Last November, I quit my stressful job in software engineering and tested the early retirement waters, learning tons of lessons along the way. Naturally, most people assumed I'd reached Financial Independence. At Camp FI in January, I heard the phrase “You're FI now, right?!” numerous times, and I was always careful with my response: “The wife and I are on the cusp of FI”. So are we FI or not?? The question is simple, but the answer is… complicated.
Market Volatility Blurs The Line
According to the idealized budgets I've set up for the wife and I, our annual spend is about $25,000 per year. Multiply this by 25 per the 4% rule, and we need a portfolio of $625,000 to support this annual spend passively forever. And our portfolio did indeed reach this number earlier this year!
But then the market dropped down a bit… and we dipped back under that particular magic number. In fact, we've crossed above and below this line many times these past few weeks thanks to daily market volatility. But it makes no sense to say we were FI on January 30th but weren't on Feb 5th. Instead, it's better to look at Financial Independence as a smooth continuum of benefits, with various milestones along the way. This is in line with the ‘Stages of FI' J.D. Roth and Joshua Sheets wrote about over at Money Boss and Radical Personal Finance. I've summarized just a few of these benefits here:
- FU Money Benefits
- Confidence to walk away if a job goes against your values
- Ability to quit a job and have months before you need to find a new one
- Lean FI Benefits
- Basic passive financial security for all essentials (food, shelter, etc.)
- Can spend months or years looking for new jobs with no fear of running out of money in the short-term
- Flex FI Benefits
- Full passive financial security if you stay flexible
- Can probably start early retirement if you stay conscious of your expenses and reduce spending/increase income during downturns
- Financial Independence Benefits
- Full passive financial security
- Work is truly a choice, forever: your money works so you don't have to
- You have ‘enough'
- You can pursue passion projects with no concern for money
- FAT FI Benefits
- An abundance of passive financial security, with all the frills
- You have more than enough
I'm comfortable saying we have most of the benefits that come with the ‘financial independence' milestone. We have passive financial security. The wife continues to work by choice. I'm able to test out early retirement and figure out how I want to spend my newfound free time. I'm in no rush to find new work, and if I do take another job in the future, it will be something that I enjoy, rather than taking whatever I can get to ‘pay the bills'.
So I'd say we're somewhere between Flex FI and FI, closer to the FI side. This makes a lot more sense than saying we can passively support $24,999 in annual spending but aren't FI yet. You see, the line is blurry; thanks to market volatility the resolution of a portfolio is in thousands of dollars, not singles! But this isn't the only issue when it comes to answering the question “Are you FI yet?”
Previously we discussed the Early Retirement Equation, which helps you calculate what savings rate you need to retire exactly when you want to. But there's a much simpler equation to calculate how much money you need to achieve financial independence:
Annual Expenses / Safe Withdrawal Rate = Required Portfolio Value
Super simple, right? Only two variables! The problem is, there's a ton of assumptions going on behind the scenes of those two variables that need to be questioned.
What Are My Annual Expenses?
This seems like a simple enough question… you track your money via online tools like Personal Capital for a year or two, create an idealized budget, and bam! You have a high degree of confidence in your annual spend. Let's compare budgets! Here's ours:
|Budget Item||Annual Spend|
|Business & Side Hustles||$577.00|
|Family & Gifts||$600.00|
|Gasoline & Tolls||$600.00|
|Gym & Fitness||$383.00|
|Property Insurance & HOA||$900.00|
|Travel & Vacation||$1,200.00|
One of the key assumptions of the Early Retirement Equation is that your spending before early retirement, during your accumulation phase, will be the same as your spending after reaching early retirement, when you start drawing down on your portfolio. While this simplifies the math, it may not reflect reality! That's why it's essential to leave room for flexibility, since you can't know your future annual expenses with complete certainty. It's really important to get this number as close as possible; if it's way off, you might not save enough money… or on the flip side, you might work years longer than necessary!
