shot at even “on-time retirement” for myself, I go back into the work-a-day world to bring in a second full income.

She’s also been trying to play the “martyr” and “if you loved me” cards about working full-time to support the household plus her mother plus her niece, plus doing excessive volunteer work. She doesn’t like that I’ve called her on it. We’ll see how this all plays out over the next quarter, as I land the next job (to get her off my back) and work side hustles (to buffer the household against whatever next shock she’ll inflict).

Gonna be … interesting. Moral: find a compatible partner, keep the communications active in both directions, and get agreement on what’s most valuable *for the household*.

Traps with the 4% SWR

On the “4% safe withdrawal rate” rule of thumb. Crafted as a comment a year ago on¬†a blog article¬†by a¬†Belgian/Spanish FI¬†enthusiast. He¬†sized his portfolio in the first draft of his financial plan using this rule-of-thumb. ¬†For ease of conversation, he denoted his post-FI expense level target “E”.


The 4% rule-of-thumb comes from US historical 30-year horizon that the Trinity study looked at. Others have explored longer horizons in the US, and Wade Pfau looked at developed nations in a 2010 study, available at http://www3.grips.ac.jp/~pinc/data/10-12.pdf

Pfau 2010 results suggest your “safe withdrawal rate” in Barcelona is 2.56%, set by the 30-year experience starting 1957. 4% for you would fail to last thirty years for 36% of Spanish 30-year sequences of returns. Nest-egg required would be 469*E. Ouch! (Belgian is worse, at 1.46%, 40% fails, and 822*E — double ouch!)

These are for portfolios where the principal is fair game. I presume you want to live off income alone? If so, your “My Portfolio” link gives 3.36% dividend yield, or 358*E, probably with much lower failure probabilities. Much better!

For comparison [when I wrote this response at the end of 2015], I’m in the US, using in-state muni bonds at 4.51% yield, or 266*E. The bond stash continues to build slowly at 124*E.

A thousand thousands

I’m trying a “simple little life challenge” that I think I invented: ¬†a thousand thousands.

It’s pretty much what it sounds like.

Pick out a thousand different ways to reach a thousand of somethings.  Then track and complete.  Kind of a low-hurdle variant on a bucket list.

I’ve not put lots of creativity into it yet. ¬†There’s mundane bits like “passed one thousand cars on the road” or “invested one thousand dollars in a month”. ¬†Somewhat more effort would be “one thousand crunches” or “one thousand push-ups” (in progress). ¬†Much longer term would be “one thousand Toastmasters meetings” (finishing this year) or “one thousand months alive” (age 85 or so).

As I recall, I’m at 60 thousands and counting. ¬†(Told you I’ve not put much creativity into it yet.) ¬†Well, 61 once I log “write one thousand words on a blog” which this post should ensure I hit. ūüôā

Moving forward

This sabbatical has been wonderful. My wife’s reactions to it, decidedly not. So the plan changes somewhat.

I’ve had my taste of early retirement. I shift focus specifically to bare-bones FI. That itself will be somewhat problematic, given additional expenses coming in beyond what I’d saved up for or planned for — choices made by my wife and locked in before I had a say. ¬†Family drama, feh.

I’ll return to work, feed the fosterling, and fund the daughters’ college work over the coming years. I will also fill in the dividend stocks, so at least the floor expenses are covered from ongoing passive income. Anything beyond the basics that my wife wants, she’ll have to fund herself. ¬†Ditto for my discretionary spending. ¬†In effect, I’m tracking us for regular retirement now.

I’m still processing this major let-down. ¬†Adding insult to injury for the FI/RE goal, she wants me to transition back into work just so she can stop working herself. ¬†Past experience is that this will reduce the expenses drastically, just not enough to make up for having only one income. ¬†We can use the investments to make up the gap, but then it’s not getting reinvested.

My¬†investment plan remains unchanged in principle; ¬†target amounts will change as I get updated spending numbers. ¬†Since the girls’ college funds were raided to support the fosterling, we’ll have¬†the daughters borrow for their college education, and we’ll help them repay their student loans from current income. ¬†Moral: ¬†if you’re more sure of college expenses than we were, use 529 plans to clearly dedicate¬†those funds by locking them away.

This also reinforces that one’s¬†choice of partner in life is make-or-break, in finances¬†as in so many other matters. ¬† ¬†For example, we’d be using retirement funds for current spending if my wife knew there were ways to access them. ¬†(Nobody¬†tell her how!)

I’m disappointed. ¬†And I get to deal with it. ¬†Whee.

