Ramblings of an Extreme Man


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Money, Life, Retirement – 7. Reading List 

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time — none, zero. You’d be amazed at how much Warren reads–and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.” Charlie Munger

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As mentioned in the first rambling of this series there is very little original thought in this entire long winded series of ramblings. I can take credit for some bad jokes, an overly long passive aggressive hashtag and I’ve put a fair bit of effort into the spreadsheets over time, but all the thoughts that have prompted this series are covered elsewhere by people who are no doubt my superiors in rationality, mathematical ability, turn of phrase and attractiveness to the opposite sex.

Anyway, if you’d like to learn more here are some of the things I have read that I recommend:

Books:

Your money or your life by Vicki Robin – https://www.amazon.com/Your-Money-Life-Transforming-Relationship/dp/0143115766

The four pillars of investing by William Bernstein – https://www.amazon.com.au/Four-Pillars-Investing-Portfolio-ebook/dp/B0041842TW

The millionaire next door – Thomas Stanley – https://www.amazon.com/Millionaire-Next-Door-Surprising-Americas/dp/1589795474

A random walk down Wall st by Burton Malkiel – https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/0393330338

The Simple Path to Wealth by Jim Collins – https://www.amazon.com/Simple-Path-Wealth-financial-independence/dp/1533667926

Common Sense on Mutual Funds by John Bogle – https://www.amazon.com/Common-Sense-Mutual-Funds-Anniversary/dp/0470138130

The Bogleheads guide to investing – https://www.amazon.com/Bogleheads-Guide-Investing-Taylor-Larimore/dp/0470067365

Early Retirement Extreme by Jacob Lund Fisker – https://www.amazon.com/Early-Retirement-Extreme-Philosophical-Independence/dp/145360121X

Websites:

Apps:

If you’d like to suggest any others please leave a comment below.

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Money, Life, Retirement – 6. If God is a DJ, life is the dance floor, love is the rhythm and you are the spreadsheet**

“A wise mans life is based around fuck you”  John Goodman in The Gambler

When I’m not being extreme or rambling about things on the internet I’m sometimes paid to get things done in a certain way for a certain cost in a certain amount of time as a project manager.

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A project is basically a methodical way to get from a starting point to an end point. A lot of the formal project things that you do for a project apply equally well to other things where you are going from a starting point to an end point . One of the key things at the start of any project is the part where you spend time planning and analysing by considering things like the following:

  1. Working out what the end point looks like
  2. Working out the steps and order to get to the end point
  3. Forecasting the amount of time to get to the end point in enough detail so that you can track progress
  4. Forecasting the cashflow for the project in enough detail to know if you’re on track
  5. Analyse the constraints
  6. Analyse the assumptions
  7. Analyse the risks

We took care of number 1 in the above list in a previous rambling. By using the 4% rule (or similar) you know where you need to get to.

We’ve somewhat taken care of number 2 in the above list in the previous rambling where I gave an example about my investment approach, which provides an example of how to get to the sum that the 4% rule requires to reach financial independence.

To take care of the rest, you need to make a plan. It’s important to do this for two reasons:

  • If things aren’t written down they don’t really exist; due to the fallible nature of human memory and our psychological biases it’s likely that things that aren’t written down will change over time. For instance I think that my childhood landline phone number has 1 different digit than my brother does (he’s obviously completely wrong of course….)
  • You need something visible to act as a prompt to remind you of your goal, track your progress and remind you of your plan when required. Investing can sometimes be an emotional and exciting affair, but it shouldn’t be. When emotions come into investing is when mistakes happen. You need to plan how you’re going to manage your investments in mathematical, rational, broad daylight so that when there is a time of excitement or emotion you can refer back to your boring plan and stay the course.

I can’t emphasise this enough; write it down. This is supposed to be serious and boring. Stick it up on the back of your toilet door so you need to look at it every day. Think about your future while lightening the load. Any good project manager would not try to deliver a project without first writing down the project plan. Your freedom and investment plan is a whole lot more important than a project, it deserves a written down plan.

Your investment plan should:

  • State your goal
  • Document your approach and the decisions that you’ve made so you can refer back to it in times of doubt, including the following:
    • Asset allocation
    • If using ETFs which ETFs
    • If using a managed fund, which managed fund
    • Rebalancing policy if applicable
  • List all assumptions and constraints
    • Income
    • Expenses (before and after Financial Independence)
    • Assumed average return
    • Withdrawal Rate (4% rule or similar)
    • Current savings
  • Forecast progress in a method that can be tracked at appropriate intervals
  • Do a risk analysis, capture the relevant risks and what your actions will be if they eventuate so you won’t be making decisions on the fly, you’ll be executing well thought out plans.
    • What if you lose your job?
    • What if your assumptions are wrong?
    • What if the stock market crashes?
    • What if you come into some money or get a pay rise?

When I went through this exercise I put together a spreadsheet that took all constraints and assumptions and turned them into the following outputs:

  • Time until financial independence
  • Savings needed to retire, and
  • A forecast to measure progress against.

This spreadsheet lets you analyse your constraints and assumptions and modify them to see how the outcomes change. It’s a powerful tool to crunch the numbers for hypothetical situations.

You can get download a copy here: Financial Independance Calculator 1.0

Here is an example for someone who:

  • Earns $60,000 after tax
  • Currently has $20,000 of savings
  • Spends $2,500 per month and expects to spend $2,000 per month when they retire

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You can see that they need ~$630,000 to reach financial independence, and that will take approximately 12.7 years.  You can also see that when they reach financial independence and stop working their wealth will continue to snowball. In 28 years time they will have been retired for 16 years and will be a millionaire. If you take their Superannuation into account they will have a substantial wealth of $1.8M, and this is after not having worked for 16 years!

