Of those who are on the path to financial independence and early retirement, there seem to be two camps. The first is that group of people who believe “that sounds about right” is more than adequate in terms of preparation. For them a rough 4% rule is all the calculation they need to pull the plug and walk away from paid employment and they will deal with whatever happens when it happens.
I sit firmly in the second camp which comprises those for whom the numbers are critical. We believe the security of our future is based on the accuracy of the maths, so we better damn well get it right. We refer frequently to our spreadsheets, model a range of different scenarios based on varying annual returns and expenditure levels and try to determine every conceivable outcome of our “what if” biased brains.
Different strokes for different folks as they say, I’m not here to say which method is better. I sometimes wish I could take a more relaxed approach and be more like the first group – just chill out and spend my time on something else.
But that’s just not how I’m made. I work with finance all day long in my day job. Spreadsheets are my comfort zone; my security is in knowing the numbers and calculating them in several different ways, triangulating and cross-referencing and checking, checking, checking, so I apply the same discipline to my FIRE calculations.
For me, one self-built spreadsheet is not enough. I want to farm the knowledge of the experts and validate my results. I have several ways of doing this and yes, I realise the principles behind all of these may be the same, but think of it like a psychological comfort blanket. If I keep getting the same answer using different tools then I can’t be too far wrong.
So what are all these methods I am using to validate my FIRE calculations?
Overall Guardrail – The 4% Rule
I love this graphic from Camp FIRE Finance which illustrates how much you need in investments in order to safely withdraw a certain amount from your portfolio each year.
This approach is suitable for straightforward situations – where levels of expenditure are likely to be stable over a period of years. My financial plan for retirement is more of a staged approach. I will be retiring when I still have dependant children and so I have modelled my plan over different chunks of years as expenditure varies between having them at home vs university years vs flown the nest.
Nevertheless, once the children are off my hands the 4% rule is relevant for me and so I use this to model Phase 2 of my early retirement – from age 55 onward.
For this I only consider “investable assets” so I don’t include cash reserves and the value of my home. And I deduct from my expenditure any rental or other income I expect to receive in order to give the net amount I will need to withdraw from my investments each year.
The Mad Fientist
The Mad Fientist retired from paid employment at age 34. As well as interviewing some of the biggest names in the FIRE community for his podcast, he has developed a range of tools and calculators in his FI Laboratory. There is something very satisfying about inputting your net worth into his “Time to FI” calculator and being told “You are Financially Independent!”
For a quick answer to “when will I be financially independent” this site is ideal.
The Ultimate Retirement Calculator
For more detailed analysis, The Financial Mentor provides the Ultimate Retirement Calculator which is the best resource of its type I have found.
This one has much more functionality than broad-brush calculators and allows you to enter different types of income at different stages of retirement (useful for adding in state pension or social security) and one-off income events like the sale of a property or an inheritance.
It will tell you year by year inflation adjusted income, out-goings and year-end balance and will let you export the results. For that higher level of detail I have found this resource really useful.
Ok, so, I have my own monster of a spreadsheet. I have validated this via the alternative tools described above. Can I now answer that evergreen question….“Do I have enough?”
Sadly the best answer here will only ever be “probably”.
How Valid Are the Assumptions?
Using several tools to come back to the broadly the same numbers is comforting but really just tells us there is no fatal flaw in a formula. It is using the same assumptions in each model that could be our undoing if they are not sound.
There are two main ways this could go awry – either the % net growth rate after inflation is wildly different than planned, or the projected spending level is inaccurate.
Nobody knows what future investment returns or inflation will be; these are the big unknowns. We can use history as a guide to the fact that over the long term, a smoothed average growth rate is likely to be between a certain range. This of course can hide a multitude of sins – big upsides in one year followed by big slides the next. And of course there is always the caveat that history is no indication of the future. But using the experience we have gleaned from many multiples of time periods which have seen such major upheavals as world wars, political transformations, mass terrorism events and technology bubbles, to name just a few – we can take some comfort in what range a net average return could be.
You’ve heard this before but when it comes to forecasting spending levels, there is only one way to be materially accurate and that is by tracking your spending over time.
If you don’t know where your money is going now, how can you predict what your spending will be in the years to come? How will you know what to estimate for contingencies if you can’t see what range those unexpected extras usually fall between?
(And before you say that unexpected expenses can’t be narrowed down to a range – consider the unexpected cost of replacing a gear box if you drive a Ford Fiesta compared to a Lamborghini. Compare the cost of a new roof for a six bedroom home to that of a two bedroom home).
I have used a piece of software called Moneydance to track my spending for years. It is remarkable how little it has varied from year to year. Yes, something unexpected always creeps in and this experience assures me I have the correct level of contingency in place.
Do I Have Enough?
So given there are assumptions in play, there is no right or wrong answer. Do I have enough? Probably. If my assumptions are correct (and I have modelled a range of increasingly pessimistic scenarios) then yes I do. Are the actual net returns likely to be somewhere in the range I have tested? Probably.
And before that unnerves me too much, a gentle reminder that there are backups in place. Flexibility – perhaps moving to a 3.5% or 3% withdrawal for a time. Cash reserves – 2 to 3 years of living expenses not counted anywhere else. And finally, state pension from age 67+ also not factored into the plan.
Do I have enough? Probably – more than likely – just not quite definitely.
That’s a difficult concept for someone like me but I’m coming to terms with the fact that you can plan and plan and check and check but at some point, you have to make the leap.
Maybe I’m more like the “sounds about right” camp than I thought.