- 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
When we started writing Quit Like a Millionaire, we never expected the sheer impact it would have on the lives of real people. It’s one thing to have blog readers write in and say “I love your blog! I sent it to my friend!” but a whole new level to get e-mails saying “your book changed my life.”
And as wonderful as these e-mails are, I sometimes wonder if our message is received quite the way we intended, especially when we get e-mails like this:
Dear Kristy and Bryce,
I just finished reading “Quit Like a Millionaire“. And I feel radiant, knowing that I’m closer to FI than I thought. I can’t thank you enough for putting the effort into writing this book!
I had toyed with the idea of moving from the US to Colombia in 10+ years from now and after reading your book, I’m convinced that’s what I’ll do but probably sooner!
I have questions about the strategies you talk about in the book: Cash Cushion, Yield Shield, and the Roth conversion ladder.
ABOUT MY SITUATION:
According to my calculations, only looking at my new estimated spending when I leave the US, it seems that I can retire in 5 more years. As of now, my gross income is 80k USD. At this point, I spend about $35,000, once I move it will drop to about $15,000 USD.
And I don’t have any fixed assets, the biggest debt I have are my student loans which are 79k right now, the interest rate is 5.7%, I have 8 more years to pay off the loan. But I plan to continue paying this down through the Public Service Loan Forgiveness (PSLF) program, even while living in Colombia, working an additional 3 more years for an NGO.
So I believe that in those three years that I’m in Colombia paying my loan, I’ll probably make around 30k being conservative.
This brings my retirement a lot sooner than I thought. After I’m done paying my student loans, I plan to do a side hustle and make about 10k a year or more. Whatever extra I make I plan to continue investing it.
Could you help me figure out when I should begin implementing the yield shield, cash cushion strategy, and if I should do a Roth conversion ladder?
So far I only have $32,425 in assets (just including my 401k and Traditional IRA), and I’m saving about $25,500 a year (cash savings, Traditional IRA, 401K) with an ROI of 6%. Here are my calculations:
Year Balance Savings ROI Total
1 $ 32,425 $ 25,499 $ 1,946 $ 59,869
2 $ 59,869 $ 25,499 $ 3,592 $ 88,960
3 $ 88,960 $ 25,499 $ 5,338 $ 119,797
4 $ 119,797 $ 25,499 $ 7,188 $ 152,483
5 $ 152,483 $ 25,499 $ 9,149 $ 187,131
6 $ 187,131 $ 25,499 $ 11,228 $ 223,858
7 $ 223,858 $ 25,499 $ 13,431 $ 262,788
8 $ 262,788 $ 25,499 $ 15,767 $ 304,054
9 $ 304,054 $ 25,499 $ 18,243 $ 347,796
10 $ 347,796 $ 25,499 $ 20,868 $ 394,163
And I think my FI number is 125k, so that puts me between year 3 or 4. But I’m guessing it would probably be better to move down to Colombia in 5 years, to be on the safe side.
Here’s why I think that it will take me 5 years, and I hope you can guide me.
In your book, you write about implementing a cash cushion and yield shield when you’re ready to retire.
But should I aim to have enough cash and yield when I’m ready to retire? By the time I retire, I’d like to have 75k in cash and dividends and then set up my yield shield for 5 years. Am I thinking about this the right way?
As of now, I don’t have any yield or enough cash. I started contributing to a 401k 3 years ago, and recently to a Traditional IRA, so that’s probably why I have little in dividends.
I have a 401k where I currently own 80% in iShares SP500 Index, and 20% in bonds (Columbia US Treasury Index), I picked the stocks and bonds with the lowest fees. But I noticed that my dividends are not doing so well under this selection. And I was told by CUNA, the management company, that all the dividends in my 401k just get reinvested back and that the SP500 doesn’t accrue many dividends.
I also have a Vanguard Traditional IRA, that I just opened, and I’m hopeful that my dividends will grow faster here. I have 70% in Vanguard Total Stock Market (VTI), with a yield of 7%, and 30% Vanguard Total Bond Market (BND), with a yield of 4%.
Do you think I should wait until I have 75k in dividends and cash, to retire?
And lastly, since I potentially have 5 more years to retire should I begin my Roth Ladder conversion now? The way I see it if I remove the little amount of money that I have in my portfolio now, I would have less money growing passively in the 5 years that I have left to retire. So I’m not sure if a Roth conversion ladder is the best approach for my case.