If you change some of the variables you can really start to get a sense of what things matter on this journey to financial independence. For example, here’s the same scenario but with spending $300 less per month while working and spending $200 less per month after retirement. You can see that it take almost 2 years off your working life!

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Combining that with some of the other things you might need to consider as part of your investment plan (some things were mentioned in part 5) may look something like the following example:

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Writing down your investment plan and sticking it up somewhere in your house so it’s visible shows your high level long term goal and your annual progress in tracking towards that goal. This will provide a readily available reminder of the core decisions that you’ve made and show what those decisions will compound to over your investment plan timeframe.

For a large important project such as buying your freedom; the planning and tracking should go that one step further into the detail than what we’ve covered above. High level plans are great, they show where you’re going and how to get there, but for something as important as buying your freedom back from wage slavery, you should take the detail that extra step further to allow you to monitor progress to a detailed level, at least until your trajectory is well known and stable.

To go into this level of detail you should track every expense and every income. You should already be convinced of the necessity of knowing your average spend to allow you to use the 4% rule to work out how much money you actually need to retire (as mentioned in part 3 and part 4). If you track every expense and every income you can use the power of spreadsheets to track in real time:

  • your net worth,
  • the amount of money needed to retire and
  • the amount of time to get there.

This is a worthwhile exercise as this provides a feedback loop that reinforces the relationship between expenditure and time until you can actually buy your freedom.

I’ve made a spreadsheet template to do this which you can download here – Your life in a spreadsheet 1.0 – TEMPLATE

Here’s how it works:

Data Entry Tab:

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This tab is split up into Expenses on the left and Income on the right. Here you record every transaction date, category, sub category and amount. You do similar on the income side. I’ve included sample transactions in the spreadsheet to demonstrate how it works.

The next tab is the Dashboard:

While this looks like an intimidating tab, it provides a lot of information to allow you to track your progress.

The main things you need to input are the safe withdrawal rate and your assumed rate of return, given in yellow below.

You will also need to refresh the two pivot tables to reflect new information as it’s entered into the data entry tab. The two pivot tables are the Income and Expenses tables given below.

From the transactions entered into the Data Entry tab a number of useful things will be calculated per month to allow you to track your progress. In the top left corner your performance will be calculated for 3, 6, 12 month averages as well as from the beginning of when you started tracking your data.

A task you should do at the end of each month is reconcile your recorded transactions from the data entry tab with your account balances in the Balances section . This will make sure that you haven’t missed any transactions, expenses or income.

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This tab also provides information to allow you to review your expenses in the columns to the left of the expense pivot table. For each expense subcategory the following information is calculated:

  • Your average spend per month
  • The amount of money you need to save to be able to support that average spend indefinitely, and
  • The time you need to work to be able to spend your average amount in that subcategory.

This is a powerful thing, for example, using the sample numbers given in the spreadsheet gives the following two different outcomes for hypothetical take-away food spends per month:

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For an average spend of $300 dollars per month on take away food the hypothetical person would need to save $90,000 to maintain this average spend indefinitely, which would take 4.21 years.

However, if by reviewing their expenses every month, considering if that expenditure actually makes them happier or not and reducing the average take-away spend to $150 per month; the amount of savings the hypothetical person needs to sustain that average spend indefinitely drops to $45,000 and they save 2 years off their working life! And that’s just from take away food…

People are generally really bad at relating short term actions to long term consequences. Some examples are fat people eating too much and smokers smoking until they get lung cancer. The power of this spreadsheet is that it shows the direct relationship between your short term expenditure actions and the long term consequences of how long you need to work to support these short term actions.

Charts Tab:

The next tab shows your progress in 2 charts. The first chart shows your Total Income, Expenses, Net Savings and Income from Investments per Month. The second chart shows how your total savings have increased over time. Every time you update the pivot tables these charts will automatically update.

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Investment Tab:

The investment tab provides a way to track your investment performance and asset allocation:

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Each time you buy a share / ETF you record the transaction details in the bottom yellow section and refresh the pivot table.

This provides a way to manage your asset allocation. By entering your target allocation and market value for each share the table will calculate how much you need to buy or sell to get back on target. It’s worth noting that if you wish to include your emergency fund in your bond asset allocation you will need to modify the formula in the Current Weight column to include this.

At the end of each month you capture the Market value and gain / loss numbers from the top table in the monthly reporting columns. This will allow you to input the Portfolio Unrealised gain or loss into the data entry tab for the month from the Gain / Loss per month row. This will then count to your total net worth over time.

It’s also worth noting that if you choose a managed fund rather than managing your own ETFs / shares you will only need to record  the monthly reporting information for input into the data entry tab.

Lists Tab:

The last tab of the spreadsheet contains the lists for the categories and subcategories of income and expenses. You can configure the categories and subcategories to match your needs. Just make sure for the Expense Categories that you use Name Manager to make sure the name of the Category matches named ranges that contain the values for the subcategories. Also make sure that you put in nil cost entries in the data entry tab to reflect the new sub categories (these are hidden in the top rows of the data entry section), you may also need to re-point the total expenses column in the dashboard tab to the bottom of the expense pivot table.

