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We’ve written extensively about the 4% rule, and we’ve also written about how to guard against an unluckily timed market crash screwing over your portfolio right as you retire. And to recap, the way to guard against this (called Sequence of Returns Risk by finance wonks) is to do the following:
- Swing your portfolio towards fixed income assets to establish a “Yield Shield”
- Build up a 3 year cash cushion outside the portfolio
- Identify ways to cut your expenses to below the Yield Shield if a market crash happens.
- Travelling to low cost countries is our preferred method. “If shit hits the fan, we’re going to Thailand”
And all that’s great, in theory. Many other famous bloggers have backup plans too, but rather annoyingly (for us, not them) their blog starts making money and the backup plans become a moot point. Who needs to care about withdrawing from their portfolio when they can just live off their blog income?
So as a result, it seems that despite the fact everybody has backup plans, nobody seems to have had their backup plans tested in any meaningful way, right? How annoying. Damned FI bloggers and their success!
Well, as it turns out, someone did have their backup plans tested. Who, you may ask?
Us.
The Oil Crash
Gather round, children. It’s story time.
The year was 2015. Obama was president, health care was totally a thing that people could count on, and half the people in showbiz hadn’t been accused of sexual assault. It was a simpler time. And up in the frozen Northern reaches of Toronto, 2 annoying millennials had stumbled into Financial Independence the year before and had just completed their last day of work. Freedom from work! Freedom to travel! So in June 2015, we got on a plane and embarked on our year-long victory-lap trip around the world.
And then the oil crash happened.
Now to those who may not be following the day-to-day gyrations of WTI (West Texas Intermediate) crude oil, it wasn’t that long ago that a barrel of the black stuff was over $100 USD. But around mid-2014, the Saudis, annoyed at fracking in the US and the emerging Canadian oil sands as competitors to their near-monopoly on oil production, decided to really open the taps and flood the market. Their aim was to drive the price of oil as low as possible, and boy did it work.
It was, as we Westerners would call it, a truly baller move.
Because in Saudi Arabia, all one has to do is poke a stick in the ground and oil will come out [citation needed]. Other countries had to work for it, drilling and fracking and shit like that. I don’t know the details. I’m a computer engineer, not a chemical engineer. But anyway the end result is that the cost to produce a barrel of oil in Saudi Arabia is a LOT cheaper than producing a barrel of oil in Alaska, Texas, or Alberta. So by flooding the market with oil and driving the price of oil down, the hope was that it would drive non-Saudi oil producing companies out of business.
And MAN did it work. From WTI crude’s peak price of $107 USD, it fell all the way down to $29 USD in Jan 2016.
This fucked up our portfolio, to put it mildly. Because a significant part of it is based on the Canadian index, and our stock market is so heavily resource-based, we had the experience of retiring, and then seeing our portfolio go into a goddamned free-fall.
The 4% rule more formally stated is this: If one were to withdraw 4% of your starting portfolio and adjust for inflation each year, you would have a 95% chance of the portfolio surviving for 30 years.
A 95% success rate means a 5% chance of failure. And that 5% chance of failure is caused by a market crash at the beginning of your retirement.
And in that moment, we thought we were part of the 5%.
So What Did We Do?
We only started this blog in May 2016. So when the crash happened and our first year of retirement drew to a close, we were staring at a negative return on our portfolio. And in case you were wondering, no, we didn’t rely on our blog to earn any additional money. There was no blog income because we hadn’t started it yet.
So shit got real. But in that moment we realized how to measure whether our retirement was still on track or not.
And that method is this:
Every Year After Your Retire, Pretend You’re Retiring All Over Again
What does this mean? When you’re saving your way to retirement, you’re chasing that 4% number for your portfolio target. You spend $40k, and according to the 4% rule you need $1M, so that’s how much you need to save. And when you hit that number, you retire. Woohoo! But remember what the 4% rule actually means. If you withdraw 4% (inflation adjusted) of your starting portfolio, you have a 95% chance of lasting 30 years.
So after a year has passed, your portfolio may have gone up. Or (in our case), it may have gone down. What to do know, am I still on track?
