The truth in numbers
The numbers don't lie. They tell a tale of a society living well beyond its means. This is why 80% of Americans are broke and living pay check to pay check.
The traditional thinking of Financial Independence is to amass a large amount of cash by savings, then invest it at interest rates that return more than a draw rate, and eventually you can retire. In this episode we are going to burst that bubble by focusing on the falacies of this approach and how Financial Sustainability offers a contrarian position that you might want to entertain.
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For those in the FI community, before you think I’m coming at you and you need to put up your defences, hear me out. I’m not. I love what you are doing and you should keep it up. I’m just going to offer you some options to evolve what you are doing towards financial sustainability and why you might want to do this. So put your shields down and listen up because I’m going to challenge you a bit (but in a good way).
Money is an interesting animal. We make it through income, and we spend it to survive. It is used to buy our food, pay for a roof over our heads, provide us with energy, communications, clothing, put our kids through school, etc. Money has become the lifeblood of what we would think of as capitalism and capitalistic society.
For centuries, people have tried to make more and more money. The “Lifestyles of the Rich & Famous” was so popular because it put out there a poster child of what a lof of people thought should be a goal. Hip Hop & Rap culture further underscored this with lavish lifestyles. Even our current president was the guy who told you he wanted you to be rich. The pursuit of being rich has consumed millions, yet only a few get there, and of those few, only a percentage of those get to stay there.
The FI and FIRE movement are no different to any of those that precede them in history. The truth is that they also just want to be rich. The reasons behind this may appear to be less caustic though. They want freedom - freedom from a 9-5 job that takes them from their families, freedom from submission to a boss or a faceless corporation, etc. And as a result, they are willing to embrace frugalism to get there. By NOT embracing the lifestyles of the rich & famous approach, they save like squirrels for a long winter that is their retirement. The constant beacon that keeps them going through this is a poster of a guy sitting on a beach, or their friends sending back Instagram moments from Changmai or Puerto Vallarta, etc. It keeps them going day after day, as they slug through the 9-5, socking away more and more wealth.
So we are going to break down three falacies that have to be challenged and addressed with the current thinking of the FI/FIRE movement in this episode.
1. The goal of retirement
2. The saving of money
3. The investing strategy of equities
OK, let’s start with falacy #1...the concept of retirement.
This is the”mission” for those seeking FIRE (Financial Independence Retire Early). The finish line, so to speak. The idea is that in your youth, you live like you were still in a dorm in college and you save a substantial percentage of your take home pay, by living frugally and stashing it away like squirrels with nuts for the winter. So that one day you can tell your boss to shove it, quit your job and live free in the world.
But as you know, this approach is naive as I’ve spoken about constantly. The idea that by amassing enough nuts you can put it in low risk investments and live off the dividends and interest on those investments can be a challenge. That your skills that were the reason you had a job in the first place, are put back in the closet so that if you need to bring them out at any point and dust them off, they never look as shiny and new as your competitors and if you have to re-enter the workforce it is going to be more at an entry level position (again) than as a well honed senior master of your craft.
Additionally the concept of living on a fixed income for the rest of your life is not appealing. Just ask any 65+ year old retiree. Sure sounds great, but as you find opportunities in life that you want to pursue with your new found available time, you come face to face that starting anything new in a capitalistic world typically requires capital. You might decide you want to learn how to be a potter. Well someone has to buy the wheel, the kiln, the clay, the lessons, the space in your real estate to put it all, etc. That requires money. Maybe you decide you want to learn to fly a plane. Who’s going to pay for the lessons? The flight time required to eventually get a license?
Or do you say NO to these things, and learn less expensive things. Maybe you cover the cost of travel with travel hacking. Well the idea of travel hacking to do it for free is great until you realize that those that do this trade on their organic spending habits (like a business) and you live frugal so you don’t spend that much at all. So you have to put the governor on those plans. Covering those minimum spend requirements to get the travel rewards of that new credit card takes the ability to spend money, and sure you could play the manufacturered spending game but after you hit that 5/24 rule, then it is all about points through organic spending and that’s where your strategy falls down. Remember, you don’t spend that much now, so that strategy won’t work anymore.