 

And that concludes this rather long winded series of ramblings. As this has been an epic multi-post ramble I’d like to summarise some of the key points for emphasis:

  1. Money is a direct result of a bargain you make with your employer to hand over a very large portion of your life. In effect it’s special paper life force tokens you can exchange with other people for other things.
  2. Your life, and by association money, is not a renewable resource, it is finite.
  3. There is a counterparty to every transaction and they are only entering into the transaction because they think it will be beneficial to them. By inversion it will probably be net negative for you
  4. Due to hedonic adaption you shouldn’t spend large amounts of your paper life force tokens on things that make you temporarilly happy that you will become used to and don’t increase your happiness in the long term. You should invert and spend your paper life force tokens taking things out of your life that make you unhappy.
  5. By committing to full time employment you’ve actually limited the time you are free to be in control of your life to only 2 days a week. Two days a week is but wafer thin Monsieur. Only when you’re in the position where you don’t have to work is any choice to commit to full time employment valid, up until that point it’s a decision made under compulsion.
  6. To optimise anything you need a feedback loop. Measuring and reflecting upon your expenses per category each month is a feedback loop that will allow you to optimise your spending so that you are not spending more on things that do not make you happy.
  7. If your salary gives you a certain amount of dollars per month, by tracking your expenditure per month you can invert that relationship and work out the number of months per dollar. You can then work out the conversion rate between the price of things and the amount of your life you are trading for that thing.
  8. The amount of money needed for indefinite retirement equals your yearly expenses divided by the safe withdrawal rate.
  9. It’s been shown historically that a 4% withdrawal rate could probably last indefinitely with a 75% stock, 25% bond mix.
  10. The most important thing that determines the amount of time until you can retire is your savings ratio. With a 4% withdrawal rate, no current savings and a 7% assumed return a savings ratio of 50% means you can retire in 15 years, a savings ratio of 75% means you can retire in 6.8 years.
  11. People are generally bad at relating short terms actions to long term consequences. In order to get to a point where you can buy your freedom you should forecast your plan to financial freedom and track every expense to turn that forecast freedom into actual freedom.

I hope that this has provoked some thought. No matter what the end outcome of that thought is, critically analysing your life choices or lack there-of is a good thing and should be encouraged by everyone.

I also hope that the spreadsheets and methods involved in this series provide some insight for some.

If you have any comments, suggestions or if you agree or disagree with anything that I’ve written and would like to let me know why I’d love to hear it. Please comment below.

In the next post I’ll provide a recommended reading list.

 

 

**You know when I first came up with the name for this rambling I thought it was some half remembered chorus from some techno dance song from my alcohol fuelled irresponsible youth. Later I realised it’s from a Pink song. The same Pink that teenage girls, “I used to be cool” mothers and effeminate men like. Wow.


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Money, Life, Retirement – 5. How to get to where you want?

“If you aim at nothing, you will hit it every time.” Zig Ziglar

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So now that you know how much of the paper life tokens you need to be able to buy your freedom permanently, how do you manage to roll up a sufficiently fat wad of them to get there?

You spend a lot less than you earn, and you invest the rest. Put your money to work, let compound interest do the heavy lifting for you.

There are a lot of ways to invest; some people invest in shares, some invest in real estate, some invest in bonds or term deposits, some invest in magic beans or bit coins. You should probably speak to a professional before investing (or at least read a lot of really good books). I’ve spent a lot of time reading investing books and I’m going to give an example of my approach and a description of why I made the decisions I did. I set myself a goal of reading a certain number of books on investing and to decide and write down my strategy only when I had finished.

I doesn’t matter how you manage to build enough wealth to satisfy the 4% rule; only that you earn an appropriate average return above 4% that will account for the compounding affect of inflation, and that you don’t lose your principal. What follows is only an example of the method that I am using, there are many others. This is not advice, only a description of the choices I have made and why.

I first of all set myself some principles to guide my decision making:

  • I wanted it to be simple. I already have a full time job and didn’t want another
  • I did not want to use any leverage. Leverage won’t make a bad investment good, but is more than capable of making a good investment bad. Furthermore if there’s a counterparty to every transaction and if that counterparty is a bank who is more sophisticated than and understands mathematics and risk better than you do, it’s more than likely that they are getting the better end of the deal.
  • I wanted diversification. Humans are fallible (even me), and I didn’t want any one mistake costing me my freedom.

Asset classes and allocations: Growth vs Income

I then decided what asset classes I wanted to invest in.

Here is a chart showing the performance of some different asset classes over the last 20 years with $10,000 initially invested and all dividends reinvested:

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Source: http://insights.vanguard.com.au/VolatilityIndexChart/ui/advisor.html?utm_source=IndexChart&utm_medium=LandingPage&utm_campaign=Ret2016&utm_content=Ret

Over a long time period stocks perform better than all other asset classes, however the price can be quite volatile. Hence I decided I also needed bonds to smooth out the fluctuations in my total portfolio. Appropriately rated bonds are safer than stocks, pay regular coupon payments (interest) and the price should be reasonably stable.

Stocks and Bonds are both reasonably liquid assets, but I didn’t want to have to sell any if anything unexpected happened and I needed cash. If you need to sell you’ll either have to pay capital gains tax if the market is up, or realise a loss if the market is down. So I also decided I needed an emergency fund which would sit in a high interest savings account and would pay for my living expenses if I lost my job or some other emergency occurred. I decided a year of living expenses (known from part 3) would be more than enough.

I then needed to decide my asset allocation. As stock prices can move quite substantially based upon fear, greed or the greater economy, your tolerance for watching the variation and potentially the total value of your portfolio plummet should feed into what percentage of stocks you hold. If you are likely to panic and sell if your portfolio plunges in price you will lock in the loss and demolish your returns. If you can set the asset allocation so that you can remain comfortable to stay the course through any kind of future crisis your returns will be good in the long run.

