Hi RIP friends!
Today we have another post in The Principles series, where I:
- introduce fundamental philosophical/economical concepts.
- show my vision/interpretation of them.
- help you understand the subject from other points of view linking other online resources.
- describe my own strategies and other thoughts on the same topic.
I’ve shown what is Financial Independence, why I want it and how to withdraw from your NW to avoid depleting it. What’s missing here is: “when can I call myself Financially Independent”? That’s what I’m going to talk about in this post: what’s the target NW to make the call?
[Note: this post will be way less theoretical and more tailored to my personal situation and values. Mathematical details have been covered in the WR post, tl;dr: one needs a NW in the range 25-40x Yearly Expenses, according to risk aversion and expected number of retirement years. My personal choice is a factor 30x, which means a WR = 3.33% that adapts with NW fluctuations.]
Target Net Worth, Nest Egg, FU Money, FU Number, Walk Away Money, whatever… I like FU Number so let’s use it!
[Fun Story: at the time of writing this post I have no idea what FU Number is going to appear at the end of the story! I’m actually sure I’m going to enjoy the process of getting lost into the math, number tweaking, hypotheses weighting and so on. I’m blogging mainly to make recorded plans (and to commit to them), to share them so that others can learn something and, most important of all, teach me something. If your plans include Financial Independence then I strongly suggest you to sit down and do the same exercise. It’s Financial Intelligence to the ultimate level!]
Given my WR of 3.33%, my FU Number is 30 times Yearly Expenses, so what I need to discover here is how much will I need per year/month to live at my chosen standard. Bear with me: for my specific situation, this is the toughest question to be answered. I can’t use current spending numbers as “chosen standard”, due to several factors:
- Today we live in the most expensive place in the world and we’ll probably retire somewhere else. More likely in Italy.
- Today we have no kids and we may (and actually want to) have kids in the future.
- Today we have no cars and we may end up needing one or two in case we move to a cheaper country without such an amazing public transportation service.
- We have no idea if we’re going to buy a house/apartment or continue renting. This decision alone is complex enough that can’t be fully analyzed here and no general rules apply.
Along with these RIP Family specific issues there are a lot of general unknowns that we must take into account somehow that range from investment performance (is the market keeping up with 7% average growth?) and kind (switch to rental properties? keep investing? On what?) to fiscality (how income, investments and wealth are taxed in the target country?) to inflation, to… too many variables!
When playing with so many unknowns what would a prudent person do? If I were an astronaut I’d consider the worst possible scenario, where every variable will get the worst possible value – I am a software engineer and I grew up as a very close friend of Murphy’s law. This is not suitable here though, most of the variables are unbounded (like inflation) and there’s no limit at the worst case scenario. And you can’t (and shouldn’t) account for every possible bad thing that could happen in such a very long term project like early retirement.
So what to do? Well, the plan I need to come up with should be robust enough to cover for a reasonably unlikely sequence of unlucky circumstances, but it doesn’t necessarily have to work in situations where even not calling ER is going to be a mess. For example: if inflation rate will reach zimbabwean levels wouldn’t it be a disaster in any case? If there will be a third world war and staples are going to cost 100x would being FIREd change the ugliness of the situation? Should I plan for such scenarios? No, I don’t.
So, my plan needs to be robust given a “normal enough” future. I don’t want to fail and have to come back to work 15 years after FIRE, but I don’t want to accumulate way much wealth than I need before calling it. It would mean having wasted healthy years in my 40s for nothing valuable but extra safety.
Let’s go with the plan then!
As I previously said, I need to estimate, as close as possible, how much I’m going to need per year, ideally each year. Each year, because yearly expenses are not stationary. I’m not talking about inflation, I’m talking about lifestyle changes mainly due to having kids. As a first safety margin, I’d try to estimate the average yearly expenses in today’s Euros for my family as the expenses we would have in the worst years, likely with 2 kids at home. A quick research on the web (US1, US2, CH, Ita) shows that raising a child has no peak years, costs are slowly increasing over time but mostly constant.
Plus: should I account for expected one-off expenses and/or windfalls? Let’s do this way: let’s try to estimate them and in case the windfalls are expected to be greather than expenses let’s not count them, as extra safety margin.
- Windfalls/Heredity: my parents have a couple of properties that I and my sister are going to inherit sooner or (hopefully) later that are worth few hundreds thousands Euros. My father is a saver and a frugal person who doesn’t like to spend his money. He’s probably going to leave us cash in the order of few (one or two) hundreds thousands Euros.
