I made some terrible bets on the Super Bowl this past weekend.  At the time I made the bet, everything seemed to make sense and I thought I was in a position to come out way ahead for the year with football betting.  Unfortunately, the game did not go as well for me, either as a fan of the New England Patriots or as (I would term it) a somewhat degenerate gambler.  On the plus side, my homebrew beer was delicious, as was all of the food I ate (probably too much) so my Super Bowl was fun, it just didn’t add very much to my retirement fund (which is why I don’t bet very much at all).

As far as gambling goes, the stock market is consistently a gamble – making my retirement plans somewhat risky as this is where I am hoping the majority of my cash will be coming from to fund my retirement.  I’m hoping that in the 10 years I will have to invest, and the 40-some years I’m hoping to live off of these investments there is no significant collapse.

In the off-chance that I invest in stocks the same way I bet on this year’s Super Bowl (and capitalism has carried on) I do have a backup plan.  In my retirement fund calculations, I have not included some funds that will be coming in.  On top of my retirement savings, there are three sources of income which may be added to my retirement.

The first source is my work pension.  I work for a crown agency of the Ontario government and have a defined benefit plan, which at this point is fully funded.  Right now, I have no plans of leaving this company in the near future.  This source should provide a significant increase to my cash flow at age 65.

The second source is Canada Pension Plan income.  From everything I have read, this is a relatively safe bet, even over 30 years from now.  If for some reason it turns out that the statements Prime Minister Harper made that CPP is “fully funded and actuarially sound” is not, I’ll still be okay.  If this pays off, there will be a considerable boost to my retirement account.

Finally, and the one source I am not sure of is Old Age Security.  Depending what you believe and what happens over the next 40+ years, this potential source of income may disappear.

Added all up, after age 65 I should (hopefully) have a considerable buffer in monthly income.  I will be fine without these, but felt it prudent to not include this income – which I really have no control over.

What do you include in your retirement calculations?  Do you have any “extra” sources of income that may be a buffer after age 65? (Or whatever age retirement will be in the future).

First a little history, what is Old Age Security?  Well despite being called a pension, it really isn’t one at all.  First off there is no money saved for this program despite being around since 1952.  It is paid for entirely out of the General Revenue Fund by the federal government in the current year.  Thus our 2010 tax dollars paid out our 2010 OAS benefits that year.  The programs needs an overhaul…badly.  How so?  Well there are a few interesting facts like the taxpayer to retiree ratio is currently 4 taxpayers to 1 retiree, which will decline to 2 taxpayers to 1 retiree by 2030.  Add in the program is expected to cost $108 billion by 2030 up from $36.5 billion in 2010.  So if you have three times the cost and half that taxpayers that means you need to increase taxes or cut service by six times  today’s payments just to fund this program.    I don’t know about you, but I’m not prepared to pay that much more tax just to keep the status quo.

The other thing people tend to forget is what is the program supposed to do?  While some people do think of it as a pension plan I personally tend to think of it as a social safety net.  It provides a basic income to seniors while some additional funds for low income people with the GIS or Allowance programs.

So what will changing the age requirement for OAS do?  It delays the problem some what and reduces a little bit of the cost, but if you really want to have significant cost savings the government is going to have to do more.  So what is a likely target, in my mind, if you want to be fair about it you start by increasing the claw back provisions.  This way the basic function of the program can stay in place while we take the extra money out the hands of retirees that need it the least.  By the way, the claw back starts when your income hits about $67,600 and by  about $109,000 you have to pay all of it back.   I don’t know about you, but if your making over $75,000 a year in retirement, I don’t really think you need the OAS.

So how would you deal with this huge cost increase to the OAS program?  Raise the age, increase the claw back or something else?  For US readers, the problem is similar for the Social Security program, so feel free to rant or make suggestions.

I previously wrote about problems I was having with my back.  At the time, I decided to go to a chiropractor and physiotherapist in order to attempt to rid myself of the back pain I was experiencing.  I did this for a few months, and the outcome was somewhat unsatisfactory.  Rather than continuing to spend money (well, my benefits provider’s money) I chose to go another route.

Starting about this time last year, I worked to get stronger and more flexible, rather than focus on having a chiropractor or physiotherapist work on little muscles.  I have been able to almost triple the amount I can squat, approaching almost twice my body weight (along with increasing my strength in other ancillary exercises) – in the process, my back pain has essentially disappeared.  I’m no doctor or anything, but I don’t think it has hurt me by getting stronger.

I plan on maintaining this level of strength as far into the future as possible in order to stay as mobile as possible for as long as I can.  This, along with a healthy diet will hopefully give me a good chance of being mobile into my 80′s.