Here is a graph showing the best, worst and average yearly returns based upon the percentage of stocks and bonds that make up a portfolio over a long period of time. Stocks are seen as a growth asset with higher risk, bonds are seen as a defensive asset with lower risk.

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Source: https://static.vgcontent.info/crp/intl/auw/docs/corporate/principles-for-investing-success.pdf?20170426|161125

I thought that for me the 70% stocks 30% bonds seemed like a good compromise between a good average return and lower magnitude negative returns in the negative years.

I also did an asset allocation questionnaire which you can do here which suggested that for me an allocation of 70% stocks and 30% bonds was appropriate.

Asset classes and allocations: International Exposure

Having decided upon the asset allocation to growth and defensive asset classes the next thing to decide was the weighting to Australian assets vs International assets.

A common split seems to be 50% Australian assets, 50% International assets. The theory goes that if your Australian assets go bad due to problems with the Australian economy your wealth will be somewhat protected.

I intend to spend a large part of my retirement in Australia or New Zealand and all things being equal, if the Australian economy goes bad Australian asset prices will head south, but prices of things you need to buy to live in Australia or New Zealand should get cheaper as well.

Furthermore when you invest in Australian publicly listed companies you have the benefit of being able to receive franking credits. Franking credits are a tax bonus when you get paid dividends. As Australian companies have generally already paid 30% tax on their earnings franking credits are a way to compensate you so that you aren’t taxed twice on the same earned income. For instance, if a company pays you a $100 dividend that is fully franked you receive $30 in franking credits which is used to offset the income tax you pay on the income from the dividend. For example if your marginal tax rate is 30% you don’t need to pay any tax on the $100 dividend. Taking this to the extremes, if you intend to live on an income low enough to pay no tax, your fully franked dividend payments will increase by 30%. For exampe a 5% dividend yield will turn into 6.5% gross. This is free money.

As I will live on a lot lower income that I do now in retirement (I save a large percentage of my income currently) I will drop down several tax brackets and franking credits turn out to be a pretty powerful bonus.

After considering all of the above I settled upon 70% weighting to Australia and 30% International.

Combining these gave the following Asset Allocation:

Australian Shares: 50%

International Shares: 20%

Australian Bonds: 20%

International Bonds: 10%

I included the emergency fund high interest savings account cash holding in calculating the bond allocation as well as they are similar asset classes.

If you’d like to model your own ideas about what your portfolio should look like, the returns, yields and exposures you should check out this site.

Investing approach

Having determined my asset allocation I needed to work out what type of investing to fill the respective allocation buckets with.

There are a few different types of investing; there is the active type where you are actively choosing which stocks to buy and sell based upon some kind of calculated or perceived value (value investing) or where you trade based upon trends in price movements (technical analysis), or there is passive investing where you buy small chunks of the entire market via a low cost fund that contains parts of the whole index or part thereof (index fund) not attempting to find better companies than the average, simply owning everything.

I have throughout my life tended to settle on the value investing side of the argument. This is the type of investing Warren Buffet, Charlie Munger, Ben Graham and the like are proponents of. I have believed that the market is often irrational and through being  rational and patient you can take advantage of Mr Markets irrationality and make greater returns than average. More recently I’ve come around to a more passive investing approach. The men listed above are actually my heroes in a nerdy kind of way, and it’s been very hard to take a good hard look at one of my core beliefs and actually change my mind, but here are the reasons I have:

  • If you’re actively investing you’re competing against highly paid investing professionals who have significantly more time and training than you do to put into their trades. They often have access to CEOs etc to obtain greater insights than you. When I say competing against I mean they can be directly on the other side of the trade from you with their greater time, knowledge and access to management.
  • Research for active investing takes a lot of time, time that I don’t have. I used to enjoy reading financial statements and building discounted cashflow models, but now I’d rather go fishing or surfing.
  • By picking individual stocks there’s always the chance that the financial reports are fraudulent and the company’s stock price can go to zero. If you buy the whole index there is no chance the entire index will go to zero.
  • Once you work out how much money and the time it will take to reach financial freedom the variable that affects it the most is your expenses. Performing sensitivity analysis upon your rate of return will show that an increase in the return above what can be expected by an index fund perhaps won’t provide the benefit in time to reach financial freedom it should once the additional time, effort and risk is taken into account.
  • The majority of professional active investors aren’t able to beat the average market return once transactions costs and fees are taken into account, my ego can be large at times, but not so large to think that I, as an amateur can do what many professionals cannot.

Market timing and rebalancing

While I had changed my ideas about Value investing, by implication this also meant that I needed to acknowledge that I probably shouldn’t be attempting to time the market. To reinforce this I needed to examine a key decision I made way back in 2008. During this time I was looking at buying a house in Melbourne. At the time houses were selling at a gross rental yield of approximately 2-3.5% depending upon the house, which was of course a lot worse from a net yield perspective. The more I looked into the market, the more convinced I became that this did not represent any kind of investment value and that any purchase of a house wasn’t investment grade due to the extremely low yield. I was convinced that anyone buying a house as an investment was in fact speculating with leverage for capital gains, and I thought that at any time there could be a market correction or mean reversion back towards the long term averages for several housing value metrics leading to a permanent loss of capital. Fast forward to 2015 and Melbourne house prices continued to increase as follows:

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Solving for the amount that house prices in Melbourne could drop in 2015 and not be below 2008 prices gives a total of 35% before you would start to be behind where you were in 2008. This is of course ignoring inflation, interest on mortgage repayments, stamp duty, council fees etc. The humbling lesson I was forced to acknowledge here is that even though I may be convinced that the market is completely irrational it doesn’t mean at all that the market will become rational at any time in the future. In the words of John Keynes, “the market can stay irrational longer than you can stay solvent”.

