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Wednesday, April 26, 2017

Early Retirement Pitfalls

Posted by Tim Stobbs on March 26, 2010

Early retirement is suppose to be this great thing.  Do what you want when you want.  Yet doing it does have some pitfalls that you need to watch out for and hopefully avoid a few of these.

1) Underestimating expenses. It’s amazing how during your working life you get use to your lifestyle that you tend to forget about certain items like health benefits, replacing your car, your water heater, roof … you get the idea. When your planning for an additional 20 years of retirement you better make sure you check your expense list twice. One way to plan for this is to make sure when you go into retirement that everything is new and/or that you have planned for an extra replacement money.   At a minimum I suggest a $1000/year for each car and home you own.

2) Not having any margin of safety on your calculations. It’s nice to hope that things turn out just the way you plan, but let’s face it, life doesn’t work that way. So you better leave some wiggle room when doing the math. In my case I drop my expected rate of return by an extra 1%. Some people like to boost their expenses by an additional 10%. Either way works out fine, but you do want to have some cushion there.

3) Not enough diversification in your investments. In order to avoid having your retirement savings go up in smoke you need to make sure you can suffer some serious damage to your savings. The solution is to avoid putting all your nest eggs in one basket. You most likely want a conservative mix once you get near retirement, but not too conservative that inflation takes you down in twenty years.  So you most likely want a high interest savings account, bonds/CD’s, perhaps a REIT and a mix of other equities in Canada, US and the world.

4) Forgetting about taxes. Knowing your Canada or US tax law is required to build a good portfolio as much as diversification. For Canadians you need to know about the three types of investment income (capital gains, interest, dividend) and how each is taxed.

5) Unrealistic expectations. You can’t travel the world and live in five star resorts and leave work at 30. Ok, perhaps one in 15 million can, but I know that isn’t me and most likely not you.  So keep your dreams reasonable.

6) Cut off peak earning years.  By leaving your working life earlier you cut off your peak earning years.  So the earlier you leave the harder it becomes to pull off since you are losing more of your high income years.

7) Emotional considerations. Some people do all the math and planning but forget one thing. What are you going to do with all that time? So they end up bored and go back to work. My question is what’s the point of saving if you don’t have a plan for your activities in retirement! Early on in your planning you want to start considering this. After all you don’t want to forget about enjoying your life now and you also want to ensure you will continue to enjoy your life in early retirement.

So what pitfall are you most at risk of falling into?  Or did you have another pitfall to add?

Comments

7 Responses to “Early Retirement Pitfalls”
  1. Robert says:

    I disagree with #3, diversification. I tend to side with Mark Twain who said: Keep all your eggs in one basket, then watch that basket! But I think the most important thing, with both the investment strategy and #7 (lifestyle design, for lack of a better term) is to start now.

    Don’t wait until you’ve retired to invest for income or to develop a hobby. Invest and live (on evenings and weekends) as though you were retired now. That way, you can spend ten years or so addressing the pitfalls and either adjusting your strategy or knowing that you can live with the results.

    However, I plan to work after I achieve financial independence. That addresses almost all the other pitfalls: too little income, too extravagant dreams and no margin of safety. Not depending on a paycheque means I can do something because I find it fulfilling, regardless of pay. Any pay I earn can be used for present lifestyle, since my retirement is fully funded. (The “risk”, in this case, is ending up with too much money, but I’m okay with that).

  2. Robert says:

    I agree you need a capital allowance in your expense projections. You can easily estimate it by listing the major items in your house (furnace, water heater, car, roof, appliances, etc.) and estimating their working life and cost.

    Add it up over time (say 15 or 20 years) and you have an idea of how much you will need each year to cover these eventualities.

    Another item might be moving and realtor costs, if you plan on moving to a smaller place at some point.

    When I do my projections I often forget the costs of a replacement car, even if I plan on keeping a new car for 15 years. And inflating what my base Civic costs today for 10 years or more. Still, putting something in is better than overlooking it.

  3. Mama Zen says:

    I don’t plan to retire early, most of my decision is based on point #7. I like working, and I like my work. I plan to work less, to take sabbatical years periodically, but I hope I will be able to work for a long time (as long as I like to work). But I really enjoy your blog even if our goals are different, because to be able to accomplish my goals I need a little more financial litteracy and I can find some here :-).

  4. deegee says:

    Health insurance is my biggest concern, although I am feeling better about that with the recent HI reform just passed by the U.S. Congress and signed into law by President Obama a few days ago. Still, my HI premium went up 20% in 2010 so if it keeps rising at that rate every year it will be a problem. I had budgeted an average annual increase of 7% but can tolerate some increases a little bigger than that.

    I did two things before I retired in 2008 which will keep my expenses down. The first was to buy a new car to replace my 15-year-old, ailing one in 2007. I drive very little so the maintenance costs are lower (except for insurance because I have to buy Collision again). The second was to get some expensive dental work done in 2008 before I lost my COBRA dental coverage. Since I had that work done, I have been nearly cavity-free in my last 3 semi-annual visits.

    I do have a safety margin in my overall budget, as I am turning a good surplus in these first years of retirement.

    My total income taxes are very low (about 7% of total income), so that is not a big issue.

    I have a different asset allocation mix than I had before because it has to be more income oriented. But I still have plenty in equities, just not as much as I had before.

    I was working only 12 hours a week when I retired and had not worked full-time since 2001, so my peak years of working have been well behind me for some time. The wage income I was forgoing was not very large.

  5. ET says:

    I read this several times: It’s amazing how during your working left you get use to your

    I think what you wanted to say may be:
    It’s amazing how during your working life you get used to your

  6. Canadian Dream says:

    ET – Thanks. It’s fixed.

    Tim

  7. Dougster77 says:

    All good points. The are that has always thrown me out of my budget are all the annual fees from credit cards, insurance, etc.

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