Well, if you think about it, your chances of success are exactly the same as someone who has saved and invested up to your new current portfolio balance, is thinking of retiring, and plugging numbers into FIRECalc. Would that person still retire? Or would they choose to stay working?
Example, Please!
Let me give you an example.
Say you’re like us. $40k living expenses, $1M portfolio. In the first year, say your portfolio goes down 5% while throwing off 3.5% yield. So now your portfolio is $950k, it’s generated cash of $35k, and your living expenses remain at $40k.
In this situation, if you were to continue doing a “normal” early retirement (as if such a thing exists), you would take the $35k cash, sell off $5k more to make up the $40k at a loss and hope for the best. This would take your portfolio down to $945k. Going forward, this would result in a withdrawal rate of 4.2%. Putting that info into FIRECalc puts your success rate at 92%.
Hmm, the success rate has gone down! That means my risk of failing has now increased. To be precise, your chance of failure has increased over the next 30 year window, from 5% to 8%.
So what should you do in this scenario? Well, it’s really up to you. You have lots of options. Here are a few:
- Increase your income via side hustles
- Reduce your spending via budgeting
- Reduce your spending via travelling
- Eat into your cash cushion
- Go back to work (as a last resort)
Let me give you an example. Say a part of your spending is $5k in travel. If you cut that out next year, your withdrawal requirements go from $40k down to $35k. $35k / $945k = 3.7%, and plugging those numbers into FIRECalc reveals a success rate of 99%! So by cutting $5k from your retirement budget, you’ve actually increased the success rate of your retirement!
What We Did
So what did we do? Well, when this scenario happened to us, we chose to eat into our cash cushion. Rather than take a withdrawal in the first year, we chose to spend down 1 of the 3 years of cash we had saved up and avoided withdrawing. Because we did that, not only were we able to avoid selling any assets during the downturn, we reinvested the dividends that had been generated, essentially buying into the trough. And as a result, when the oil prices rebounded from $29 USD to it’s current level of around $60 USD, we were able to participate in all of the upside, recovered our original portfolio, and then participated in the gains of this crazy post-Trump stock market.
Now, our portfolio has climbed in value, yet our expenses have not. Right now, our portfolio is $1.182M (as of the time of this writing), yet due to travelling our expenses have gone down. We’re looking at our spreadsheets right now and we’re projecting a total expenditure of $36K for the year. That’s including Mexico, US, Central America, South America, UK, and Central Europe! How is life this easy? It almost feels like cheating.
Actively Manage Your Withdrawal Rate
The first couple of years after retirement are the riskiest, and a small (5%) probability does exist that your retirement may fail. However, be re-retiring every year, you can measure the change in your probability of success. So the 5% of people whose retirement fails would have seen their withdrawal rate gradually creep up as their portfolio got hammered, but did nothing about it. They would have seen their success rate drop every year from 95%, to 80%, to 70%, and yet chose not to reduce their spending, work a side hustle, or move anywhere cheaper. So rather than simply be a victim of bad luck, the 5% of people who fail would have been able to see their ship starting to get pointed towards an iceberg yet ignored all the warning signs and let it happen.
Don’t be one of those people.
But on the flip side, by actively watching and managing your withdrawal rate (especially over the first few years of retirement), you can execute on your backup plans as the need arises and avoid being seriously hurt by bad timing. And over time, you’ll find the vastly more likely scenario of seeing your portfolio grow. And as your portfolio grows, your withdrawal rate naturally drops, and your success rate increases.
For us, now that we’ve successfully weathered the oil crash storm by using our cash cushion, our portfolio has grown in value to $1.182 M (excluding cash cushion and passion project earnings). At the same time, by travelling and living nomadically, our personal inflation has actually been negative, so we’re going to keep our spending target at a conservative $40k. This means that going into 2018, our withdrawal rate will be $40k / $1.182M = 3.4%, which according to FIRECalc, has a 100% success rate.
And once that happens, you’re done with your worrying about running out of money post-retirement. A 100% success rate means you have successfully secured your place as one of the people who WON’T run out of money after 30 years.
Re-Retirement
So every year, re-retire. Pretend you’re still in your job, with the amount of money you now have because of stock market fluctuations, and decide what to do. If your withdrawal rate has gone up and your success rate has gone down, start executing on your backup plans. And if your withdrawal rate has gone down and your success rate gone up, pat yourself on the back because your retirement is now safer than ever.
