Buying Time For Living Life
Yep – it’s the FIRE Triangle again. And this time we’re here to talk about the final piece of the puzzle, Time. The one thing you can’t buy. Or can you?
What price do you put on your time?
It’s not something people often stop to think about – but the price you put on your own time is something you can actually work out. In fact – that’s exactly what you are doing when you are working towards FIRE.
By following part I and II of the FIRE Triangle you’ve already done the hard work of working out your own personal life scope range and you’ve put together your own expected cash-flow picture. Now when you put the two together, you get your first view of when you will be financially independent and can choose how to spend your time.
Working Out Your FIRE Age
This is going to be another of those ‘no easy answers or magic unicorns’ moments. Again, sorry. Working out your FIRE age is going to involve looking at another bunch of assumptions and assessing for yourself if you are happy to take them on board or not.
The 25x rule that’s often referred to has another huge assumption baked in to it about expected investment returns and portfolio allocation. Essentially it’s based off a piece of research by Trinity University released in 1998 (updated in 2009) which tested different combinations of bond/stock allocations against historic market performance . Several great blog posts have already been written which do a great job explaining these in more detail. Mad Fientist, WallStPhysician and Retireby40 are a few of my favourites I’d recommend you spend some time reading.
The big three assumptions you need to know about though are;
- The study was based entirely on US market data
- Portfolios needed to retain a high proportion of stocks throughout retirement (+50%)
- Average returns (real, i.e. inflation adjusted) were 2.6% for bonds and 8.6% for stocks.
To be clear, I’m absolutely not saying the study is in anyway incorrect. Absolutely it works – but only if you are happy to follow the same assumptions it uses to draw its conclusion. Just that like most things mathematical – any output from a model is only ever as good as its inputs.
- Our investment portfolio is not 100% US market-based. And even with Buffet’s “don’t bet against America” comment – I wouldn’t be happy with that lack of diversification given the length of time we’ll be living off this.
- A minimum of 50% stocks is a pretty high percentage of stocks when you’ve retired. That’s a fair amount of volatility in your portfolio to handle.
- In today’s low interest, low yield world – chances of getting anything like a 2.6% post inflation rate on a bond seem pretty remote for a while yet.
We’re also (hopefully) going to be living off this portfolio way beyond the 30 year mark it applies to. So whilst it’s a great piece of work and a wonderfully simple rule of thumb – as ever, that’s what the 25x rule is. A guide – not the answer.
Solving The Retirement Age Question
So how did we do it? Well, the answer is, unfortunately, the long way. Step one and two we’ve already covered which is what got us to this graph from part II;
As a quick re-cap and for those of you who’ve jumped into this mini-series in the middle – this graph is a high-level view of your main cash-flows of income against planned expenditure – resulting in the dotted black line of net cash-flow. This needs to be at or above zero to maintain your expected ‘life-scope’ without dipping further into your savings.
The holy grail of FIRE is to be able to sustain our lifestyle scope through passive means. Not having to work if we don’t want to. Spending our time on what motivates us – not what pays us. To achieve this we need to invest excess cash-flow from our early years in order to fund more future years of living expenses.
FIRE is like a ‘Buy One Get One Free’ . Save one year – get two later.
So let’s take a look at this same graph but from a ‘cash-flow required’ perspective;
What this shows us is simply our ‘missing’ cash-flow requirements. In this case, our expected annual expenditure less expected pension income. As ever, all values are on a ‘real’ basis, i.e. adjusted for inflation so as to be able to compare like for like. This shows us the cash-flow we need our passive income sources to produce to be able to declare victory on achieving financial independence.
So how do we go about working out how much we need to save to do this? For that – we need to introduce the next part of the puzzle – ‘Investment Pot Value’.
Putting A Value On The Future
With this new understanding of our future cash-flow needs – it’s now possible to work out what size ‘Investment Pot Value’ it will take to fund these. And as importantly – how long it’ll take us to save this lump sum value in order to generate our required cash-flow.
So let’s start adding some scenarios on what kind of numbers we’re looking at. The first case worth understanding is from a pretty risk-averse position of simply matching inflation. No expected growth, minimal risk. Literally how much cash you would need to have at each age point for that to then last out the rest of your expected years. In our case it would look like this;
The grey bars are showing us just the cool £2.675m required at 25 to live out the rest of our days as planned. Ouch. Not exactly the kind of loose change we had down the back of our sofa.
Fortunately – if you’re interested in FIRE, you tend to be of a mind to accept that taking some level of risk is required for any kind of gain – financial or otherwise. So let’s add a few different scenarios and see what kind of investment pot value we would need if we accept a bit more risk.
So what this graph is showing us is how much we need to have invested at each age point at differing levels of returns in order to produce the cash-flows we’ve said we want. The blue scenario is assuming a 7% constant rate of return, purple is a constant 4% and orange is a hybrid – starting at 7% and dropping to 4% at age 45. All values are post inflation and so unsurprisingly you can already see that all three scenarios are substantially lower than the previous £2.675m at age 25.