- Expected one-off expense: kids… I plan to help my future kids (and I want to plan for 2 of them) with a lump sum in the order of magnitude of 100K of today’s Euros, probably not given as a single fat check but in tranches over time. This is to help them with University, career, rent, startup,… I’d like to see them flying away on their own as soon as possible. The lump sum has nothing to do with a monthly allowance while living in our house (like my father did with me). That would be in the plan of yearly expenses.
- Expected few-off purchases: we may need a car or two in the future. Either I consider a car purchase as a yearly expense (a fraction per year) in the plan or as a one-off here. I’d say let’s put them in the plan. I’m not a fan of new and expensive cars, so my car purchases would be in the “below 5K Euro” each, ideally a used car every 5-10 years to be driven till its death. That’s negligible in term of yearly expenses. Miss RIP is more oriented to new cars though. Need to discuss or plan accordingly.
Summing this up: one off purchases and lump sums are more than compensated with expected windfalls so I’m not taking measures to face them now. We don’t have kids now, in case we’ll have one or none things are going to be easier (financially). It’s very unlikely we’ll have more than 2 given our age, but who knows. Twins? Well, these are variables we’re going to discover before FIRE date anyway. We’ll adapt our plans accordingly.
Plus: should I account for annuities due to pension benefits? Let’s say no – extra safety margin – but calculate them under current legislations anyway:
- Swiss Pillar 1 Pension: If I reach FI in 5 years I’d be accrued 9 years of Pillar 1 contribution. I’d get back ~400-450 CHF per month at age 65. Miss RIP will get a little bit less, depending how much she’ll work. Here‘s a link to get an estimate of your Pillar 1 Pension.
- Swiss Pillar 2 (Mandatory) Pension: same here: 9 years, expected total = 54K, expected annuity (6.8% per year) = 3600 CHF per year = 300 CHF per month starting at age 65. I’m not counting the extra mandatory portion since I’m going to take it out as a lump sum when leaving Switzerland (or buying a house) so it’s in my NW (well, the mandatory part is in my NW too since there are situations where I can cash it out but it involves moving to a country without pension agreements with Switzerland, like US or other non-european countries). Miss RIP has no Pillar 2 at the moment and I think her employer should/must offer her a plan.
- Italian Pension: I don’t actually know if I’m going to get some of the money I’ve paid during the years I’ve worked in Italy… Italian pension system is so messy, impossible to understand and biased toward traditional work history. I heard that if you don’t collect at least 15 years of contributions you get nothing. Maybe years worked abroad counts somehow… It probably depends if I’m going to retire in Italy or not. And eventually it will kick in very very late, somewhere around age 70 in the best case. It may be possible Swiss Pillar 1 and Italian pension would merge together. I don’t actually know and getting information on this topic is a real pain. Let’s say I won’t have any italian pension.
So, annuities with current timeline will kick in at age 65 (~20 years after FIRE) and are in the range of 8500 CHF per year. Still no, I don’t want to consider them in my plan. I like surprises 🙂
I’ve listed above few safety margins. Planning several of them is the way to handle a fair amount of uncertainties, as shown by MMM. To be as safe as possible (but not too much) I’m going to consider few more:
- 3.33% WR is pretty safe.
- Planned yearly expenses bigger than likely, both during family years (40-60) and traditional retirement years (60-??).
- Two kids is the worst case (financial) scenario… and I’m sure there are tax discounts and/or other tools to mitigate the cost of a kid.
- Windfalls not included.
- Annuities not included.
- Very unlikely that I’ll be earning ZERO for the rest of my life: side jobs, consulting, freelance, writing, sharing economy… some of my dreams will probably help me along the way.
Ok, cool, things are supposed to go smoothly if I stick with my pessimistic plan. Things are going to be better than planned. Probably. What to do if a series of unlucky events will hit hard (more expenses that planned, bad investment returns, asset loss due to financial institutions going bankrupt, earthquake that destroys my properties,…)?
- As soon as I reach a significative deviation from the plan (planned 3.33% withdraw < 20% of planned yearly expenses) I’d try to shrink my budget and/or withdraw more than 3.33% and/or boost incomes (sharing economy, consulting, freelance). 20% is my Oh Crap threshold.
- As soon as planned withdraw goes below 40% of planned yearly expenses I and/or MissRIP would look for a traditional job. 40% is my Oh Shit threshold. I sincerely hope this won’t happen.
Time to estimate yearly expenses, the hardest job. I’ve no clue but a rough idea that 3K Euros net per month will suffice, in Italy, with 2 kids. According to Numbeo, life in Italy costs roughly half of what it costs in Switzerland. I can’t simply cut in half our current spending (60K CHF per year), since other variables are missing in that budget (kids, cars) bot some may disappear (expensive vacations, dinners out, rent?).