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I see what you guys did there. It’s quite clever. However, you guys are mildly tweaking the rules of the experiment (Bengen’s paper and the Trinity Study). In those studies: http://www.retailinvestor.org/pdf/Bengen1.pdf , the 4% rule is only used in year 1 and then then withdrawals are adjusted for inflation and deflation. The experiment is in a sense Markovian because today contains all the information you need about the past – but this information is baked into the cake – both in terms of how much you have but probably more importantly into the cost basis of your portfolio.
I subsequently listened to a podcast on a very detailed analysis of why exactly 4% works. It turns out that 4% is defined by 4 extreme events in the past 120 or so years. These include the Great Depression and the inflationary period of the 1970s. If you could drop those periods, the SWR might go up as much as a 1-2%. In fact, most retirees, not going into such extreme events, might find that a few years later they can up their withdrawal percentage with no problem!
Anyway, the point of saying all of this is that what you guys have here is very smart and will definitely protect you. What you might realize in say 10-20 years is that far from running out of money, you guys have saved too much! First world problems right?
Ooh Markov chain reference! Math-high-five!
Yeah this approach gives us a framework to evaluate each year what we can do with our withdrawal target and see its effect on the success rate. In all likelihood, you’re right our portfolio will run away from us and we’ll start getting into a situation where we are so safe (like 2%) that we could increase our spending and STILL be 100% success rate. We probably won’t because that’s not how FIRECracker rolls, but that should be fun 🙂
High Five to you too Wanderer! Love your blog guys, keep doing the awesome work!
I feel the need to thank you for all your advice. Your blog has been the most helpful to me while getting started on my own FIRE journey, and I know I’ll be referring to posts like this for years to come as I start to see bigger fluctuations and crashes. There are way too many people who, like me a year ago, know absolutely nothing about investing and preparing for retirement, and your step-by-step guidelines have been a godsend!
Echoing this! In January I’ll be ready to start investing (finally), and will be cracking open a Questrade account per the early investment posts. Then I can roll through that series from the beginning! So grateful to have crystal-clear steps laid out without slogging through days and weeks of research/trial-and-error.
Glad you guys/gals are finding this helpful. That makes everything worth it.
Y’all make a great point to exactly what (I think) every blogger I read says.
The 4% rule and such are great guidelines to let you know where you stand, but the key to a long and successful retirement if flexibility.
If you can roll with the punches the you will be fine, if you can’t you need to save more for the just in case.
Yup. Flexibility is absolutely key. And now that we’ve discovered how effective geographic arbitrage is as a way to control expenses, it’s even easier than we thought.
Great blog as always Wanderer. Question, where would “3 year cash cushion outside the portfolio” be kept at? just a regular savings account at a bank?
Thanks.
Savings account would be good. I HISA hop it around. Right now it’s sitting in a Simplii Financial account earning 3% promotional interest.
Good advice. Do you ever consider spending more as your portfolio increases? I ask this because, a couple of years ago, our retirement took a bit of a turn, in that we decided to buy a home, not our usual house purchase that makes us money, but a home complete with separate shop for my hubbys classic truck obsession, big yard, front veranda etc etc. It was a big decision because it definitely changed our retirement. The house cost twice as much as one of our rentals, so we sacrificed rental income, to have the home we wanted. This means we need to watch our spending. We made this decision to spend more of what normally would be in an investment, since it bought us something that overall has made our life more comfortable. Can you guys foresee increasing your budget to get more of what u want?
I may but only if it didn’t risk my retirement. If for example my portfolio runs up to the point that my $40k target is say a 2.5% or 3% withdrawal (which is a 100% success rate), I know that I could increase my withdrawal to 3.5% and it would STILL be 100% success, so there’s no reason NOT to spend more in that situation.