Similarly, I have attempted to build a strong core financially.  I am repaying my only outstanding debt (my house) as quickly as possible, and I am going to invest as much as possible in order replace employment income with investment income.  At the core of my financial plan though is the simplicity of keeping my expenses low.

Low expenses, as a part of my financial plan has provided me with more financial independence than anything else I have done.  I make pretty good money right now, enough that I can keep my goal of retiring at 45 in my sights.  If I decide that I don’t want to do the job I’m doing right now (or something like it), I could find a job that pays minimum wage and I’d be fine financially.  Working a minimum wage job  would limit my early retirement opportunities but it does provide a certain amount of security knowing that I won’t be on the street if my company decides they don’t like something I’m doing or I decide I don’t want to work there anymore.

Much like building my core muscles in my body, I constantly maintain the core of my financial plan by monitoring my spending.  I don’t consider myself a miser or anything, I just ensure that if I’m going to spend my money on something, it’s not a waste.

What do you consider to be the core of your financial plan?  How do you maintain your focus on this over time?

It seems that volunteering is a common theme among retired people. At the YMCA, I met a woman who explained that she’s currently transitioning into retirement. Without being rude, she is quite a bit older than me, probably nearing the normal retirement age. She worked for years as a psychologist, helping children (eg. with ADHD) adjust to their usual environments, such as school. She has decided that she wants a smooth transition to retirement. Her first step was to stop taking on new clients. Each client is a relatively short term project, measured in months, not years. This reduces her commitment (and income, I assume), without ending it all at once. It also gives her a modest amount of extra free time.

Most people, after working full time for the majority of their lives, crave a routine and a feeling that they are contributing to a cause larger than themselves. The woman I met has chosen to volunteer at the YMCA in order to be part of a group effort and to have a time commitment that builds into her routine. I’ve talked with other people who either worry what they would do with the spare time afforded by retirement. They seem to take literally the proverb “idle hands are the devil’s playthings”.

That may hold true for some people, but having the luxury of being able to choose where and how to spend my time gives me options that wouldn’t be available otherwise. My favourite things to spend my time on relate to my interest in public education. I regularly spend time in our school, volunteering in one or the other of my sons’ classes, or joining them on field trips. I also talk with other parents about their experiences with and expectations for our school. I have the luxury of being able to read news, scholarly articles and books related to the education issues that our school and our system are facing.

None of these activities were planned as a transition to help smooth me into retirement. But I think that a smooth transition is certainly worth the effort. I continue to try and sort my activities into a regular schedule that produces a routine. Fortunately, whenever I feel that I’m wasting my time, I can take my daughter (who’s not in school yet) and play with her. Nurturing my kids is time well spent.

Do you have plans to ease the transition from one stage of life to the next?

I am by far the last person to ask about specific investing advice (for now, I hope to change this in the near future).  What I can tell you is what I am looking at right now in my future investment plan and why I am going to do it this way.

I have an undergraduate degree in Economics (which doesn’t really mean a whole lot, I do not claim in any way to be an Economist, but I sometimes remember some of the stuff I tried to learn in the four years of school I was paying for) – one of the main facets of Economics is an efficient market, whether it is in a labour market, commodity marketplace or in the case of investing stocks and bonds.  The efficient market hypothesis (as it applies to stocks) basically states that prices reflect all known information available.  A lot of investing books use this hypothesis to tout index funds, essentially saying “the market is efficient anyways, don’t try to beat it, just own it (through index investments)”.  I generally agree with this, and think that index investing is right for most people – it’s safe (or relatively safe, as compared to either keeping cash under a mattress or picking stocks based on a hunch) and pretty easy to do, I just don’t want to do this.

I’m not eschewing index investing due to its simplicity – I’m pretty lazy and would enjoy something like a Couch Potato Portfolio, where I rebalance a few times per year and generally don’t worry about my investment otherwise, compared to a dividend portfolio of single stocks, which require constant monitoring.  No, I’m going to invest in things that are going to pay me cash now, not later.

Why is having cash now important to me?  There are a couple of reasons:

1. I’ll need cash when I retire – a constant cash flow that comes from investments such as stocks, bonds and REITS will replace my salary at some point (hopefully).  Having to sell off the stock itself does not seem like a good long-term plan to last through retirement.  Dividends (or interest) paid out will allow me to own the original investment (which will hopefully appreciate).
2. I don’t really trust the marketplace – This may seem like a silly reason to choose an investment, but for me I would rather have cash in my pocket now and see money coming in rather than investing in a company hoping to pull my money out at some future time.  I realize that I am a little crazy for this, but rather than seeing the stock appreciate, I would rather take a portion of my investment off the table.

My first reason is perhaps a little more rational than the second, but they both work for my purposes.  To me, investing has a lot to do with personal preference and these are mine.