Status update

Finally awake enough and coherent enough to use a few minutes of spare time to post.

The wife’s snoring continues unchanged. I have managed to adapt a little bit, though not enough to prevent sleepiness from interfering with driving, tending the children, and otherwise enjoying life.

sigh. This trial run at early retirement ends because of factors beyond my control. We’ll have much to address about the past two years. For now, I batten down to make progress without drawing much attention within the household, sort of “FI in hostile territory”.

Not what I wanted. Embrace reality, and move forward.

Replan!

Life will throw curve balls no matter where you are in your FI journey.

Today’s example comes from my household. The past three years, we supported my mother-in-law and niece on the far coast of the US. That’s 3000 miles of distance and an extra $1500 of monthly outflow. Just last¬†week, we successfully merged the secondary household back into the main household. ¬†(My half of the garage is layered with unpacked boxes still.)

Our FI target remains roughly the same, since it presumes an empty nest and my mother-in-law making her own arrangements. We’ll rethink side accounts for children’s education and other growth, since we expect to become responsible for the niece. The nest will empty a few years later, causing more outflow and less to save/invest during the last push for FI. ¬†RE is more remote again, at least for now.

The six-month-became-twelve sabbatical has run its course. We need more income. Time to explore the new career I’ve eyed the past few jobs: technical management, with people reporting to me. Fallback is technical project work. Side hustle must get real,¬†creating and maintaining websites for local businesses and non-profits.

As I replan, I suspect we’ll appear to regress on our FI journey. Our¬†core investments will continue to grow untouched, which comforts¬†me. Any side hustle income will go directly into further investment, or perhaps paying down the HELOC we still have — one choice to capture in the revised plans. And we should work¬†out possible college undergraduate funds for the niece which won’t interfere with those for the two daughters.

So much new stuff to account for! While we’re in the “long grind” portion of the road up to FI, at least I can’t complain it will be boring. ūüôā

Have you realized some major change along the way towards FI, that brought you to replan? How did that feel? How’s that worked out?

Draft zero of FI plan

Here’s a “draft zero” of a Financial Independence plan. Clone it into a document for your own use. Numbers here are representative.

Plan

E : annual expense : observed : $36k
W : withdrawal rate : chosen : 4% (US historical)
T : target for assets invested : E/W : $900k
A : assets invested : observed : $45k
I : after-tax income : observed : $45k
S : savings : I-E : $9k
Y : yield on overall portfolio invested : observed : 4%
N : years left to FI : (T-A)/S/(1+Y) : 91
R : savings rate : S/I : 20%

FAQ

That’s it?

Yup. Pretty straight-forward.

So I just plug in my current expense, after-tax income, assets invested, and portfolio yield, and out comes my target number and how long until I’m there?

Yes. You might want to turn this into a tiny spreadsheet, since you’ll be tweaking it.

OMG that’s a lot of years!

That’s an upper bound. Play around with the inputs to start figuring out what’s acceptable to you. Go explore better ways to calculate this, too, if you want a better estimate.

No, seriously, that’s longer than I’d like.

Yup. You can make changes to the various inputs (observed and chosen) to discover what effects that would have on the numbers. How would you go about making such numbers happen in real life?

That expense number looks low to me.

People can, have, and will live on that (even less), if it’s fulfilling and sustainable. My own E changes as I adjust what is in my fulfilling life and what that costs to manifest.

That withdrawal rate looks high to me.

Go explore the arguments, and decide for yourself. I put 4% here as a defensible default, knowing full well you (the planner) will adjust it to reflect your own (hopefully researched and informed) opinion.

That portfolio yield looks low to me.

Adjust to suit your chosen asset allocation and actual returns. Doesn’t matter whether it’s real estate, stocks, bonds, businesses, or other investments, go observe it.

That income number looks low to me.

Probably. Raising income is one of your prime levers for raising savings, and thus reaching your target sooner.

My expenses will differ before and after transition to FI life.

Cool, go figure out how to adjust the calculations. And what those later expenses will be. ¬†This is, after all, a draft — when you want to change something, you can go out and learn what you need when you need it. ¬†One step at a time, you’ll reshape this into a living plan which reflects your path forward.

… and a controversy

[Essentially part two of last week’s post Two FI/RE equations ….]

Some folks can’t keep a budget because the difference between expectation and reality isn’t narrowing. Those who won’t acknowledge some aspect of what’s real in their life, will have money troubles among the other troubles in which reality rubs their noses.

I promised you a controversy

I assert that making progress on FI/RE requires personal growth. If you’re not growing and changing on this journey, you’re doing it both slow and wrong.