But as for a big house purchase like the one you’re suggesting that would carve a big chunk of my portfolio, no. That would risk my retirement and possibly force me back to work.
what if in 2019 / 20 there is a big housing crash in the heated markets of Canada
and some of us FI ‘ers wanted to purchase a house
but we are retired ??
can we get a mortgage based on our net worth over a million etc ??
or go the route of selling some ETF’s to purchase a house ..
but capital gains would be a bit of a killer ? even if its only 50%
just wondered because at some point a house purchase could be a good investment as long as its not the entire portfolio …
i know renting is great but many parts of BC now its such a low vacancy rate ..
would you guys ever consider it in years to come ??
Once the money’s in the house, it’s no longer part of your net worth and can no longer be considered in your 4% calculations. If that math works out (like, I had 1.5M, needed 40k, and wanted to buy a $500k house) then sure. Otherwise, no.
No no, I wasn’t suggesting a house for you, I know that’s not what brings you guys value, at least not now. But I was thinking of more splurges while travelling, or whatever else brings your life value.
At any rate I liked the suggestion of reassessing our retirement plans yearly. Because one thing about retiring early is that you have lots of time to experience different options in what to do in life. That’s why this post resonated with me, just because u retire doesn’t mean you r stuck living one kind of life, you just gotta count the cost, and know your back up plan.
Oh in that case yeah. Splurges in the range of “Let’s blow a few grand on a cruise this month” are fine (as long as the math works out and it doesn’t threaten your retirement). Splurges in the range of “Let’s spend half our portfolio on a house” are definitely not.
Hi, am I missing something by querying what you guys will do down the road since you’ve calculated for a 30-year retirement when you actually need 60 years because you’re only in your mid 30’s?
I kept the retirement period at 30 years in this example for simplicity’s sake, but you can calculate the success probabilities for a 60 year retirement just by adjusting the setting in FIRECalc. Interestingly, it’s not that different. For example, for my 3.4% withdrawal rate, FIRECalc shows a 100% success rate for 30-year periods and a 99.1% success rate for 60 year periods.
Thank you, Wanderer. Is there any chance you guys could do an article on exactly how the withdrawal process works with a year-by-year chart like you use for calculating someone’s FI-ability? I don’t quite understand what you mean, for example, by adjusting withdrawal for inflation, etc. Thanks!
If you started with a $1M portfolio, and a spending rate of $40k, then your withdrawal rate is 4% (implying a 95% success rate).
Then, say next year after dividends and capital growth, your portfolio goes up by exactly how much you spent. So in year 2, your portfolio is still $1M. If you chose to, you could increase your $40k by 2% to $40800 to account for inflation, but this would increase your withdrawal rate to 4.1%, and bring your success rate down slightly to 93.2% If, however, you chose to forgo your inflation adjustment and continue spending $40k, your withdrawal rate and success rate would remain unchanged at 4% and 95% respectively.
So every year, you could choose to take (or not take) your inflation adjustment from last year, and then divide that by your new portfolio size. Taking or not taking your inflation adjustment is just another knob you can turn to tweak your portfolio’s retirement health each year.
thanks for the article …
using Garth’s 60/40 portfolio .. of which 20 % is bonds ..
bonds go up in a stock market downturn , which is then used to rebalance and buy on sale ETF stocks …
or sell the inflated bonds to cover some of the living expenses .. ?
I’ll cover that in a future article.
awesome . thanks . . you guys rock
Love this article – we are I think very much so near the retirement possibility (been tracking our expenses much more closely but with kids a little more variability and risk inherent it feels like is making us keep saying each year we stick out in our regular jobs allows us to save $x more, and then there are always those expenses we forget about, like medical travel insurance for us for the year is another $200) but we are also risk adverse – that extra 3 year cash cushion is a brilliant idea! So basically I need a FI number and a cushion (and you know, investments that actually match that) then confidence we have both! And then say screw our jobs and run like the wind into blissful partial retirement (I have a nice part time job I can do for a long time as long as I have good internet)!
Part time jobs you can do remotely actually help your retirement numbers a LOT. If you make just $10k a year, that’s $10k less withdrawal pressure you need each year, which translates into $250k less on your savings target, so that’s great that you have one.