Maybe you move to a less expensive place to live. That’s great, but do you have the same opportunities to engage your brain and your time to live happy and challenged there, or are you sacrificing this for the dream of retirement?
Again, I ask you to speak with someone retired who is over the age of 70. Would they love to re-enter society as a contributing worker? Maybe not at the pace they previously had, but would it not challenge their brains more and make them feel more like a player rather than a spectator in life? I suspect that no matter what your age is, you want to be a player and not a spectator. Well I hate to tell you this, but there is a cost of entry to be a player.
There’s this natural thing in human DNA and that is to progress and evolve. Progression involves some level of risk, and in a capitalistic world that typically involves some level of capital. If you choose to never evolve, get up in the morning, have your cup of coffee, read the blogs, watch some TV, take your kids to school, come home, read a book, make lunch, maybe write some emails to your friends, pick up the kids from school, make dinner with the family, watch some TV and then go to sleep, only to do it again and again and again, you will come face to face that the rinse & repeat lifestyle of a retiree is no different to the risk & repeat lifestyle of a worker ant in a job, except the retiree doesn’t have any income coming from their time.
You decide you want to travel to escape the monotony. OK, but if you have kids you won’t be doing that for the short term. Or pets. Sure, you could probably find a dog sitter for a few weeks here or there, but not for six months or twelve months. Those dogs won’t know you and you won’t be their masters anymore, so no pets for you. Your kids have needs too, and therefore you will need to find solutions in travel for their education and their needs, which can be challenging. You may need to home school them, which reduces your ability to be dynamic as well. So if you don’t have pets and you don’t have kids, then maybe you can do that. What about your significant other? Do they have the same goals? What if they loose the shine of travel after a while? What if you or they want to see their parents, or their brothers & sisters? Can travel be sustained forever? Well not if you have the normal need that we humans have to establish a “home” even for a short period of time. Home helps us define a center, and although it is true that you could have multiple homes around the world, that requires capital. Lots of capital. And remember.... You decided to give up your income earning job, so maybe participation there is no longer an option.
Life moves forward with or without you. Women have biological clocks. They might want a family. It is natural. Men have a need to go out and conquer things. The hunter & gatherer in our psychy. The roles could be reversed, but one way or another life has this nasty habit of tapping you on the shoulder periodically and reminding you of these things that often overtake the ambition of a total retirement. And these things require capital.
Using the myth of retirement as your end point works great if you need something to drive you towards that. You are going against the grain of society - that’s a good thing. You are aiming to not live a life like everyone else who can’t escape the treadmill. That’s a great thing. I applaud you for having the willingness and tenacity to do that. But I caution you that the goal of FIRE might literally put you from the frying pan into it.
Falacy #2 - The saving of money
For centuries those that found treasure became consumed by storing and protecting it. The gold miners of the 1800s were often killed and robbed not because they were in search of gold, but after they found and mined it. On their way to the bank vaults, they were gunned down and killed by bandits hell bent on stealing their treasure.
The same is true in other assets. Crypto currency exchanges have routinely been hacked. Banks are constantly robbed at gun points. Tweakers break into vending machines to get the coins, etc. Once you have something of value, you spend all your time protecting and worrying about it.
But let’s assume you find a nice local bank that you trust that won’t abscond with your money. So you put your money into a savings or money market account. Then you get your first bank statement and you are really disappointed. First, there are the fees. Banks love fees. But then the big disappointment is the interest rate.
Almost nothing. I mean banks that give more than 1% interest on savings are few and far between. Yes, there are some that give that - maybe more - but with that is the rising risk of bank default and taking ALL of your treasure away. So you just elect to go with the “too big to fail” banks.
