Now that we are past the one year anniversary of our early retirement in 2016, I promise I will get back to more posts that focus on the personal finance side as opposed to the lifestyle side of the change …
I’ve written about a lot of the MILESTONES that led to our early retirement last year, but someone recently pointed out that I haven’t shared anything about how we established what our expected spending plan in early retirement would be.
Clearly, there are only three variables when you are looking at leaving work and becoming a full-time goof off: 1) how long you’ll be retired (life expectancy – age); 2) size of your nest egg (and annual return on it); and, 3) your spending expectations.
Many people think that the last of these three is the most challenging to put their head around – and I agree – because it requires you to have a specific plan of what you want to do with your time and where you will do it.
Here’s how we approached it ourselves:
- ASSESS YOUR LIFESTYLE TODAY – The best place to begin is to better examine what you already know today. We use Mint.com to track our spending and any future forecast can be rooted in what you like and don’t like about your current lifestyle. Look at the big spending categories and start jotting down some thoughts on how important they are to you and how satisfied you are with them. Are you happy with where you live? How much you travel? The cars you drive? How often you go out for entertainment? All of these questions come with a potential financial impact that you can calculate.
- CREATE A PRICING FRAMEWORKS FOR WHAT YOU WANT – We are quite happy with a lot of our lifestyle, but there are things we wanted to do more of and a few we could do less of. We like to travel, so we looked at how much we had been traveling and created a plan for what we would want to do in retirement. A copy of this framework is HERE – and it has so far worked well for us. I created a similar framework for other spending goals including how often we would get new vehicles, how we would fund our son’s college years, and how we expected to pay for health insurance, and how much charitable giving we wanted to do. Like our travel framework, each utilizes a simple framework to make some assumptions about what we want. The math doesn’t have to be perfect, but committing a plan to paper makes it real.
- HOW AND WHERE WILL YOU LIVE? – I think it is more important to think about HOW you want to live than WHERE. Questions like, “will we have one house or two (vacation home or cabin)?” or “will we live in a modest house or luxe mansion?” Are the big questions. Compare that to what it costs for you to live the way you do now – does that mean upsizing or downsizing? We love our current house (although it has been a bit of a financial failure), but we don’t have an immediate plan to move or buy a second house. I created a framework around a ‘snowbird’ home in Florida or Arizona, but we didn’t include that in our early retirement plan. We agreed that if we decided to do that, we could fund it by downsizing our primary house and ‘splitting’ the money into to places. If you have a plan to move to a different city or part of the country, it is quite easy to go on real estate websites and see how much it will cost to afford what you want.
- THINK ABOUT YOUR KIDS – We have one son at college now and have talked a lot as a family what our expectations were for him and what it means financially for us. We are paying for his college, but do not have a plan to include him in our spending plan over the long run. His college needs are relatively easy to define in financial terms and budget for. If your kids are younger and you haven’t checked out the net price calculators that all colleges have on their admissions’ websites – that will help you plan (you are probably already doing this as part of your college savings approach). Our son understands our approach and knows he needs to be responsible for his grades and working summer jobs (and holiday breaks) to build up his savings for when he graduates and is on his own.
- DON’T GET INTO TOO MUCH DETAIL – When it comes to everyday spending items (food, clothing, gas, utilities, insurance, etc), I think less is more. Unless you are planning for significant changes in these areas, just assume they will go up at the rate of inflation over time. Some will go up faster, others will go up slower, but you could spend a lot of time assessing them without adding much insight.
- WHAT’S YOUR POTENTIAL FUDGE FACTOR? – Doing all of this planning helped us come up with a pretty clear vision of what our desired retirement lifestyle might cost. Obviously, plans are only perfect when you write them – our tastes and interests will change in the future and anything can happen. As a result, we chose to ‘over save’ for the lifestyle we wanted by about 15%. That gives us some wiggle room as our lifestyle develops and also will help us have a buffer against any calamity that may come our way. There is no magic to the 15% number – we pulled it out of the air. If you are less sure of how you want to live in retirement, you may want to save more. If you feel like you have a lot of fun money already built into your plan, you might want to save less. Your call.
Once you have your spending plan, you can work it into a retirement calculator like FIREcalc that does a Monte Carlo analysis of your plan relative to the other variables of your retirement: time horizon and savings plan. If it ‘fits’ with a comfortably high probability of success rate (based on historical market returns), you can feel good about your plan. If not, you need to either go back and adjust some of your lifestyle wishes or work a little longer to achieve them (which will also reduce the years you need to fund retirement).
I found that it was a continual process for me to iterate on all of these numbers over and over during the last 5 years that I was working. I kept refining and refining until it we felt that we had a good picture of the lifestyle we were ‘buying’ in early retirement. While we are only a year into it, I still feel like we are incredibly well-planned for what we want and have the flexibility we need if some things change.
Please comment on these thoughts and any others that you have been using in planning your retirement savings.
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