Dividend paying ETFs, in times like these, lower volatility, but a guaranteed payout. A great way to diversify and sleep at night. I do believe we are coming to the end of this market cycle,( I have a great crystal ball) Therefore if you are 100% Volatile Equities (Nasdaq, small caps) I do believe now is the time to rebalance, and avoid the situation:
“This fucked up our portfolio, to put it mildly. Because a significant part of it is based on the Canadian index, and our stock market is so heavily resource-based”
Sorry but as a Canuck, and doing some serious mathingtheshitup… I agree, the Canadian Market has been the worst… Oil really killed us, and if its not oil, its the Banks, the 4 big banks go tits up, the TSX would probably fold…
So what then, S&P, Nasdaq, Dow ? Bitcoin? ok not Bitcoin…
thanks Wanderer, I have recommended your site to many others, cus its not full of bullshit, you are honest with success’s and failures.. its refreshing.
spaceman
Thanks! I am of the camp that the TSX has been lagging for no great reason lately and due for a catch-up, but we’ll see. Our banks are releasing their quarterlies right now and so far they look pretty stellar.
Great post as always! I worry about this all the time: will we have enough money when we “retire”? When are we going to be able to say enough is enough? How many cushions do we need?
But by reassessing where you are every year, and checking your ROI and your spendings, you have a much higher chance to be successful. I really need to remember that!
Yup. Have backup plans and know when to execute on them.
Great post once again.
I thought today was a buy day? Are we left to use the mathshitup-inator on our own moving forward?
Oh, we’re done with buys. The workshop has ran for a full year as originally intended. Once we figure out the Vanguard transfer stuff I’ll do a summary of everything we’ve learned.
So first of all, you two are my heroes precisely because you’re not making a fortune off your blog or any other side venture (yet). The people who do aren’t walking the walk. But you are. Kudos.
Your sequence of returns post blew my mind, so I read this post expecting another grenade. If I read it correctly, though, there was no grenade, but a demonstration of braininess by my favourite money couple. You had bad luck in that you retired shortly before a local market downturn. Fortunately, you’d already prepared for this and lived off 1/3 of your three-year cash reserve. You were also prepared to lower your expenses, as in Thailand.
What I learned: your portfolio actually went up, because you lived off your cash reserves and reinvested during the downturn, and retired people should use FIREcalc to redirect themselves before they use up their reserves.
Did I miss anything?
And I wonder how your plan differs from the “WARM” model here: http://jlcollinsnh.com/2017/09/09/sleeping-soundly-thru-a-market-crash-the-wasting-asset-retirement-model/
I know your retirement portfolio components are more aggressive than his, but I imagine his 20% extra cushion is probably similar to your three years in cash plan. Thanks for any insight!
Thanks, and yes you pretty much got it.
And the WARN model is completely different. Basically, that model moves everything into cash and just spends it down year over year. Maybe suitable if you’re older and can reasonably predict how many years you’ll live but not too useful for super early retirees like us.
In the US atleast, factor in the SS income withdrawn at the age of 62, 67 or 70 as an additional potential source of income.
Right. That also helps. I’m sure there are calculators out there for that.
2 great points: 1- some FIRE bloggers make a shit ton of money off their blogs in retirement so take their advice with a grain of salt. 2- re-evaluate your retirement every year. Life changes, the market changes, inflation and expenses change, so should your withdrawal rate (or in the very least consider your current situation and choose to adjust or not adjust in the coming year)
Yeah, maybe one day we’ll be one of those people but not for now 🙂
I really enjoyed this post because it was actionable and from real experience of a downturn in retirement. Have you replenished your 3 year cash reserves after drawing it down the first year in retirement? Did you do this by selling assets or saving dividends? I also have a question on the 4% rule: “withdraw 4% (inflation adjusted) of your starting portfolio”. How does inflation adjustment factor into the withdrawal amount each year? Could you give an example to clarity? This inflation adjustment will affect my target FI numbers. Thanks in advance!
We’re going to be doing a withdrawal in December to replenish our cash cushion. I will be doing a detailed writeup of exactly what we did when that happens.
And if you started with a $1M portfolio, and a spending rate of $40k, then your withdrawal rate is 4% (implying a 95% success rate).
Then, say next year after dividends and capital growth, your portfolio goes up by exactly how much you spent. So in year 2, your portfolio is still $1M. If you chose to, you could increase your $40k by 2% to $40800 to account for inflation, but this would increase your withdrawal rate to 4.1%, and bring your success rate down slightly to 93.2% If, however, you chose to forgo your inflation adjustment and continue spending $40k, your withdrawal rate and success rate would remain unchanged at 4% and 95% respectively.
