As many of you already know I have a very optimized plan when it comes to us spending our money each year. I don’t spend more than I have to on my water bill, we borrow books from the library prior to buying them and will gladly spend money on buying a wine kit to brew at home instead of buying a bottle from the store. Over all this results in us having a very good life on far less than most people would for a similar lifestyle. Our spending is highly optimized to our particular wants and needs.
So for years I’ve generally considered optimized spending a strength of our plan after all when you are reducing your spending the you have more money for savings each month and you also can reduce your overall retirement goal. For example, if you need $1 million to retire with a $40,000 per year expenses, if you drop your expenses to $30,000 you only need $750,000. So you don’t have to save that extra $250,000 in the first place. I always considered this a good thing.
Except when it isn’t. Oddly enough I came across the idea it can also be a weakness to your retirement plan. Which I thought was a bit silly at first until I realized what they were getting at (sorry I don’t recall where I read this or I would link back to the source). Having overly optimized spending also means you don’t have much fat in your budget to cut as the core spending (like your property taxes, home heating, power or water) takes up a greater percentage of your overall budget. It also means any jumps in those core expense have greater impact on your budget as you have less optional spending elsewhere that you can cut to cover it. After all, when you are overly optimized you already cut most of the optional spending out years ago.
So let’s compare two cases to demonstrate this: let’s say family A is spending $40,000 a year and they retire with $1 million saved. Then the stock market drops 40% and inflation spikes so their core spending goes up $1000 per year. So being reasonable people they look to cut $1000 per year out of their spending (or 2.5% of their yearly budget) and they go after a few things they haven’t optimized before and make up the difference. Then we have family B with $30,000 a year spending and only $750,000 saved. They have the same event and $1000/year increase in core spending from inflation. Now they have less to cut in the first place and they have the added bonus of the increase being a higher percent of their spending at 3.3% of their yearly budget. Over all family B’s ability to cut spending is more limited and the increased core spending dollar amount has a greater impact overall.
Hence the point that overly optimized spending can also be a weakness during your early retirement beyond being a help to get you their sooner. So how do you deal with this issue? Well me personally I don’t plan on changing my plan because of this, but I would suggest the idea of making sure you do have some buffer in your budget. You might not really need that buffer most of the time, but even if you don’t use it initially that extra money could be spent on a one off event later on if you aren’t using the buffer. For example, take an extra trip every five years if you aren’t using that buffer amount. The size of that buffer is a personal choice and will shift with how much slack you have in your overall budget. The more optional spending you have, the less buffer you may need and vice versa.
So do you have overly optimized spending? What would you do to resolve the risk of higher inflation and a lower market?
“Sorry.” My wife says to me.
“For what?” I ask.
“I over spent on your Christmas present.” She replies.
I shrug my shoulders, “It happens. I’ve done it for you on the odd year. How much?”
“$7.” She replies with a slight grin.
You see why I love this woman right. She feels the need to tell me she went over budget by $7. Not because she feels guilty, but we just have a long standing policy of being honest with each other. For the record, I under spent on her by $5 this year.
Yet to me that is a perfectly normal part of our Christmas budget. Yes you will over spend on somethings. That is entirely okay to do, as long as you are under spending on other presents. So for us, this has been the rule of thumb for years. Just because you have $5 left over in the budget doesn’t mean I NEED to spend it on one more item for their stocking. After all do you really think buying that one little thing will make or break their Christmas? The answer is no (and if not you have an entirely different set of problems). The result of this long standing rule, well we usually come under our Christmas budget. Which is good because some years we have made mistakes like forgetting to include mailing gifts to the other side of the family.
What also helps is we always set the budget prior to starting to shop and limit our gifts to mostly family. I don’t give gifts to our kids’ teachers, I don’t even know my mailman’s name and I don’t buy anything for a co-worker. We will bring a small gift is invited to a party or supper but usually the consumable kind (like wine or dessert). It also helps that both of our families have started gift exchanges for the adults.
In the end, I believe Christmas is about being together with people. I like getting a few gifts (I won’t lie) but really I don’t need much to be happy. I rather spend an afternoon drinking coffee and visiting than get another present.
So how do you keep your Christmas spending in check?
‘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).
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?