Slow

Growth forces focus on what is most valuable, thus dropping what has no (or little) value. Keeping low-value baggage requires effort, and accumulation beyond what would fulfill you, using unnecessarily extra time.

Likewise, being unclear whether there’s baggage breeds nagging fears and “One More Year” syndrome.

Wrong

Most cultures have some variation of the saying “money doesn’t change you, it merely reveals you further”. The “rich and rude” crowd does exist, yes, counter-balanced by observing similarly large numbers of rude non-rich and polite/stealthy wealthy.

Most major religious and spiritual paths have some canonical list of obstacles to clear. Whether it’s Christianity’s “deadly sins”, Buddhism’s “poisons”, or Islam’s “(acts done by the unrefined) nafs”, these moral failings have financial repercussions. Should we have any which would endanger FI/RE, we’d best address them if we want to reach and sustain FI.

The obvious personal-finance example here is “lustfulness”, provoking divorce and the shattering of nest-eggs, households, and fulfilling relationships. Far more ruinous would be “envy” and “jealousy”, which diverts attention away from your own vision of fulfillment, resets your targets any time someone else does something good, and even brings you to put effort into destroying others’ progress instead of making your own. These produce the “*they* moved the goal posts” complaint so often heard among the financially-strapped.

You can step through your own path’s list. For those who haven’t chosen a path, try the same exercise with perversions or blockages at each layer of Maslow’s hierarchy of needs — see the graphics over here.

Using this insight

Accepting this statement gives you non-financial aspects to add into your FI/RE plan. These support the financial progress by preventing emotional detours, encouraging precision about your targets, and sharpening your vision around what you will manifest in your life after FI transition. Likewise, removing or limiting the effects of character flaws can make FI transition happen sooner and with less resources.

I think it good to give an example from my own FI/RE plan. I aim to correct a flaw I have, which minimizes my networking and my reaching out to friends and neighbors. Having more deep relationships than I have now is part of what my fulfilling FI life looks like. That will require some extra time, effort, and resources to create. That’s in parallel with putting enough investments into place, a typical component of an FI/RE plan. It slightly raises my monthly budget, and thus my nest-egg, reflecting that I do not think FI life would be fulfilling without those extra relationships.

So, am I full of beans here? What adjustments will you make to your FI/RE plan to reflect improving yourself alongside your finances?

Two FI/RE equations

Pete Adeney, in his alter-ego voice of “Mister Money Mustache”, posted a recent blog article “Happiness is the Only Logical Pursuit“. I think it captures a crucial aspect of the journey to Financial Independence.

He digs into Maslow’s hierarchy of needs, and how we can use it consciously to more quickly make choices about what we do. A passing graphic shows a typical consumerist interaction goes about its mischief in throwing us off becoming better people. Then he quickly segues into why producers have more fun than consumers, steps into stoicism, then hops over to a very rough but deceptively accurate summary of Buddhism. I want to focus on this summary, a single simple qualitative equation, to highlight what it means for us.

suffering = expectations – reality

This applies to all forms of personal growth and development, of which an FI/RE journey is merely one expression. By now, anyone who’s read personal-finance blogs and articles (for some time) has come across the principle that

savings = income – expenses

Let’s rewrite this a little:

– savings = expenses – income

I don’t know about you, but my head is spinning with implications from the clear parallels.

Why build and maintain an emergency fund? To suffer less.

Why live within your means? To suffer less.

How do you fit within a tight budget? Expect to do/use/buy less.

Why do people react negatively to changes in their jobs? It’s forcing a change to part of their identity, their reality, while they keep their expectations unchanged (at least at first).

In the Western business world, there are several models of communications and behavioral tendencies. The DiSC model captures the insight that roughly half of people prefer to start making changes by changing themselves, and half by changing others or their environments. These two different modalities operate on altering expectations and reality, respectively. Thus the constant observation that there’s two “competing” camps on progress towards FI, frugality (lowering expenses, changing expectations) and earning (increasing income, changing reality).

Since the net effect we want is raising savings (reducing suffering), we can do any combination of dropping costs and bringing in more money (wanting less and actively changing our circumstances). The competition isn’t between two opposed means of progress, but between two complementary behavioral tendencies.

The existence of the parallel, or rather, that the second/third equation is a specialization of the first, suggests why unhappiness follows folks who retire from work instead of to some preferred activity: financial progress is but a reflection of wider progress. Many cultures have sayings which capture the observations that wealth merely allows someone to be more who they already are, and how you go about building and using your wealth speaks volumes about who you are and how you grew on your journey to wealthiness.