So every year, you could choose to take (or not take) your inflation adjustment from last year, and then divide that by your new portfolio size. Taking or not taking your inflation adjustment is just another knob you can turn to tweak your portfolio’s retirement health each year.
The takeaway for me is to re-evaluate the withdrawal rate every year depending on portfolio size and to re-calculate the success rate. There’s flexibility in spending and generating side income, if needed, to ensure success. For my FI numbers, I had too many variables to be confident in a fixed withdrawal rate over 30+ years. But by evaluating every year and running a new experiment of retirement success, as suggested in your post, it’s manageable and in the spirit of agile! Thank you for your detailed example above! It’s taken a load of my mind.
Btw, will you be doing anything different to your portfolio to prepare for a probable market correction (bear looming in the all the media news…)? I’m trying to diversify to non-US equities and may pick up some Gold ETFs. I don’t want to actually own gold bars and have to worry about storing them. But the Gold ETFs have counterparty risks. Is this still a good hedge to use Gold ETFs?
if the balanced portfolio gives 3 % in dividends a year
then one needs to sell something in the portfolio in the year to give the extra 1 %
making a 4 % withdrawl
what i am figuring out is when and how to get that 1 % into cash > ?
one method could be ; the US equity ETF s are at all time highs .. . . so is now the time to sell some for this years living expenses ?
to get that 1 %
i would not sell all by the way because no one knows how high is high ? .. .
which is why i stay invested .
i am only talking about getting that 1% cash for living expenses ..
I’m going to do this in December myself and will do a detailed write up when I do, but basically you set a portfolio target of how much cash you need to raise (1%), then calculate the transactions you need to rebalance to that target, which will naturally instruct you to sell your winners.
Again, a little complicated for a comment reply. I will write this up in an article sometime in December.
thanks again …. i figured this must be the best method … and of course if it was down year then bonds would probably be the only ones to sell ….
Thank for the great article. I’m not retired yet and I wonder how I will manage it. I have some tought about it: What I understood from the trinity study is that you need to setup your portfolio to generate an average 7% return in order to swr 4%, the 3% remaining is for inflation. With the actual low rate of bond we need to have a high proportion in stock to provide 7%.
3 year in cash seams to me unproductive except that we are in a low interest rate/low inflation era. So low that HISA provide almost the same return as bond with lower volatility. It seams wiser to hold in cash for HISA than having bond etf.
In another era I think I would follow the shiller PE10 ration and move higher in bond when PE10 is high and heavier in stock when it is low. I saw the long term simulation and it provide about the same return as 60/40 ratio but with less volatility. I think it would help figuring which side of the portfolio to withdraw.
Yeah, you’re right. Bond ETFs these days dampen volatility but don’t provide much yield (considering as you’ve noticed I can HISA hop and get 3%). To counteract this, I’ve moved most of my own personal portfolio’s fixed income allocation into higher yielding fixed income stuff (Preferreds, REITs, etc.) to get a 5% yield on that side of my portfolio.
This is very helpful advice. Thanks for the writeup, does provide me with some comfort as I plan on pulling the trigger soon.
If you guys are ever in Singapore, hit me up – I’ll love to take you out to drinks.
Cheers.
I would LOVE to be Singapore right now. I’m trapped in frigid Canada for the holidays and I am NOT happy about it 🙁
Hi Wanderer,
Think positive. Don’t use the word “trapped”.
Ben
Such a great strategy for people who are naturally overly cautious *cough* me *cough*
We’re on track for financial independence in 5 years but I’m already fighting one more year syndrome… this strategy is a way to stay confident in the face of the unknown
And the good ol’ Wall of Fear. We talked about that a lot in Chautauqua Ecuador. Check out FIRECrackers’ article on that: https://www.millennial-revolution.com/build/scaling-wall-fear/
this is good stuff.
i had a thought when i read through: you could give yourself a raise in income by moving to something like preferred shares ETF’s when they irrationally go on sale. just need to make a list and look in on a couple of funds every 3 months or so. that being said, i parked a bunch of money in PFF and it’s off a few percent from our buy point but throws off monthly cash at around a 5.7% annual yield. it’s just something you wouldn’t want to be forced to liquidate when it’s down. i like the monthly payouts which we reinvest.
