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Monday, March 27, 2017

Non-Linear Spending Models

Posted by Tim Stobbs on September 28, 2016

‘I’m wrong.’ I thought to myself the other day as I was building out a more detailed model of our spending for the next five or so years.

The reason was for a very long time I had always done my spending models based on a linear spending plan and ran the calculations on an annual basis.  Basically I just assumed I would spend $30,000/year regardless of the year. The year 2020 was the same as 2021 or 2022. It was a conscious choice to simplify things when I started but now that I’m looking at modelling my spending but as I looked closer I realize that assumption really doesn’t hold up.

Spending is actually a non-linear function.  Some months are higher and others are lower, that I’ve always know from my previous net worth posts where I track our spending. Yet what I didn’t consider is how that applies to years of spending as well.  This became particularly obvious when I ran a test case where I assumed I started my early retirement in 2018 and after adjusting for other income sources (like my wife’s business and government benefits) I ended up the the following planned investment withdrawals by month (assuming I don’t bring in any income from a job).

non-linear-withdrawal

So you can see it, while I still averaged our monthly spending over the calendar year the requirements to take money from our investments isn’t a constant stream on a year to year basis.  This is partly why I started down the idea of semi-retirement since because of our non-linaer spending our investments should actually continue to grow even after I’m not at my day job. In fact we will be pulling out less than $1000/month for a period of about two years. This becomes a bit of neat trick as it allows us to keep saving towards full retirement even when we are only semi-retired. Of course any additional money I earn other than investments will further drive down those numbers and allow us to shift to full retirement sooner if we wanted.

Overall I estimate that because of this fact we only need to be semi-retired for about five years or so and then we have the option of shifting to full retirement.  Or alternatively we could keep working beyond that time and put the money into a slush fund for travel or other fun things.  The point would be we really don’t need the money for day to day spending.

In the end, it was nice to know that my idea of semi-retirment looked more than reasonable and put my mind at ease with the entire plan, all because I stopped thinking about things in a linear fashion.  Have you ever had an ‘ah’ moment with your retirement planning?  If so, what was it?

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