Well if you were banking on your money growing organically, you are out of luck. You come face to face with the fact that we have entered a stage in the world that I don’t see changing for a very long time, where banks realize they make money lending not holding the liability of your savings, so they are sending a subtle message to you that they don’t want your savings but they do want your debt. Of course you know that debt enslavement is the antithesis of the FI movement, so you won’t participate with them on that. But where do you put your treasure?
And here’s another thing that really hurts. Because you are not spending money on things, you have no eligible tax deductions. Welcome to the higher end tax rates. You are earning like crazy to save, but in doing that you are no longer eligible for govt subsidies in things like the ACA (Affordable Care Act) and you are no longer eligible for FAFSA for your college bound kids, etc. Yes, Mr. Richy Rich, the buck now stops on your desk to help fund the country. So you are now in the higher tax rates, so more money is being extorted from you for taxes. Federal, State & City levels. You look for tax deferred investments like HSAs, IRAs, 401Ks, etc. but they don’t let you touch that money until you are way older - because the actuaries and bankers defined that “retirement” is an old person’s game, so we structure all the tax incentives towards you working and generating more taxable revenue for the country. Why? Because it costs a lot of money to run the country and they can’t do it without everyone’s participation. You want to save, save, save so they will take their pound of flesh while you make a lot of money, knowing that you won’t be a big contributor when you quit your job. And they will take it before you get to even see it - W2 income earners are the highest taxed individuals because they have very limited tax deductions to enjoy, so you get that taken from you in your paycheck. Forcing you to work longer and harder - live more frugally, etc. just to keep above the share of the treasure that Uncle Sam wants. He’s your partner whether you like it or not, and it doesn’t matter where you decide to live if you are an American - he’s your partner until the day you die, and he needs his pound of flesh or at least the report of why you haven’t paid him his pound of flesh.
But let’s say that even if you get ahead of these things, you are still left with where to put your treasure so that it makes money on your behalf and that leads me to falacy #3.... The Stock Market.
Falacy #3 - The Stock Market
The financial advisor business and accounting industry are extremely conservative. They won’t recommend any financial product or service that doesn’t have pretty good odds at giving a return back to their clients. Retirees often are not savvy when it comes to investing, so they put their faith & trust in someone who has their back. It used to be their bank manager or their accountant.
But those very same people are living in a world of low interest rates. You see banks (and the financial industry) makes their money in three main forms - interest rates, artbitrage on transactions and fees. Interest rates are the difference between what they pay you for holding your money vs. what they charge someone for using it, arbitrage comes from things like foreign exchange fees where they buy capital at one rate and sell it for another, like the buy & sell exchange rates you see at the airport, and fees - the fees you see on your bank statement or late fees on credit cards, service fees, etc. Of course there are probably many other ways to make money - like the ball in the cup illusionists out there. But to keep this simple, those three give you a sense of how that industry makes huge money.
So the reality is that you have your treasure that you’ve earned and you want a return on giving it to someone else to use. You go to the bank and they tell you that they don’t want it because they can get capital from central banks cheap so why do they need yours? Well they do have regulations that require them to hold assets to back their lending models up, but fractional reserve banking has changed so much over the years that once they reach certain asset levels, they no longer need your money. There’s no incentive to give your treasure to a bank.
The old “4% rule” thing is something that many in the financial investing biz used as a way to define how much you can safely draw down from your treasure per year to live on. The models in the FI community worked on the basis that if you saved $1 million, you could draw down 4% ($40,000) a year, and live on that. Well there are two enemies of that rule - inflation and interest rates.
Inflation is the assumption that the value of $1 degrades over time. That what you make on your treasure has to be more than the inflation rate, or the second law of thermodynamics (entropy) kicks in. That everything in the universe is constantly degrading. If you believe the smarty pants economists out there, they will tell you inflation rates are at 2% or so. So you first have to make 2% just to get ahead of that. I’m here to tell you that is total BS. Look at your health insurance premiums that have risen 45% in the past 7 years, or the cost of your lunch at Subway over the past 5 years. But that’s for another show. Let’s go with the fiction based 2% number.