That’s exactly what we did. Preferreds, REITs, and a few high-yield bonds thrown in for good measure. Great minds thing alike!
First time poster, long time lurker. I’m a fellow engineer and I find myself binging on your blog posts!
Wouldn’t you have achieved the same results if your 3-year cushion ($120k) was a part of your retirement portfolio?
I ran the numbers through firecalc and a $1M portfolio shows a 94.9% rate. A $1.12M shows a 100% success rate.
Well, you don’t calculate your cash cushion by taking $40k x 3 = $120k. You do it by taking the difference between your living expenses and your portfolio yield and then multiplying THAT by 3. So for a $40k living expenses and a 2% yield, your cash cushion would be ($40k – $20k) x 3 = $60k.
Any advice on how to forecast the cash cushion you’ll need? Since you won’t know that year’s yield until actually getting ready to retire (if that makes sense). I remember you guys over estimated cash cushion (which isn’t a bad thing)… so worst case is over-saving (but that might delay retirement). (ex: time needed to save $60k vs $120k).
You can predict your portfolio’s yield be taking a weighted average of the dividend yield of all your ETFs.
And yes, I accidentally over-saved my cash cushion because I a) didn’t take my portfolio yield into account when I did my calculations and b) didn’t spend nearly as much as I thought I would need to during our 1st year trip around the world. Doi.
I’m so proud of you two and I’ve learned so much from your perspective, even if I am about fifteen years older! 😛
Thanks! Glad we could help.
Haha, I sounded like a mom there.
In some cases, it makes sense to set up a credit line and use it if needed. I recommend investing or simply using the cash cushion to get some serious deals.
For example, I recommend getting apps like Flipp. You can view the latest flyers and coupons from your favourite local stores and search by items. A month ago, I noticed Colgate Total toothpaste was 50% off at the local Costco (Costco is not always the cheapest place to buy). I remember what Mark Cuban said and bought almost 2 years worth of toothpaste. Safely made a 50% return on my money for two years. Thanks to inflation the price of toothpaste will only go up. I did the same thing when chicken breast was on sale (didn’t buy two years worth but my freezer is full). Those are some serious savings that add up.
The more you save, the less you need to earn on your investments.
Hi Wanderer,
If I need to build a 3-year cash cushion, does it mean when calculating my FI number, I should multiple by 28 instead of 25?
So If my yearly expenses are $40,000 do I need investment 28 times of that which is 1,120,000 (40k x 28)? How should I math that shit up?
No. Your “main” portfolio should still be living expenses x 25.
Your cash cushion is calculated like the following: (Living Expenses – Portfolio Yield) x Years of Cushion. So if your living expenses were $40k, your portfolio yield was 3%, and you wanted 3 years of cash cushion, you would need ($40k – $30k) x 3 = $30k.
Thank you so much for writing this! With all the attention that most FI bloggers put on side hustles, even after they hit their FI number, I sometimes feel like I’m on an island by myself. Five months of FIRE, working on my passion projects, no plans to intentionally generate income, got my back-up plans in place for a crash… life is good. Keep up the good work on the blog!
Seeing you are FI … A fun side hustle while you travel is to do ESL teaching across Asia … you can negotiate you hours and usually get housing …. while not eating into your base nest egg … thus you protect your investment capital – it is a fun way to meet folks and travel at the same time …. and it can be short term – CPO, From the Far Side of the Planet 🙂
Great article, Wanderer! One of the best ones I’ve read from you 🙂 and it totally makes sense. I will have to keep your words in mind when I FI ?
My thumbs developed carpal tunnel from scrolling down through all the comments lol. You get so many!
Thanks, Jack! Glad it was helpful.
So when you say park 2-3 years of living expenses as cash, do you leave it in a high-interest savings account? laddered GICs? … or?
Nope, just HISA’s. We HISA hop to get the best rate—around 2.5-3%. In that sense, there’s no need for laddered GICs which are more annoying to access your money.