- How Has Covid-19 Affected Your FIRE Journey? Part 6 - August 10, 2020
- The Power Of Forgiveness - August 3, 2020
- Reader Case: Lawyer in Pain - July 31, 2020
So we got this e-mail in our inbox the other day (e-mail has been edited for length):
Hi FIRECracker and Wanderer,
Well I just saw the article on the Greater Fool and all I can say is… Way to go!!! And Congratulations!
My situation is a little different… My wife and I are 35 years of age and we have two kids (a 3 year old and a 1 years old). We plan on exiting the rat race sometime next year for a new chapter in our lives… we own our home (mortgage free next year) and have ~$350k in a diversified portfolio. We will sell our home (evaluated at $650k) and invest the proceeds. We’ll then have our money working for us!! With a conservative 3% SWR we will have a long life with our portfolio. We will be purchasing an RV and traveling (Canada, US, Mexico, etc…) with our kids full time so we can start living life.
We can’t wait… but mind you we are nervous. Nervous to be quitting two great jobs (incomes, benefits, etc…) selling our home, possessions, everything we’ve worked for. We second guess ourselves but after a long week of working the grind and not being able to spend quality time with our kids make us realize why we want to do this.
Coming from a family who’s philosophy revolves around following the straight line… education, work and work some more it will be very, very difficult to explain our rational. How did that go for you guys?
I am also curious about how your investments are structured as to maximize tax efficiencies? Also, how is your portfolio allocated? We have mine allocated 90% Equities (70% US and 30% International) and 10% Bonds mostly Vanguard ETFs, albeit our work pensions and savings plans which are Blackrock ETFs. I know it is rather aggressive but I “think” we can weather the volatility…
Anyways… again, Congratulations and lets get a Revolution going!
Well, NervousReader, first of all, with a $650K home and $350K portfolio, you are doing AMAZINGLY well for your age. Most people don’t even have 100K in the bank by 35, so kudos on all your hard work saving and investing. You are not that far off from where we are. Congrats!
Now, to get down to brass tax, let’s start by answering your questions:
1) Coming from a family who’s philosophy revolves around following the straight line… education, work and work some more it will be very, very difficult to explain our rational. How did that go for you guys?
As the child of strict Asian parents, and having lived under a totalitarian government until I was 8, I gotta say, it wasn’t easy. Basically, my parents are STILL mad at me for not buying a house, and to this day, think I’m an unemployed bum. But even with their disapproval, and lots of hate from “friends” and ex-coworkers, I would STILL gladly pick this life over any other. I only have 1 life to live, and I’d rather live my life than someone else’s.
And that’s the entire reason why I started this blog. Society has brainwashed us to believe we must do things a certain way, just because “that’s the way it’s always been done”. And if you’re happy, then great, keeping doing what you’re doing. But if you’re not, don’t let fear or dogma keep you from making a positive change. Life is too short to care about what everyone else thinks, and that’s why the #1 regret of the dying is “I wish I’d had the courage to live a life true to myself, not the life others expected of me.” And having taken the leap, I can honestly say I no longer live with regret.
2) I am also curious about how your investments are structured as to maximize tax efficiencies?
Great question! A full article is needed to properly address this, but from a high-level view, we have:
- Bonds, REITS, US equities in RRSPs (or 401(k) for our American friends)
- Canada and international equities in TFSA (or Roth IRA)
- Preferred shares in non-registered accounts.
Basically, you want the highest taxed securities (ie bonds) in RRSPs and most favorably taxed securities (ie dividends) in non-reg, once you’ve maxed out your RRSPs and TFSAs. US equities go into the RRSPs in order to avoid the US withholding tax.
We will talk about tax minimization strategies in detail in a future post.
3) Also, how is your portfolio allocated?
60% equity, 40% fixed income, with preferred shares, REITs, Real Return Bonds and High Yield Bonds mixed in.
Now that that’s out of they way, let’s see if NervousReader can ACTUALLY retire.
To figure this out, we need to do a “ShitHitsTheFan” analysis. Why? Because as engineers, we have an insatiable NEED to care about risk analysis, risk mitigation, and all that boring stuff. In order to make sure everything runs smoothly, we need to have backup plans for the backup plans. That’s just how we roll.
And really that’s the thing about life. Life is full of risks. The point is not to shy away from these risks and live so cautiously that you might as well not have lived at all, but to mitigating the risks, so that when life inevitably kicks you in the ovaries, you have sufficient protection.
So, looking at NervousReader’s situation, I see 5 “ShitHitsTheFan” cases:
SHTF Case #1: Closing Costs for the House
With home values hitting all time highs, many homeowners become so enamored with their gains, they forget about closing costs. And with lawyer, real-estate agent fees, maintenance, and staging costs, it adds up pretty quickly. So if we look at all this in detail:
Real-estate agent fee:
- $32,500 (5% of 650K)
- $1000 (or more depending on the upkeep of the home)
They can choose to list the property privately without a real-estate agent, but that may significantly decrease their sale value, as some buyers won’t buy a house without an agent.
Also, given that they will not be mortgage free until next year, can we say for sure that their house will be worth 650K by then?
Given the costs above and assuming they can sell the house for the expected value next year, they would be able to net 616K+ 350K (in investments), giving them a portfolio size of $966, 000…just shy of a million.