Do you invest for capital gains, or cash flow, or a mix?  How do you decide (or did you decide) on the type of investments you were looking for?

What?!?! Then how do you model that into your retirement plans?  Simple, you can’t.  Depending on the situation your ‘safe withdrawal rate’ can range anywhere from 1.8% to 25%.  This all depends on several factors like the amount of fees you pay on your investments, the rate of return on your investments and the sequence of those returns, and your personal rate of inflation.  In a nut shell you can’t model it yourself because it becomes a circular reference, which you might be familiar with that error if you have ever had to do complex modeling in Excel.  In a nut shell you series of references to other variable results in your last object referring back to your first object, you end up with a closed loop that can’t be solved.

So if you can’t model it why are you telling me about it?  Ah, that is the right question.  I mention this fact because in reality, when you are actually living on your savings in your early retirement period you shouldn’t have a constant withdrawal rate.  Instead you should ramp it up and down depending on those factors I already mentioned.  So in today’s current context with low returns, low interest rates and slightly higher inflation you should consider lowering your withdrawal amount below 4%.  Then when you hit some good years like those leading up to 2008, you can take an extra vacation if you want.

This really isn’t that hard as people already do this in real life prior to retirement.  If you lose a job, your spending doesn’t keep going out at the same level.   You adjust your spending to your lower income as much as you can to ride out the bad times until your income level comes back up.   Yet doing this requires you to have some fat in your budget to cut back on, if you purely rely on cutting back spending.  The other alternative is to increase your income by getting some short term work or selling a non-income producing asset such as your vacation property.

So the lesson in all of this is you don’t want to retire early on the absolute lowest point of your spending, you want to in fact have a bit of fat or safety margin in your plans.  This is somewhat obvious risk planning, but you might be surprised how often the obvious isn’t really seen by people.  So please have a few backup plans when you retire early including some extras in your budget.  That way you can cut back during the lean times if you need to.

I think that one of the main things that people would question about a retirement plan where you retire at age 45 is how you could afford to do this?  Economically speaking, there is a significant opportunity cost to retiring in your 40’s, which in the past has been prime income-earning years.  In my case, I could be giving up hundreds of thousands of dollars in income that I very well might need at some point (for whatever reason).  Not only that, but in order to retire, I have to save a significant portion of my income – giving up on a lot of “stuff” and experiences that this income could buy.

The riskiest part of retiring early is outliving the savings that have been accumulated.  It would be very undesirable to be in my mid-eighties and find out that I have very little money left.  The potential for bankruptcy is something that needs to be examined prior to leaving the workforce and something I will have to monitor while I am no longer bringing employment income in, as I would not like to live off of cheap cat food in my retirement years.

For me, I will accept this risk.  I would like to control my own day, rather than having to go to work in order to pay my monthly expenses. I would rather do what I want to do.  This freedom is worth a lot to me and I am willing to give up my prime earning years, as well as “stuff” now (a second car, a bigger/fancier house, an 80 inch television) to be able to do what I want to do from my 40’s on.

The risk of running out of money can be mitigated by (a) saving enough in the first place and (b) ensuring that money withdrawn from investments is done so safely, which depending on what you read is around 4% per year.  Additionally, as long as I monitor my budget compared to my investment earnings, I would hopefully be able to curtail some expenses in order to stay retired and not have to re-enter the workforce.

On a whole, the goal of early retirement is still fairly small-scale, when you look at the population as a whole.  Most people haven’t put much thought into it, and if they do happen to stumble across someone like me (in my experience) tend to dismiss the goal and are quite skeptical on whether I can do it or not.

If you’re on an early retirement path, how do you deal with the potential risks that come with exiting the workforce at a relatively young age?  Are you comfortable taking this risk?

For example, I worked with a young couple who were both employees of the provincial government. As we reviewed the information about their benefits, it quickly became apparent that they would be able to retire between age 50 and 52 with a full pension. After that conversation, they decided to increase their spending, buying a rental property, buying a vacation property and buying a new car. If they’re going to be able to retire early anyway, the thinking seemed to be that they might as well spend their excess income.

For the people that I advised, the retirement age of 60 or 65 seemed to be a constant. When they earned any extra money, they chose to use it for additional spending. In this way, once they were on track to retire at age 65, the variable was how much they spent on their lifestyle in the meantime.

When I began earning an increasing income at work, I chose to hold constant my present spending. As I earned more, I started by paying down more debt. Then I used more money to invest (given the market opportunities). Because my additional income went to increasing my net worth, my retirement date moved ever closer. For me, the variable was when I would be financially prepared to retire.