Instead of trying to time the market I decided that as the different asset classes I had chosen to invest in weren’t 100% correlated I would periodically rebalance my holdings. This would by comparison of the different asset class prices force unemotional purely mathematical buying low and selling high from a relative comparison point of view. I decided that during the time that I was pumping cash into my portfolio I would rebalance with input funds, and after retirement I would periodically rebalance once a year.

Investing vehicle

Having decided upon my asset allocation and that I would be investing in index funds the next question was how? There are two main methods for index investing, I could either purchase Exchange Traded Funds (ETFs) through a stock broker, or use a managed fund that matched the asset allocation I was looking for. The way I made this decision was based upon the fees that I would be charged. I compared the fees that I would incur by using a fund such as the Vanguard LifeStrategy Growth Fund or using ETFs. Here is how the fees as a percentage of funds invested compared:

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The ETFs would allow me to vary the asset allocation simply if I needed to, however the managed fund rebalances automatically and requires no effort, set and forget. In the end I decided to go with the ETF approach as it would let me change my asset allocation in retirement if I wanted to and it was slightly cheaper, however based upon the work by William Bengen there’s probably no need to change the allocation from 70:30 and the simplicity of the Vanguard LifeStrategy fund is appealing.

The next and final step is to write all of this down in an investment plan where forecast progress can be tracked and turned into actual progress over time. I’ll ramble about that and provide some useful spreadsheets that tie all of these ramblings together in the next post.


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Money, Life, Retirement – 4. How much do you need to retire and how long will that take?

“You really don’t need to begin saving for retirement before you reach 60. At that point, simply save 250 percent of your income each year and you’ll be able to retire comfortably at 70.” Jonathan Pond

If you were to guess how much you needed to retire indefinitely how much do you think that would be?

  • One million dollars?
  • Two million dollars?
  • It depends upon how long your retirement is going to be for?

Well it depends upon two simple things:

  • The amount of money you need to spend each year to sustain your life,
  • A withdrawal rate that will not diminish your savings over time (safe withdrawal rate).

This can be expressed by a relatively simple equation:

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When you save the amount above you have enough money to buy your freedom. You have reached financial indepenence.

If the safe withdrawal rate is going to make your savings last forever it needs to be less than the average long term return of the asset classes you invest in to account for the variability in their return from year to year.

Some historical returns of different asset classes is given below:

Asset Class 20 year historical return
Australian Shares 8.7%
Global Shares (hedged) 7.6%
Australian Bonds 6.8%
Global Bonds (hedged) 7.7%
Cash 3.4%

Source: http://www.asx.com.au/documents/research/russell-asx-long-term-investing-report-2016.pdf

To work out an appropriate safe withdrawal rate, it’s useful to refer to a study done by a guy called William Bengen, which you can read about here (it’s actually really good). He showed that for a historical period of 50 years that included the great depression and periods of rampant inflation that a 4% withdrawal rate would in almost all cases see your initial savings last for at least 50 years. There are some caveats of course;

  • If you are unlucky enough to retire just before a major stock market crash you should probably reduce your expenditure and increase your asset allocation to stocks
  • You need to get your asset allocation right (his data showed a 75% stock and 25% bond mix worked well)
  • You should rebalance your asset allocation about once a year
  • It’s worth noting that if you are an Australian reader you’ll have access to your Superannuation at approximately 65, in which case you could potentially use a higher number than 4% depending upon your age. (your super and non-super total withdrawal rate should still be 4% or below though)

Here’s some examples of how much money you would need to satisfy the 4% rule for different yearly expenditures:

Expenditure per year (before tax) Amount of money needed to retire
$15,000 $375,000
$20,000 $500,000
$25,000 $625,000
$30,000 $750,000
$50,000 $1,250,000
$70,000 $1,750,000
$100,000 $2,500,000

Additionally there’s a great calculator here which will calculate the percentage chance of your initial savings lasting for a certain number of years based upon historical analysis of years of previous changes in asset prices with the withdrawal amount taken out each year.

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Modelled for a starting portfolio of $500,000 and $20,000 expenditure per year (4% rule) where the yearly expenditure increases with CPI every year over a period of 60 years gives the following:

There is an 82.6% chance of having money remaining at the end of the 60 year period (historically). In most cases the modelling tool predicts a substantial amount of money left over at the end of the 60 years (an average of $2,700,000). For Australian readers, this also doesn’t include Super windfall which you can access at approximately 65.

However a guy by the name of Ty Bernicke did a lot of research upon spending habits as we age and found that over the age of about 56 yearly inflation adjusted spending actually decreases by approximately 2% per year. Modelling for this, assuming a retirement age of 35 and the same starting portfolio and expenditure above (4% rule) gives the following:

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A 96.5% chance of success and an average portfolio size at the end of the 60 years of $3,700,000. Again this is ignoring Superannuation.

So having established that the method to determine how much money you need to retire is a function of your yearly expenditure and the withdrawal rate, which should be close to the 4% rule, it’s now time to work out how long it will take to save that amount of money and buy your freedom.

The main thing that determines this is your savings ratio, which is given by:

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Coupling this with the previous equation for the amount of money needed for indefinite retirement you can see that the effect of expenses on the time you have to retire is non-linear.

