Posted by Canadian Dream on January 18, 2012
Are you sitting down? Yes, then good. If not, you might want to pull up a chair. I’ve got a confession to make. You know that 4% safe withdrawal rate that me and other early retirement bloggers go on and on about, which is suppose to be the amount you can safely pull out each year and not run out of cash over a 30 year time frame. Well it turns out that most of the assumptions used to model that don’t really apply in real life (for full details, you can read this long, but excellent article). The real truth of the matter is that a ‘safe withdrawal rate’ isn’t a constant at all but rather another variable.
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.
Posted by Dave on January 17, 2012
This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.
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?
Posted by Robert on January 16, 2012
This is a guest post by Robert, who lives in Calgary and works as a financial advisor retired at 34. He is married, has three kids. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
Thinking back two years or five years or ten years, how did your earnings then compare to your earnings now? Due to improving skills, seniority and inflation, many of us earn a larger income over time. In my experience, as people earn more, they choose to spend more.
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?