I’m wondering if it would make more sense in my situation to take the 10% penalty and pay the taxes, I was reading about that on Mad Fientist
If I go this route, do you recommend that I take out more than what I need in a year, or only take out what I need for the year and pay the penalty and taxes?
Anyway, reading your book was an eye-opener for me, I’m spreading the gospel of FIRE, with my friends and family.
I really appreciate your time and I’d be so grateful if you’re able to take on my case!
Hoo boy, this one’s a doozy. We get a LOT of emails like this from bright-eyed bushy-tailed people relative newcomers to the FIRE space who think they’re only a few years away from retirement despite having relatively little money. And part of this is that we make retirement and nomadic travel look a little too easy and carefree .
Make no mistake: We are probably the most conservative, risk-averse and cautious FIRE bloggers out there. We don’t do anything haphazardly, and there’s a lot of RetireInColombia’s email that makes me cringe. Lines like “I have 70% in Vanguard Total Stock Market (VTI), with a yield of 7%” indicate a fundamental misunderstanding of how stock market investing work, so we’re going to have be very careful in picking through this reader case because there’s a lot of dangerous misconceptions in here.
You can’t retire if you are dependent on the PSLF
“I have 8 more years to pay off the loan”
Okay, so what’s wrong with this statement? To be eligible for the PSLF (or Public Service Loan Forgiveness program), she’ll need to work for a non-profit or the government, making 10 years of eligible payments for her loan to be forgiven. Big emphasis on ELIGIBLE. Which means she needs to be working FULL-TIME. Which means, no, you can’t be working part time for an NGO making $30K/year or relying on a side-hustle.
If she plans on moving to Colombia in 5 years, she’ll need to find a full-time job working for an NGO. So partial FI or partial retirement in just 5 years is out of the question. At minimum, you have to keep working full-time for 8 years.
You can choose whether you want to re-invest your dividends or not
“I was told by CUNA, the management company, that all the dividends in my 401k just get reinvested back and that the SP500 doesn’t accrue many dividends. “
Seems like this management company is as confused as she is. You should be able to choose whether you re-invest the dividends are not. What we’re talking about here is the DRIP (Dividend ReInvestment Plan) and she can opt out of it to live off the dividends in retirement. So no, they don’t “just get re-invested”. They do what you tell them to.
You’re Confusing Dividends/Yields with Capital Gains
“I have 70% in Vanguard Total Stock Market (VTI), with a yield of 7%, and 30% Vanguard Total Bond Market (BND), with a yield of 4%.”
Where do I even begin? She’s confusing yield with long term capital gains here, and that makes me so nervous all I want to say is: “please step away from your Vanguard account!” Don’t invest until you figure this out.
Yield is the dividend that a stock pays out to an investor. The long term capital gain is the increase in the stock’s value over time. You get paid the yield regardless of what the share price does, but in order to realize the capital gain, you need to sell.
The average return of VTI over 10+ years is 7%/year, but the yield is only 1.78% per year. BND pays an interest rate of 2.74% per year.
When RetireToColombia says she’s not seeing the yield she’s expecting, she’s actually talking about total return, which is a combination of both dividends and capital gains. Again, please don’t invest until you understand the fundamentals.
You need to recalculate your Cash Cushion
“Do you think I should wait until I have 75k in dividends and cash, to retire?”
To hedge for sequence-of-returns risk, we recommend having a combination of yield and cash cushion to cover your expenses for 5 years.
Well, given that RiC’s planning to live on 15K in retirement, let’s see how much she’ll need to survive the first 5 years.
After building up a Yield Shield and getting her portfolio yield up to 3%, she’ll need:
Cash Cushion = (Annual Spending – Annual Yield) * Number of Years = ($15,000 – 3%*$125,000) x 5 = $56,250.
In this case, for extra protection against sequence-of-returns risk, she should save an extra $56,250 in cash.
So $75K is actually more than she needs.
That’s Not How a Roth IRA Conversion Ladder Works
“Since I potentially have 5 more years to retire should I begin my Roth Ladder conversion now? The way I see it if I remove the little amount of money that I have in my portfolio now, I would have less money growing passively in the 5 years that I have left to retire. So I’m not sure if a Roth conversion ladder is the best approach for my case.