Housing: what would be our housing solution? Renting a flat? Buying a flat? Buying a house? Living in a RV? Living in a cohousing/ecovillage? I don’t know yet the answer, let’s plan for the “normal” scenario: buying a flat in the range 100-200k Euros and paying a low interest mortgage (or cash) for it. I’ve been thinking about buy vs rent. My opinion is that if you plan to stay in the same house for more than X years you should buy. X depends on several factors, but it’s in the range 3-7.
The equity portion of the flat would be in our NW but it won’t generate income and it will work against the 75% – 25% stocks/bonds investment split to meet the trinity study requirements. Should I consider just the investments as base for my WR or the whole NW? Should I take a mortgage and have higher monthly expenses (but more invested capital too) or pay cash and reduce the expenses and the invested capital (not an easy question: 1 – 2 – 3)?
I can’t answer right now. I’ll need to take a look at concrete houses and mortgage rates and look at the actual numbers. I can only speculate here. So let’s speculate: I’m buying a 100 square meters house for 150K Euros (120K price + 30K renovation costs) in a rural area in Italy not far from a major city. I’m paying 20% down (24K) and taking a 2-3% 20 years mortgage for the remaining 96K, plus paying cash the renovation costs. My investments will be hit by 50K, my yearly expenses by 6K.
Health Care: If in Italy, health care is “free”. We won’t need any insurance. Awesome! Well, it’s not that simple…
Taxes & investments: my stock/ETF investments are after tax money, so I don’t have to pay taxes on them. Investment earnings are taxed in Italy though. Both in the form of taxes on dividends and capital gain (not while I’m in Switzerland). I think there’s also some sort of extra tax for investments owned in foreign countries, need to investigate. I don’t know if I can keep my current investment account if I’d move to Italy. A lof of issues may impact my current FIRE strategy and make it stop working. Need to investigate.
One obvious thing to do to avoid unfair capital gain tax while in Switzerland is sell and re-buy just before moving back to Italy, to cash the tax-free capital gain. Anyway, after paying investment taxes I won’t have income taxes. Withdrawing money from my after-tax investments should be tax neutral. That’s awesome! Well, need to investigate that more since Italian tax authority is greedy with legally earned wealth (eyes are both closed with criminally earned one). In case my target country is not fond for living on investments earnings I may switch strategy and go for rental properties. I know how taxes work in that situation and I may make it work, even though I’d rather remain an index funds investor.
Do you see how hard it is? My current situation (living in Switzerland, no kids, renting, no cars) is so different from what I expect to retire on.
I can’t help but ask for more time to get to know some of the unknowns in my equation. For now let’s assume 3K per month will be good, given the above mentioned safety margins. 3K per month means 36K per year. At my 30:1 ratio, i.e. 3.33 WR it means 1’080’000 Euros. Let’s make safer, 40K per year. It means my FU Number is 1’200’000M Euros.
That’s a sad news, since so far I was aiming to a Million. It was not a secret, since my logo says 46.9% and my NW says 468’823 Euros 🙂
Maybe I’m taking into account too many safety margins and not trusting my ability of earning money even without having a job. A recent article from Financial Samurai shows how the fear of running out of money in retirement is overblown.
I can stick with my original rough estimate of 1M – reachable in 5 years, at age 44 (actually linear forecast says 4 years, based on 2016 performance… but I doubt that both the market will keep running at this pace for next 4 years and future kids won’t impact our saving rate) – or accept the new estimate of 1.2M – reachable (stretch) in 6 years at age 45. I don’t think it’s going to change a lot. In case I’d go for 1M I’ll probably surrender to the OMY syndrome and will end up working another year anyway. With the safer plan of 1.2M I’d pull the trigger as soon as I reach the goal.
I’ll take my time to think about it. For now, let’s set the FU Number at 1.2M and site logo will be updated accordingly at end of August 🙁
As expected, this post created more confusion than clarity. Instead of helping clearing my mind I’ve come up with more questions and things to go deep with than I had before start writing it. It’s been necessary though, and more questions are going to come in the near future. Is Italy suitable for early retirees? Is really 3K Euros a reasonable monthly expense with a family of 4 persons? Will I have some unplanned passive income streams at FIRE time that can lower my withdraw necessities? Are there any expected windfall coming from Miss RIP side? Are we really going to create a family? Follow me in this journey and you’ll know!
What’s your FU Number?