The wife and I actually disagree on our number. I think our expenses will go down a tad after she retires from full-time work, so I want to support a $25K annual spend. The wife wants the flexibility to spend even more in FI, and would like to support an annual spend closer to $35K to enjoy luxurious, stress-free financial freedom. So who's right? Should we split the middle? I thought my number was already luxurious with its built-in $3,000 miscellaneous cushion! Unfortunately, this isn't the only assumption we need to question on our quest for FI.
Is My Safe Withdrawal Rate Safe?
As I've discussed here on the blog, the 4% rule is a great place to start when deciding your annual Safe Withdrawal Rate (SWR). The 4% SWR is a result of the Trinity Study, which showed that 96% of the time, a 50/50 stock/bond portfolio with a 4% annual withdrawal rate lasted at least 30 years. This SWR is equivalent to saving 25 times your annual spend.
The Mad Fientist wrote an excellent article about how the success of a portfolio is primarily predicted by the volatility in first 10 years of withdrawals, giving rise to a discussion on sequence of return risk. Dropping to a 3% SWR hedges that volatility, but you’ll have to save 33 times your annual spend instead of 25.
In contrast, choosing a 5% withdrawal rate (a.k.a. Flex FI) will help you reach FI quicker, since you only need to save 20 times your annual spend, but remember that this requires more flexibility, particularly if your first 10 years of FI are rough market years. The 4% withdrawal rate, then, is a nice middle ground and is the SWR I'm using in my own calculations.
I seem to be in the minority in the FIRE blogging space, but I actually think the 4% rule is extremely safe! Why? Because it assumes (1) I'll never earn another dime in my 50+ year retirement, and (2) my spending is completely inflexible. Both of these assumptions are ridiculous for me, and the majority of the FIRE community.
A Cushion For Your Cushion?
But what if I want to build a safety margin right into my SWR? Remember our discussion of the FAT FIRE milestone, where we bake in an abundance of safety and luxury in retirement by simply reducing our SWR? This is a perfectly valid approach, but could be unnecessary if you already have a safety buffer built into your annual spend, like I do. The wife likes the idea of building cushion into both equation variables, but the cost of that cushion is substantial:
Joel's numbers: $25,000 * 25 = $625,000
The Wife's numbers: $35,000 * 30 = $1,050,000
That's a difference of $425,000, and a huge discrepancy between our desired portfolio values! As you can see, relatively small differences in your base assumptions lead to drastically different FI numbers! But this makes sense; our philosophies are different, our risk tolerances are different, and our ideal FI lifestyles are different. We're different people! The wife also enjoys her current job, which probably influences her preferences on these items, just as hating my job shaped my own ideas on the subject.
There are even more assumptions we didn't discuss: What if you don't need your money to last forever? What if you want to slowly drain your principal as you age, passing away at the ripe old age of 108, with only $5 left to your name? If portfolio preservation and leaving millions of dollars behind isn't a priority for you, then perhaps a higher SWR is appropriate?
There are so many assumptions to consider when calculating a FI number that works for you and your family. Mess up on either your annual spend or your safe withdrawal rate and your early retirement date could be off by years, not months! Once again, the key here is flexibility; give yourself the room to change plans along the way, and as the wise Miss Mazuma said at Camp FI, “Don't frugal yourself into a corner.”
So are we FI? Possibly. Even after all this discussion, I don't know the answer for sure. If we're not, I'd wager we're at least past the proverbial FI event horizon, and reaching FI is more of an inevitability at this point than anything else. The wife plans to keep working another year or two. I plan on making some money with my writing and music side hustles, and might even pick up some part-time software work later this year if I'm feeling particularly ambitious!*
The interesting thing is, since I quit working the job I hated, I think about money significantly less often. I no longer check market performance every day. I spend more time on fun stuff, and less time obsessing over numbers. My advice echoes that of J.D. Roth: Live the life you want to live, and let financial independence be a side effect, rather than the goal.
So while it makes for interesting blog fodder, the actual answer to the question “Are we FI yet?” is: who cares?
*I know, even I'm surprised by this! But I took for granted the value of all the little social interactions in the workplace. Some part-time work, with some cool people, on something I'm actually passionate about might be just what I need.