Expenses
I’m actually more of a fan of the phrase “financial independence” – having the ability to spend your time as you choose.
I think the term “retirement” conjures up the image of a golden watch or some golf commercial you happen to see on a Sunday afternoon.
Some never actually “retire” and instead simply focus on doing what they enjoy – whether that happens to produce money or not. I think that aspect should be celebrated and not diminished.
The most important part of figuring out retirement or financial independence or even a gap year (or ten), is going to be your expenses. That’s the baseline, that’s where you start.
The unfortunate part is that I cannot easily detail what your expenses happen to be (or what they should be).
It’s unfortunate in that it makes this article a bit one-sided (not in that I want to control your expenditures). It’s a personalized decision. Highly personalized in fact.
To this point I’d simply like to indicate one thing. Spending ought to reflect your personal desires and passions.
If you’re spending money just to impress your neighbor, that’s often a quick path toward being both unhappy and broke.
If you enjoy expensive cars, and learning about them and using them and working on them, then that’s a fine passion and you can plan for that accordingly. But if you’re only buying a new car because your neighbor just got the newest series, you’re flirting with an insatiable desire to “keep up.”
Given a limited amount of dollars, you don’t want to be throwing away a good chuck on them on stuff you don’t care about. That forcibly detracts from the stuff you do care about. And this applies to all expenditures. Thinking about whether or not something is actually important to you can better define your expenses and goals.
Whether you spend $20,000 a year or $80,000 will have a large influence on your ultimate success. I’m not suggesting that you spend as little as possible. Instead, I’m simply indicating that you ought to think about spending in a way that works toward your ambitions and cut out the stuff that doesn’t really move the needle.
Thinking About The Portfolio
With that, I’d like to think about the other side of retirement: income; in this case specifically with dividend paying securities.
A lot of people like to quote the Trinity Study indicating something along these lines:
“A safe withdraw rate for a retirement portfolio is 4%.”
That’s a highly simplified conclusion from the study, but I’ll give you an example of what that would mean.
Let’s imagine that your annual expenses are $25,000 per year.
Based on a 4% withdraw rate, that equates to needing a portfolio balance of $625,000 to begin (you can think about it as 25 times your expenses as well).
The concept of the 4% withdraw rate is that you should be able to withdraw this amount each year and live off of that portfolio indefinitely. It works because the portfolio is comprised of profitable businesses generating earnings year-after-year. So the profits (and dividends) are likely to be growing even as you’re subtracting from the balance.
Incidentally, I have previously done some work on this concept and came to the conclusion that this idea is a fine baseline, but there are a lot of different withdraw rates that could work out there. That is, I’d consider this as more of a guideline instead of a steadfast rule.
You can also think about the time to retirement in terms of your savings rate. It works on a similar concept as the withdraw rate mentioned above, but puts it in different terms. Here’s a link from Mr. Money Mustache on “The Shockingly Simple Math Behind Early Retirement” that could be helpful.
While both are reasonable guidelines, I personally prefer the idea of the “crossover point” as presented in the book “Your Money Or Your Life.”
Source: Your Money Or Your Life, Vicki Robin, Joe Dominguez
When the book was published they were talking about interest income, but naturally dividend income works just as well (perhaps better).
Here’s the basic concept: once your passive income eclipses your expenses you’ve reached the “crossover point;” the moment when you don’t have to work anymore and your expenses will still be covered.
Incidentally, this is why the expense part is so important. If you make say $3,000 a month and spend $3,500 you’ll never reach this point. If you make $3,000 and spend $2,500, you’d be able to invest $500 a month and slowly but surely your passive income will grow.
Here’s where things get really exciting. If you make $3,000 a month and spend say $1,500, that has a double effect.
Not only are you now able to invest more money, but this simultaneously reduces the amount of passive income that you need to achieve. The higher your savings rate the more you can contribute and the lower your ultimate portfolio balance or cash flow stream has to be.