SHTF Case #2: Kid Costs
Given that NervousReader plans to use a SWR (Safe Withdrawal Rate) of 3%, they would need to live on $28,980K/year. Now, not knowing whether that number is feasible since we don’t have kids of our own, we’ll based our projections on other FI-ers who retired with kids.
• 1 kid
• 25K/year but with a paid off house
• 1 kid
• 50K/year while travelling around the world, and making side income from his blog.
• 3 kids
• 40K/year but with a paid off house
NervousReader’s case is similar to RootOfGood’s (2 kids versus 3 kids). The difference is that NervousReader won’t have a paid off house, but will have $6000 per child in childcare benefits from the Canadian government.
Since 40K is for a family of 5, we’ll estimate the cost to be 32K for a family of 4. And we’ll need to add rent, which we’ll assume to be around $1200/month, since NervousReader and his family can move to a lower cost location when he and his SO stop working. This gives us a yearly expense of $46,400. However, given that we now have a Liberal government that’s decided to make our childcare benefit progressive rather than flat, and knowing that NervousReader’s income will drop dramatically in retirement, he will have close to the maximum of $6000/year/child benefit. That lowers his expense to $34,400. Yay Liberals!
To support a yearly expense of $34,400, NervousReader would need a portfolio of $860K using the 4% rule. Or to be more conservative, and using a SWR of 3% as he mentioned, he’ll need $1,146,666. So once he sells his house, he’ll be off by about $181K with a SWR of 3%, but right on target with a SWR of 4%.
SHTF Case #3: Portfolio Volatility
With a retirement horizon of 1 year, the equity allocation should be around 0%. Given the low interest environment, this isn’t really possible. To get the yield we need, some equities will inevitably need to be part of the allocation. But how much?
In our opinion, in the accumulation phase, when both partners are working, 90/10 portfolio is perfectly fine, but once you retire, you’ll need more fixed income to weather any future storms. At least in the beginning, we advocate for a more conservative allocation, while you’re still getting your feet wet living off your portfolio.
However, a 90/10 equity weighting can work perfectly fine as long as you can stomach the volatility and not sell when downturns happen. Which brings us to something called “Sequence of Return Risk”. What this means is that for the first 3-5 years of retirement, if you need to withdraw from your portfolio and the market is down, you run a risk of depleting your portfolio because you’re forced to sell when the market is down to fund your living expenses. So the first 3-5 years are the most crucial, and to protect against this risk, you need…
SHTF Case #4: Cash Cushion
Something that helped us put our minds at ease is having an extra cash cushion outside the portfolio, containing 3 years of living expenses. The good news is that, at a very conservative dividend yield of 2% (the S&P500 has a yield of 2%, but check your portfolio’s yield to be sure) and expenses of $34,400, then $19,320 is covered by the dividend yield ($966k x 2%). That leaves them a shortfall of $34,400-$19,320 = $15,080 they need to cover. Multiply that by 3 years and they would only need $45,240 outside the portfolio to provide 3 years of living expenses.
Now, that 45K cash cushion is based on the assumption that they will have $966K after selling their house. If you use my estimates of $1,146,666 needed to support $34,400/year at 3% SWR, and $860K at 4% SWR, the cash cushion then becomes $34,400 (3% SWR) and $51,600 (4% SWR).
I know that some advisors say you don’t need a cash cushion, and just to use a line of credit, but we prefer to have cold hard cash. Again, backup plan for the backup plan.
SHTF Case #5: Inflation
NervousReader is heavily weighted in equities, which is a natural hedge for inflation (as inflation rises, companies raise prices, which benefit shareholders). Something to look into is real return bonds which adjust the interest paid with the CPI (seek professional advice if you’re unsure about how to do this).
Another knob to turn to hedge against inflation is global arbitrage, which is something we’ve found is hella awesome. If inflation in Canada goes up, go live somewhere cheaper. We’ve found by being digital nomads and moving around from country to country, we were able to actually LOWER our cost of living by staying in countries where everything’s just cheaper (Eastern Europe & SE Asia). Given that they have 2 kids, this is slightly more challenging but still doable as we’ve seen couples pull this off (Jeremy from www.gocurrycracker.com is the best example). They’ve told us of expat havens in Mexico like San Miguel that are super cheap yet very livable, so this is totally possible in South America.
After looking at the above 5 ShitHitsTheFan case, I’d say, once they build up a cushion outside the portfolio or adjust their allocation to be a bit more conservative, they should be in good shape. My conservative estimate, using a SWR of 3% and the child costs done above, he would need $1,146,666 +$34,400(cash cushion) = $1,181,066.
If he wants to be less conservative, using the 4% rule, he’ll only need $860,000 +$51,600 (cash cushion) = $911, 600.
Given he’s crazy-saved so well already, NervousReader’s probably only like a year or two away, so by the time the house sells next year, he should be fine (or close enough that you can just save for a few more months). Just make sure your backup plans are in place when you pull the trigger on your job.
Disclaimer: Since we’re not licensed financial advisors, we aren’t legally allowed to recommend individual assets. We are simply describing the investing strategies that got us here. Please consult a professional before implementing any of these strategies.
Retirement Readiness Score: 4/5
And with that, let’s hear from our readers. What do you guys think of NervousReader’s situation?
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