The 4% rule now really tells you that you have to make at least 6% on your money to be ahead of inflation.
Or maybe you concede that 2% draw down is more realistic (you need to make 4% on your money to do that and be ahead of inflation). In order to bring in the $40,000 per year, you now need to have saved $2 million. Is the goal of FIRE getting out of reach now? I mean if you amp up your income earning, you just trigger higher tax rates making it harder and harder to reach the top of the mountain. And you can only reduce spending down to basic subsidence levels. You still have physiological needs like food, shelter, clothing, water, energy, communications & healthcare. So you have to pay for that.
How on earth do you make this work?
Well there is one way - increase the risk levels of where you put your treasure. Remember I mentioned before that some banks will give you more interest on your money, but they may not have the same protections for your treasure that you really want. At this point, assuming you want to live on $40,000 a year, that means you need at least a 4% per annum return on your money AFTER the fees, etc. are taking from you.
What vehicles do banks or investment institutions have that can give you those returns?
There is one - equities (the stock market).
When you open that Betterment, Vanguard, Charles Schwab, etc. account and put your treasure in there, they give you options on risk levels that you are willing to entertain. Low risk typically means your money goes into US government backed bonds. They don’t pay much. Short term bond rates might give you 2%, so that isn’t enough. And you are living in the assumption that bonds are safe. Typically those in equities will use bonds to offset risk, but this means you are buying into the national debt of a country. When the US government wasn’t heavily in debt, then bonds make sense. But as I write this the US government short term debt levels are over $23 trillion, and long term liabilities more like $122 trillion, so that’s a Jenga game waiting to collapse at any moment.
You can ratchet up the risk levels with your Betterment account to their “recommended” levels - 80%+ in equities. Equities, following the 2008 global financial crisis have had massive rises in value. The DJIA is at all time highs, etc. You have to ask yourself why though.
In order to handle the massive losses of capital that people saw in 2008, the US Central Bank (The Federal Reserve) dropped interest rates and increased the money supply. When they did this, they allowed people to borrow money to prop up their losses at low cost. They also reduced the interest paid on savings for those with treasure that was protected from the market collapse.
The problem, however, is that the low interest rate money didn’t go to the average Joe out there. They were denied lending because the banks lossed so much money in foreclosures on mortgages, bankruptcies and defaults. They would only loan to those that basically didn’t need the money anyway. And even with that, it was pretty light.
Who got all this low interest money they? Corporations did. They used it to buy out their competitors, or to buy back their stock holdings, creating an artificial rise in the value of their stock price. This meant those who bought low priced stocks saw massive gains. And when the market crashes down to < 10K on the DJIA, there’s a lot of headroom to go back up. These are the cycles of the universe that I talk about. Like waves in the ocean. After the crash of the wave, there are opportunities out there to participate. For a market that enjoys the difference the “buy low sell high” approach, this was a massive windfall.
But that was 11 years ago as I record this. Most stock market bull/bear cycles have changed by now. Why is it that the glory days of the post 2008 stock market are not over yet?
Market manipulation. The manipulation occurs by a number of factors, but the biggest one is the central banks continually lowering interest rates. The US government has massive debt loads, so low interest rates work there. They can’t afford the interest payments on the $23 Trillion debt, so keep the rates low. And since all of us enjoy lower interest rates when we have debt, we all get a warm & nice feeling from all of this. Your mortgage rates go down. You can afford a car you never thought you could afford because the payments are now in reach. You go shopping and buy that new TV set or upgrade your phone or your laptop or whatever. Credit card rates are 15% - not 27%, so why not.
