This is the third of a three part series exploring various aspects of our family’s budget for 2018. Part one covered the process I used to create our budget. The second part reviewed our projected spending, saving and taxes in greater detail. Part three covers how our budget fits into our broader goal of financial independence. Please also see my posts on our journey towards financial independence here, here and here for additional background.
Linking Your Budget to Financial Independence Metrics
As I discussed in our Journey to FI, there are a couple of key inputs needed to calculate both percent to FI and the time it will take to get there:
- Percent to FI: investment portfolio balance, annual expenditures, assumed withdrawal rate
- Time Remaining to FI: annual savings, assumed real return on investments
Two of those inputs are assumptions and you should be able to get your investment portfolio balance easily if you’re tracking your net worth. The last two (the ones I bolded above) you can pull directly from your spending/savings/taxes budget. In other words, if you take your budget beyond just spending and include savings as well, you can easily calculate how long it will take you to reach FI.
Impacts on PVF
Using the math above, I calculated our potential FI metrics using our 2018 budget data. I assumed portfolio withdrawal rates of 2%, 3% and 4% to see how the numbers change under different outcomes. You should note that realizing these metrics is dependent on me actually meeting my budget this year. If I miss budget the numbers will degrade, but if I beat it they will improve.
Remember as well that there’s a double impact from change in spending: if we miss our spending budget, we not only will need a bigger portfolio to support the higher level, we’ll also have less savings to help the portfolio grow. Keeping on track for financial independence is a strong motivator for sticking to our budget. It may be just what I need to make it happen this year.
As you can see at a super-conservative 2% withdrawal rate, we are about a quarter of the way to FI and it will take 22 years at these budgeted numbers to get there. At a slightly aggressive 4% rate, we’re halfway and it will take us less ten years.
I’m encouraged that these numbers only slightly worse than where we ended 2017. We’re going to have another set of childcare expenses to take on this year but we should also have to incomes for the full year which ups our savings dollars too. Hopefully the stock market continues its upward climb, which will only help improve our numbers further.
What About Just Throwing in the Towel Today?
Even though we’re just halfway to FI by my numbers above, I’ll admit I sometimes fantasize about calling it quits right now. It typically happens on the drive home after a stressful day of work. Instead of just dreaming, I thought it would be useful to do the full thought exercise and see if it was actually in reach.
To start, let’s calculate how big a portfolio we would need to support our current $88,233 of annual budgeted expenses. You simply divide expense by the target withdrawal rate to get a range of $2.2 million to $4.4 million of investment portfolio.
We’re nowhere near those numbers today and at best we’re halfway there. Before giving up hope, however, the key is realizing that our current expenses aren’t fixed. If we ended up nuking our careers, we could likely reduce or eliminate a big chunk of costs at the same time.
Childcare. If neither my wife nor I was working, we wouldn’t need to keep our kids in daycare. That alone would reduce our required annual expenses by $24,000 and our required portfolio size by $600k to $1.2 million. Spend quality time with my kids and not have to save hundreds of thousands of dollars anymore? I’d make that deal.
Insurance. Without an income to need replacing, we technically would no longer be in need of either our term life or disability coverage. To be fair, we likely wouldn’t dump these if we weren’t completely certain we were never going back into the workforce. We’ve had these policies for a few years so are paying based on much younger issue ages than we are today. It would be much more expensive for us to reacquire the same coverage today if we let these lapse.
Pay Off Mortgage. This is a clean-up we would likely make in order to go into our theoretical retirement debt free. It would require us to spend some of our portfolio to pay off the balance, but we’d make it up in terms of reduction in the size of portfolio required.
Work Expenses. Unless you telecommute and never leave the house, there is a cost to have a job that we all have to pay. Think about things like dry cleaning, commuting costs (gas, mass transit, wear and tear on your vehicle, etc.). You may also have extra food or entertainment expenses depending on your workplace culture.
All in, I estimate we could shave more than $32,000 off our annual expenses if neither my wife or I was going to work anymore. That’s a more than 36% reduction, which would likewise reduce the required size of the investment portfolio needed to reach FI.
Note: One of the biggest question marks I’ve left unspoken up to this point is health insurance, specifically how to pay for it and whether it would be greater than what I’m currently paying today. Since this is a theoretical thought experiment vs. an actual action plan, I’m assuming the costs would be the same. In reality, they may actually decrease if we would qualify for income-based subsidies for an Obamacare plan. We would also have to figure out how to get money out of our tax-advantaged accounts prior to age 59.5. I’ve effectively ignored this wrinkle as well, but Our Next Life did a great post on how they actually plan to do it. Coincidentally, they also did a nice write-up on health insurance in early retirement too.
So what happens if we re-run our FI metrics but with the new, lower annual expenses? It helps, but not enough.
We’d get up to 77.7% of the way there assuming a 4% withdrawal rate. That’s a meaningful improvement, but it needs to reach 100% to make a difference. Why? You close the % to FI gap from 100% by saving, and if you aren’t working, you aren’t saving. With no savings, you can’t close the gap and your time to FI is eternity.
You could get to 100% by increasing your withdrawal rate, but that’s a highly risky strategy. If anything you should be trying to withdraw less from your portfolio if you retire early since it has to support your living expenses over a much longer time horizon.
With adjusted expenses of around $56,000 per year, we’d need a +5% withdrawal rate from our portfolio to cover them. That’s pretty rich and not very sustainable. Bottom line: we’re just not there yet financially.
I hope you’ve found this deep dive in our family’s budgeting process, spending categories and impact on financial independence useful. We covered a lot of ground and I’m sure some parts are more clear than others. It’s been eye opening for me to both run the numbers to see where we’re at as well as try to explain the method in my madness to others.
Have you linked up your budget to financial independence metrics to see what it says? Are there any other obvious early retirement expense changes that I’m missing?
John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.
He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.
He uses Personal Capital to track his spending, investments and investments for free and recommends you do too.