Using the NPER function in a spreadsheet you can calculate the time to save enough money to satisfy the 4% rule. Here is the time to retirement for some different savings ratios, assuming the following:

  • 4% safe withdrawal rate
  • No current savings
  • Average return on your investments per year of 7%

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You can see at the Savings Ratio boundaries if you save 0% you will never be able to retire, while at the other end if you are saving 100% of your income that means that your expenses are zero and you can retire right now. Also of interest for the Australian reader is the 12% employer Super guarantee gives a time until retirement of 38.8 years, which seems close to general retirement age.

Referring back to the previous rambling, tracking your expenses and minimising them has a very powerful effect on the amount of time until you can retire.

I’m sure some are reading the table above and thinking there’s no way they can save any more than 10% of their after tax income. It’s all about priorities, do those expensive take away coffees, fancy restaurant dinners and designer clothes really mean more to you than being able to do whatever you want whenever you want? Is not having to bite your tongue with your terrible boss at your place of employment worth less to you than a new handbag?

Even with an Australian wage of $50,000 before tax, if you optimise your spending it’s possible to save above 60% of your after tax income per year and be in a position to retire in approximately 11 years.

Now that you have an understanding of the basic maths, it’s time to come up with a plan, which we’ll do in the next rambling.


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Money, Life, Retirement – 1. Introduction

“And finally, monsieur, a wafer thin mint”, Maitre D

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Introduction to the introduction:

So I’ve been thinking about this series of posts for a while now. I often feel like everywhere I go, every conversation or interaction I have, that this topic is the elephant in the room. Often the elephant is standing on peoples necks, shitting elephant shit on peoples shoulders or trunk punching people in the testicles/uterus, but for some reason I seem to be the only person aware of this cheeky grey menace.

I think money, how you use it, and spending the largest part of your life working by default without making a conscious well informed decision to do so is the most important topic in your life, but nobody talks about it. Not making a conscious decision is in fact making a decision, a decision to be someone who makes bad decisions. In terms of extreme ramblings, this will definitely be one…**

 

Actual introduction:

So, what do you think of when you think of money?

Do you think of fast cars, fast women/men and champagne?

Or do you perhaps think of a faith based medium of exchange that has no intrinsic value of its own?

Or do you think of it as special paper tokens that you exchange large portions of your life for?

All of the above are kind of true. Money can be exchanged for all kinds of hedonic pleasures or short term thrills. Fiat currency is perhaps the largest example of species wide group think, a cultural construct that only has meaning because everyone else believes it does. Money is in fact the result of expending large portions of the finite time that you have here on this earth in what we call employment.

Out of the three examples above, it’s the third one that has weighed on me the most over the last few years.

I’ve had a reasonably unique experience compared to my peer group. At the age of 34 I’ve had a total of 3 years off work  in two big juicy lumps. During this time off I did whatever it was that I wanted to do. Such as travel, fishing, surfing, camping, growing a ginger beard, designing things, building things, demolishing things, reading things, learning things etc. When you have that amount of time off work your time is quickly filled up with things you want to do and enjoy doing. After about 3 months you start to wonder about how you ever had the time for full time employment in the first place.

Contrast this with how you feel when you get back to work. Going from having 7 days a week, 365 days a year to fill with any number of activities that you choose, to being an employee for 5 days a week, commuting to your place of employment at the beginning and end of each day, having an hour of sunlight if you are lucky to do non employment related things before having to cook, eat, clean, go to sleep and do it all again the next day. Only having a wafer thin 2 days a week to do things that you choose uninterrupted by commuting and employment.

To put this in context, here are some examples of how much time I spend in employment related activities vs time I spend in activities of my own choosing:

Time at work: 8:30 am until generally 5:30 pm – 9 hours per work day

Time commuting to work (by bicycle): 45 minutes each way – 1.5 hours per work day

Total hours per week: 52.5

Time spent mountain biking per week: 3 hours per week

5.7% of the time I spend at work I spend mountain biking on the weekend

Time spent surfing per fortnight: 3 hours per fortnight

2.8% of the time I spend at work I spend surfing

Time spent fishing per fortnight: 5 hours per fortnight

4.7% of the time I spend at work I spend fishing

Time spent having sex per week: 10 minutes per week

0.03% of the time I spend at work I spend having the sex!!!

(Ok, perhaps the last example was exaggerated for the sake of my rambling. It’s probably closer to 15 or maybe even 16 minutes.)

Thought of in this context, it is clear that money is a direct result of a bargain you strike with your employer to hand over a very large portion of your life in exchange for special paper tokens you can exchange with people for other things.

So what do people generally do with these paper tokens that they’ve exchanged very large parts of their finite life for? Is it treated like the precious non-renewable resource that it is? (your life is of course not renewable) or is It treated like a renewable resource that will be around forever and can be fritted away on the next thing that takes your fancy?

Referring to the graph above, mostly it’s the second one. Most people live in a world of expensive take away coffees, brand new cars, shoes, handbags, designer clothes and mega mortgages.

We’re continuously told via advertising and our peers that you should spoil yourself, you’ve worked hard, and you deserve it.

But what is so obvious and yet hides in plain sight is that there is of course a counter party to every single transaction. Every overpriced take away coffee has a counter party on the other side that is entering into the transaction only because they think this transaction will be beneficial to them, and by inversion, probably negative for you. Across the counter at the car dealership, hand bag store or mortgage broker is a suit wearing vampire that wants to suck your finite life force straight from your veins via a proxy we call money, while all you’re interested in is getting the right photo of you smoothing out that sold sign on the real estate for-sale sign and smiling just right for your Instagram followers. #sold #nesting #Ididntevendosimpleyear8mathematicsbeforedecidingtoenterintothismountainoflifecripplingdebt #yolo

So what should you do with these paper tokens that you’ve exchanged large parts of your life for?

I’ll ramble about that in the next post.