I’m wondering if it would make more sense in my situation to take the 10% penalty and pay the taxes, I was reading about that on Mad Fientist “
Oh God no. The whole point of the Roth IRA Conversion Ladder is to convert money from your traditional IRA into your Roth using the standard deduction limit, AFTER retirement, since your income will drop to zero at that point. That way you can get the money out tax free. If you do it while you’re working, your income is taking up that tax bracket, thus defeating the whole purpose.
Why would you take the 10% penalty? Do you like paying extra money to the government for no reason? If you end up making some money with side hustles in retirement, get your tax deferred money out with the standard deduction, and then pay some additional taxes on your side hustle. If you don’t use the ladder, you’ll get hit with 10% penalty, plus additional taxes on your after-retirement income. That makes no sense.
Now I know my reaction to her e-mail might sound a bit harsh, but as I said in Quit Like a Millionaire, I’m not here to tell you what you want to hear. I’m here to tell you the truth. And the truth is, you have to understand what you’re doing before you do it. Better to get all the kinks in your plan worked out now than to be caught with your pants down later.
Is Her Plan Even Plausible?
Okay, so with all the misconceptions out of the way, let’s see if her overall retire-to-Colombia plan is even plausible.
First, we’ll summarize her finances:
In order to support a $35K/year spending in the US, she’ll need $35,000 *25 = $875,000 by the 4% rule.
This means, it would take her:
|Year||Starting Balance||Annual Contribution||Return (6%)||Total|
(Note: for simplicity sake, we are assuming that inflation is balanced out by a yearly 2% raise at work.)
18 years. Now that might sound like a long time, but given that most people take 30 or more years to retire, it’s not bad. Plus, given that RiC is able to save 42% of her salary, that’s way better than the average US savings rate of 8%.
RiC also says she wants to move to Colombia and drop her cost of living to $15K.
Well, I’ve never been to Colombia before, but according to Numbeo , it is possible to live there on $700/person/month including rent, and having been to low cost places in the world like Thailand, Poland, and Vietnam, I can see how you can use the power of geographic arbitrage to significantly lower your cost of living while increasing your quality of life.
That being said, I’m a bit skeptical of this plan because I don’t actually know if RiC has ever tried to live in Colombia, or what the Visa situation is for the country. If she has family or roots in Colombia, then this could be quite easy. But if not, she’ll have to go through immigration, which is a whole other can of worms.
Plus, her yearly expense is $35K USD, which is on the high side for an individual (considering how we spend 30K USD/year or $40K CAD/year for the two of us travelling the world), so I’m not confident she’ll be able to drop her expenses by more than half if she’s never had to live on $15K before.
Reservations aside, let’s see how the math would work out if she made such a move.
By dropping her expenses down to $15K/year in Colombia, she will then need only $15,000 x 25 = $375,000, which would take her:
|Year||Starting Balance||Annual Contribution||Return (6%)||Total|
She also mentioned she’d like to start a side hustle earning $10K/year. That would drop her living expenses down to only $5000/year. Which means she would only need $5000 *25 = $125,000.
To build that portfolio, she would need:
|Year||Starting Balance||Annual Contribution||Return (6%)||Total|
But since we mentioned she should have 5 years of cash cushion earlier, she should add another $56K, which at her savings rate, would take another 2 years to save up, so 6 years total.
However, we have to take into account that it will take 8 years for the PSLF program to kill off her student loan. So even though the math suggests she can retire in 6 years, the PSLF is her limiting factor which will push her retirement date out to 8 years.
So my recommendation is to stay in her current job for the full 8 years until her student debt gets forgiven. It’s just not worth the risk trying to move down to Colombia before that date and finding another full-time job with a US-based NGO. Then and ONLY then, will she be able to ramp down her work hours and go all-in on her side hustle.
And finally, there’s that big assumption that our reader will be able to pull off a $15k/year lifestyle in Colombia that she will enjoy. Test this lifestyle out first by travelling there for a few weeks and living like a local. This will tell her whether she can realistically live on $15K year after being accustomed to living on $35K/year.
What do think? What would you do if you were RiC?
Some of you have asked about recommendations for tools to track your travel expenses. My friends and fellow world travellers, Mr & Mrs. NomadNumbers, have created a nifty Travel Tool, which helps you track your expenses while travelling and breaking it into categories (similar to the table I use in the “Let’s go Exploring” travel series). It’s free and currently in Beta. We would love to hear your thoughts on it!
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