The lack of straight lines is the next thing that might surprise you here – but they’re a direct result of the shape of our annual cash-flow projections – which are themselves not a straight line. As expected, they all converge as we approach 100 – not a lot of time left for compound interest to do it’s thing then!
What we’re really interested in is the earlier years though. Comparing at our start point of 25 years – we go from £603k at 7% up to just short of £1m at 4%. It’s worth noting that all scenarios require a larger investment pot out at age 45. This is a direct result of missing out on those early years of saving. I.e. you haven’t had the money invested and earning interest for you along the way which gives you the larger pot value to last out from then onwards.
Now, as ever, risk is a personal choice. But personally, there was no chance we wanted to be chasing 7% real returns once we’d pulled the trigger. Happy to take more risk whilst we were both still working and could deal with any bad years of overall returns. Hence we focused on the third scenario (orange) which uses 7% to start before dropping to 4% at 45.
To be honest – even this seems high in today’s world so I’d consider choosing your own scenarios carefully. For now though let’s stick with these and see how they stack up against our savings income.
The Power Of Delayed Gratification
The more I learn about the world, the more I’m of the mind that whatever the particular issue is – there will be a bunch of people for it and a bunch of people against it. Delayed gratification is one of these it seems to me. The concept of having less now in the expectation of having more in the future.
Banker On Fire has a great graph in this link explaining why it’s a relative recent phenomenon for humankind – basically it’s only recently that the average life expectancy makes the idea at all worthwhile. This piece by James Clear is one of my favourites if you want to read more. For now, just know that it’s one of the major superpowers of FIRE – especially when it comes to your ability to save. The more you can delay your enjoyment of your hard-earned cash through a higher savings rate, the bigger the reward it can bring.
So let’s use this to add a few more pieces of info to our graph – namely a few different views on savings rates and their impact on how quickly we can reach our target investment value pot. By savings rate I mean how much of our discretionary spending we could save each year. The resultant investment returns have all been based on the same 7%/4% combo real return rate, as per the orange scenario above.
This leaves us with something like this;
Finally! By including this piece of the puzzle we now have the whole picture of what’s required and when we could get it by – and so more importantly, we’re now able to get an educated view to the question of when we could FIRE.
For clarity, I’ve removed the previous investment pot value scenarios that we discounted as unsuited to our own risk tolerance, leaving just the (orange) scenario representing our 7% down to 4% view. With the introduction of our new savings rate scenarios, we can see where they cross over and hence when, in theory, we could FIRE.
So let’s take a look at the three different savings rate scenarios. The sharp-eyed among you will have already noticed the strange dip in our 30’s. This reflects our decision to invest our savings at that point into building our own home and keeping it mortgage free. One for another post at some point.
That aside – it’s pretty clear to see the difference that the alternative savings rate assumptions make to our results. Unsurprisingly, if we managed a 75% rate (black), we’d be looking at a much earlier FIRE date than at 30% (green). The third option (red) represented a more realistic scenario for us. A lower savings rate of 30% in the early days rising to 60% as our disposable income grew through salary rises and property income.
Using this graph, we can now see that if we ( and our assumed investment return rates ) stuck to this plan – we’d be able to FIRE at 43 with an investment pot value just shy of £1m. That’s pretty awesome news – being able to retire more than twenty years than the official age. Break out the sparkly time surely.
But anyone who believes things will turn out exactly as planned is asking for trouble. All decent project managers will include a healthy contingency budget – FIRE is no different.
Expecting The Unexpected
It’s all well and good putting in all this effort to make a decent plan, based on assumptions we understand. But there’s no point undoing all the hard work by not also planning for the unexpected.
Sand. Great for enjoying a chilled beer on.
Not much use when you bury your head in it.
Hope is not a strategy. Instead, plan for the unexpected.
The best way to deal with expecting the unexpected is to understand your contingency plans. As in what you will do if things don’t turn out the way you hope.
For our FIRE plans we added contingency to our plans through three separate ways.
- Not including the value of our entirely mortgage free house in our investment value pot. A sizeable, if illiquid, pot of cash.
- Including a lot (~60%) of discretionary spend in our Post-FIRE expected annual cash-flow budget. Gives us plenty of scope to adapt if needed.
- Adding an additional 20% to the calculated investment pot size. Allows the plan to work under lower rates of return. Handy.
All of the above meant adding a few more years to our proposed FIRE date. This worked for us since my job was very much a ‘once out, not getting back in’ type – not at the same level for sure. And since we were making sure we were enjoying the journey on the way, it was a trade-off worth making for us.
But how do you go about making those trade-offs and understanding if you have truly optimised your route to FIRE? For that you need the next and final part of the FIRE Triangle series.