Link to the next post

** I’ve been thinking about my motivations for writing all of this and what they may be. Is it perhaps my need to convince people of my argument to satisfy my need for social proof? Is it some kind narcissistic virtue signalling? Is it some way to publicly back myself into an inconsistency-avoidance tendency based corner? Or is it that I’m just worried about that a few years from now I’ll be retiring really early and eventually I’ll get bored of fishing every day while all my mates are still stuck working full time hating their lives compared to my relative freedom? It’s probably a little of all of them.
Besides an original hashtag and a pretty serious spreadsheet or two there’s not much original thought in this series of ramblings, everything here has been mentioned by some pretty smart, rational people before, I’ll give a reading list in the last post of the series.


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Success, compound interest, the tortoise and the hare

I’m from a small country town called Bairnsdale in south eastern Australia. I was once asked to provide some information about myself and some inspirational words by a friend to motivate children she works with back home and impart on them some life lessons. While I didn’t end up giving her what she asked at the time due to being extremely remote, I’ve had some time to think about this topic and this is what I’d like to say.

I’d like to talk about two important themes that apply to life.

The first is compound interest. Compound interest is something that anyone can harness. Compound interest is a super power.

The second is the story of the tortoise and the hare. The lesson learnt from this children’s story is invaluable, life is not a short race, but a long one.

I’d like to talk about these 2 themes over 3 topics:

  1. Money
  2. Wisdom
  3. Fitness

I’ll also make some recommendations in each of these topics about where you can learn what I think are some good tools to assist you in each of these topics.

Compound interest and money:

The power of compound interest in saving money is well known. Warren Buffett once said that he doesn’t think of spending $30,000 on a car as spending only $30,000. He instead thinks of spending $30,000 on a car as spending what could turn into a million dollars over 50 years, if you invested the money instead. Would you pay a million dollars worth of your retirement savings for a $30,000 new car? If you borrow money for that car, you often end up paying in the vicinity of double the purchase price (depending on how long it takes you to pay it off and the interest rate) this makes the potential million dollars that you lose at retirement even more… Here is what a the purchase price of a $30,000 car can cost you in loss of retirement savings in 50 years if you instead invested that same money. I’ve provided some different interest rates for comparison.

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Of course there are many options for achieving different rates of return, interest rates are currently the lowest they’ve ever been in Australia. You can currently receive approximately a 4% return in a bank, but over a 50 year time frame I would assume this would increase to the long run average. You could also seek other investments which may pay a higher rate than the interest you may earn in a bank account.

As for recommendations:

The best book I have ever read on the topic of personal finance was given to me by a client who was retiring in his 50s. His name is Phil. I had a progress meeting with Phil in the last week of his employment and he didn’t want to talk about progress at all, he wanted to talk about life and his retirement (he was planning to sail around the world for the foreseeable future). He gave me a book called Your money or your life. Thank you Phil.

Before any investment decisions are made I strongly recommend reading The Intelligent Investor by Benjamin Graham. No one in any circumstances should buy any asset unless they know the difference between price and value. This applies to any asset considered for investment, shares, houses, business etc.

To have an idea of what the future may hold you need to know what happened in the past. I highly recommend a great book on financial history, Manias, Panics and Crashes a history of financial crisis.

 

Compound interest, the tortoise and the hare and wisdom:

While the affects of compound interest and money are well known and easy to prove with a simple spreadsheet, I propose that the power of compound interest can be harnessed in other areas of life.

But first I’d like to talk a little about the story of the tortoise and the hare.

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The story of the tortoise and the hare, if you’re unfamiliar is about a cocky hare who is quite a fast runner. The hare is always teasing the tortoise about how slow he is, until one day the tortoise challenges the hare to a race.

The hare is obviously quite confident of beating the tortoise due to his greater natural ability. When the race starts he soon leaves the tortoise behind. Due to his over confidence, once he’s sufficiently far in front he decides to have a nap under a tree.

When the hare wakes he finds that the tortoise has passed him and is crossing the finishing line.

This story relates very strongly to life.

In the race of life people often start out fast. Take for example learning, children start out strong, they are mandated by the government to attend school from the ages of 5 until at least 16. Some people go onto University during which they may continue to learn in a structured environment until their early 20s.

For the majority, once they hit their early twenties and have whatever qualification they require for their chosen profession, think they are far enough out in front in a learning sense and stop to have a nap under a tree.

For the majority, once the mandated or structured learning has stopped they stop learning.

But life is a long race.

The difference between the tortoise and the hare can be explained by how Warren Buffett and Bill Gates both answered a question they were once asked at a dinner party. They were asked what was the secret to their success. They both gave the same one word answer; “Focus”. The tortoise has an abundance of focus, while the hare does not.

Now you may say, that’s all fine and well for a tortoise and a hare running a race, but when it comes to learning things, I’m not that smart. I’m not smart enough to learn complicated things. To that I would say that I strongly believe that any person can learn anything that they want to learn.

While it is true that some people have higher aptitude than other people, everyone is capable of learning what ever they would like. Some people may know more than others and hence be considered “smarter”, this is only because they have learnt more things.

The only difference in raw thinking power between people is aptitude, and aptitude is only a measure of the speed with which a person may learn something. Everything else to do with “smartness”, knowledge, logic, problem solving etc. is a learned skill. If someone with a lower aptitude wants to learn complex skills they can, the only difference is it may take longer than someone with a higher aptitude.

But the thing about life is we all have a lot of time.