Everyone in our society has the ability to be creative with how they use their money. Many of us are lucky to earn more than we need to survive. That excess money can either be used to increase spending and current enjoyment, or to bring forward the time of retirement (while holding spending constant). Do you make a conscious choice of how to handle additional income? If so, how do you choose where to allocate it?

As long as nothing changes between my wife’s and my finances, our house will have been paid off in around 3 years (taking 5 years total).  Until then, our financial plan is a fairly monotonous process, paying off as much as we can from each of our paycheques, while balancing this with having as much fun with the money left over.  Currently, I have a fairly robust savings/emergency fund, no debt and really nothing I can see in the near future that would make my personal finance life all that much more exciting.

I have chosen a very linear plan because it is more important to me to have no debt to reduce my monthly expenses, rather than it is to gain the benefit of 5 years of compounding.  Once our house is paid off, my wife and I will gain some sense of financial freedom, as half of our monthly fixed expenses will be eliminated – hopefully forever.  Once step 1 is complete (house repayment), it is our intention to invest until we have enough cash coming in annually to live off, which will hopefully be by the time we turn 45 (and if we’re lucky, sooner).

Until our house is paid off though, I have time to practice.  Time to get used to investigating stocks, paper-trading, to read books, blogs and other sources of information so that when the time comes that the majority of my income is going to investments, the task will not seem so daunting.  I am hoping that over the next few years I can possibly learn enough to eliminate a good percentage of “rookie” mistakes that I have read so much about on starting investors.

The problem I see is that three years is a very small window to learn, using Economic terms it is very much the short run – so I will still have a lot to learn in the ensuing (hopefully) 50+ years I’m going to be around and have to worry about my investments.  It’s a starting point however and I figure it’s better to be somewhat prepared rather than just diving in and investing 10% of our household’s retirement savings in the first year (if I want to retire at 45, I will have about 10 years to invest).

I realize that I will probably learn more in the first 6 months of “real” investing than I will in 3 years of studying, but at least I may not freak out when I start investing.

So, that’s my plan for the next few years – what would you do if you were me?

What is interesting about the book is often our tendencies for excess is partly driven by evolutionary instincts that were great for our species for thousands of years, but is killing some of us today.  Food is the perfect example of this particular situation.  For thousands of years the idea of ‘eat until you want to burst, when you can’ was a good strategy, after all you never knew when the next famine would hit.  Yet today when endless all you can eat buffets, that strategy is literally killing people.  A lot of us lack the sense of enough food to stop that cycle before it gets out of hand.

The same idea applies somewhat to information.  Marketing companies have spend a fortune trying to understand our brains and realized a few interesting facts.  Like today we are drowning in so much information that even the marketing departments of many companies are finding it hard to get their messages into our heads.  So what is the solution?  This is what I liked about each chapter, the author provides a few ideas on knowing when you have hit enough.  With information the obvious one is start on a information diet.  Did you really need to read all those news sites and blogs each day?  Likely not, so can you pare down to a smaller number of sites?  Perhaps one for national information and another for more local content.

While I could easily keep gushing on how much I like this book I will attempt to jump ahead to two other concepts I really enjoyed in the book.  The first is the fact we have a strange culture towards work, it’s like the option of having part-time work is a problem rather than an obvious solution to a lot of people’s lives.  If you can earn a good wage why do you need to work full time?  After all at some point the extra money is likely largely going to taxes and buying excess stuff.  So don’t forget to consider that when you are looking for a job, the best benefit of all just might be working 80% of the time or what ever number works for you.

The other concept I really liked in the book was the discussion about happiness.  In a culture of ‘more, more and more’ even the idea of happiness has turned into a endless quest for more of it.  Yet what is wrong with skipping the endless happiness quest and parking yourself instead at contentment for most of the time.  Really?  Nothing is wrong with that as an ideal.

In fact, if you understand how happiness occurs it damn well makes a lot of sense.  Case in point, your happiness is largely determined from comparing your baseline to you current experience.  Hence if you change your baseline in an attempt to be more happy it often fails in the long term, as what used to make you happy now only makes you content instead.

For example, let’s say you drink red wine and your day to day choice is some homemade wine from a decent kit.  Then you decide to upgrade to drinking a better wine from the store in order to be more happy.  The only problem is after a few weeks of store bought wine your taste buds and your mind have adjusted to that new level.  It’s now no longer bringing the same level of happiness and instead you are merely content and out some more money.  Adaptation is a bitch when it comes to happiness.

So overall, I was very impressed by this book as it helped explained several things that I sort of knew about, but didn’t fully grasp the concept.  I would have to rank this as one of those books you MUST read prior to planning your retirement.  You might just find you can get by with a hell of a lot less spending than you think you need to, once you understand your own level of enough.