No one needs to be truly successful in 1 week, or 1 month or 1 year. Life is a long race. If you really want to learn something and have focus you will find that you have a glut of time. And if you couple this with the observation that the majority of people decide to stop learning after they achieve their required qualification you have plenty of time to plod past them while they are asleep under a tree.

One other point I’d like to make is the difference between IQ or natural talent and rationality. To borrow an analogy from Warren Buffett. Consider a car, he describes IQ and natural talent as the power of the car engine. He then describes someone’s rationality as the drive train of the car, the gear box, the axles, the tyres. If you have a very powerful engine, high IQ,  high aptitude, an abundance of natural talent, but are not rational you have a weak drive train and cannot get the power to the ground. In other words, if you are the hare, have great natural talent for running, but are lazy and irrational, you will quite easily be beaten by someone with a lesser natural talent and greater rationality.

So I’ve applied the story of the tortoise and the hare to learning, now let me discuss how I believe compound interest can affect learning.

To do this, I’d like to borrow something from Charlie Munger and talk about mental models.

Mental models are concepts that assist our understanding about how something in the world works. Mental models are normally developed or proposed within certain discrete academic disciplines. For example there are mental models for mathematics, engineering, physics, business, psychology. But mental models can often apply across disciplines.

Take for example the mental model of critical mass. Critical mass refers to a concept in nuclear physics. If a nuclear fission reaction happens at a fast enough rate it changes from being sub critical, (in which the reaction will dissipate due to it’s own energy) to being super critical where the reaction begins a self sustaining chain reaction which gets bigger and bigger and bigger.

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The mental model of critical mass can also be applied to other disciplines. Take for example viral videos on the internet. If the viewing of a video hits a certain rate it changes from sub critical in which interest will soon die off, to super critical in which it starts a chain reaction of people showing it to their friends, and their friends and so on in an exponential fashion.

Now from learning the mental model for critical mass you have in fact learnt a mental model that will explain two phenomena. Learning one thing has assisted you to understand two things. Through learning  mental models from different disciplines and applying them where they fit, the return you get from learning any one thing becomes non linear. This is the superpower of compound interest applied to wisdom.

So to reiterate; if you are the tortoise and you stick at learning over a life time you are sure to have some impressive results.

Some recommendations:

A book called Seeking Wisdom, from Darwin to Munger.

The Farnam Street blog is written by Shane Parrish who reads a hell of a lot and shares the things he has learned. He offers great recommendations upon what to read and compiles lists of the favourite books of some very smart people. I can’t recommend this blog enough.

A speech given by Charlie Munger called, The Psychology of Human Misjudgement

Here are two quite relevant quotes from Charlie Munger:

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time–none, zero. You’d be amazed at how much Warren reads–and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

“I am a biography nut myself. And I think when you’re trying to teach the great concepts that work, it helps to tie them into the lives and personalities of the people who developed them. I think you learn economics better if you make Adam Smith your friend. That sounds funny, making friends among the eminent dead, but if you go through life making friends with the eminent dead who had the right ideas, I think it will work better in life and work better in education. It’s way better than just being given the basic concepts.”

 

Compound interest, the tortoise and the hare and fitness:

I apologise for the length of the previous section. That may have been somewhat over the top. Now I’d like to talk about a lighter topic; fitness.

In much the same way that the majority of people learn fast in their youth and then stop learning once they have achieved their required level of qualification, the majority of people do the same with fitness. Children are naturally fit and active. They play games, team sports, swim, cycle, climb trees etc. Then at some stage the team sport stops. People hit their mid twenties and stop exercising (unless they are required to be fit for their occupation). They have a nap under a tree.

Many of the hares of the world, those who were naturally fit in high school are fat and unfit by their 30s, while in some cases those who weren’t the star athletes of their high school; the tortoises, continued to plod on with consistency and get fitter and fitter.

I think the description of the tortoise and the hare for fitness is quite appropriate.

But I would like to talk about compound interest and fitness.

One form of exercise that I have found quite relevant to the compound interest analogy is strength training using your body weight.

Using an appropriate training regime you will of course get stronger. If you decide for example to do 10 push ups a day it will get easier to do 10 pushups. Then through progression you do 20 pushups a day. At some stage the number of push ups you can do will plateau, due to the law of diminishing returns.

At this point, you will say, that doesn’t sound like compound interest!

But at that point you should increase the difficulty of the exercise. You advance to doing one handed push ups on an bench at chest height, then at some stage you are doing one handed push ups on the floor. The same can be done for pull exercises, leg exercises etc.

The number of muscles you are using, the number of calories you are burning, the flexibility and balance you are gaining from each exercise increases as the difficulty of the exercise increases. So as you move to a harder exercise you are getting more benefit for the same number of repetitions. If you do 20 two-legged body weight squats, and then try and do 20 pistol squats you will know what I mean.

Ok, so you may not see true exponential behaviour, so maybe the compound interest analogy for fitness may not be entirely accurate. Perhaps if you compare your relative fitness performance in your age group it is a better analogy, but perhaps not.

But in any case the tortoise and the hare is quite accurate, and relevant to fitness.

Some recommendations:

The only recommendation I have to make is You are your own gym, the bible of body weight exercises by Mark Lauren. I’ve done all kinds of exercise in my life, and this is the most balanced, time efficient and portable exercise routine I’ve ever seen. Using this program, progression is almost limitless.

There is also a You are Your own Gym app for Android and iPhone. The app is sensational, with some basic equipment such as a chair, a door, a table, or even a ratchet strap and some handles you can increase your fitness and strength dramatically in a very time efficient manner.

 

So that concludes the longest and most serious post I’ve ever written. If after that you feel you need some less serious discussion, I recommend this and this.

Thank you for reading.