Even the President goes public to have conversations with central banks to try and drive down interest rates even further, because it serves re-elections. They can point to the high DJIA and say they are “great custodians of the economy”. That you have more money in your pocket each month because you pay a lower mortgage on your home. Or your car payments are lower. Companies get access to capital to progress their own initiatives meaning more jobs, etc.
It all looks great. But it is pure fiction.
While corporate shareholders get richer by stock buy-backs, they artificially inflate the stock price driving the markets up. Interest rates are at all time lows and the central banks have less tools to work with should there be some adverse event in the markets. Cheap money spawns higher & higher risk taking putting more pressure on systemic risk on global economies.
Meanwhile your savings rate is being driven lower and lower, for low risk investing. Forcing you (and everyone else - including seniors in retirement) to put their treasure in riskier and riskier investments. You need that minimum 5% return, so you ratchet up the risk level in Betterment, hoping that the helium doesn’t pop out of this balloon. But in the back of your mind you know that the stock market is at all time highs, has been for a long time, and you pretend that it never crashes. That markets stay up forever.
Your plans to live are for the next 50 years or so. But the stock market won’t be at these levels over that 50 year period. Sure, it has historically gone up and up. But flying in the face of that is that we have never been in this amount of debt before and we can’t sustain it. Govt services will start to cut back, social security goes away, Medicare gone, etc. Meanwhile electorial candidates are promising more of the same unbridled spending to court your votes. Healthcare for all, etc. OK, but it will cost a lot of money. And that’s going to be paid by you. Yes, you. The one with the treasure.
I can’t predict when this will all blow up. But it will. It might be a long, slow decline. Or it could be a massive pop and everything is gone. Banks are interconnected worldwide now, so a blip in one country far from us (like Brexit or China or Japan or a collapse of a bank in Germany, etc.) could be enough to tip this into a crash.
Government debt could simply mean that in order to get them out of a mess, they have to take your treasure. It could come in increased taxes on it, or it could simply be a bail-in type confiscation. Or they could simply mean that you have to pay to have someone hold your treasure and there is NO interest paid on it. Negative interest rates are thrown around as a topic of discussion everywhere, which would effectively do that. The old 4% rule will be a chapter in some dusty book in history somewhere. But never something that works now for the people.
OK I’ll stop depressing you now. You hopefully get the picture by now that the FIRE movement has some serious flaws in the models. Not only is the concept of retirement wrong, but by trying to fly in the face of cultural norms, you become the target and victim of those failing social norms.
What’s the best way out?
Financial sustainability. You need to change the idea away from “net worth” and savings, to owning assets that generate dividends on their own. And you don’t need a lot of them to do this. If your goal was to make $40K per year, or let’s say $3K per month after tax, that is really easy to do with a collection of vending machines, some affiliate marketing websites, rental real estate, etc.
Sure, it requires you to “attend” to your assets. That’s a normal part of life - pretending it isn’t ignores entropy entirely. And pretending that you don’t have to do anything because you “retired” is just plain stupid. You will WANT to do something. You are human, and attending to your assets is really fun. It is like the sense of achievement that a farmer gets when they harvest their crops. Do you know just how much fun it is to empty out the quarters into a bag in your vending machines? Or count the dollar bills? Or receive rent payments for your properties? Man, I could do that all day long.
Wait... It doesn’t require you to do this all day long. You invest about 5% of the time that you used to spend in a cubicle at work making other people rich here. Isn’t that the end goal of retirement anyway? To be able to spend little time to make money, and have the rest of the time to yourself? But now, since you have income coming in from assets you have purchased and the strict following of the rule that no money is made by you selling your time by the hour to someone, you have transcended even the national economic models - the actuary tables, etc. You know that you are focusing on the base level things that people need, not luxury commodities, so the fluctuation in income shouldn’t be severe. Even in crashing stock markets, people still need a roof over their heads. They still have to wash their cars, they still have to do laundry, they still need to purchase diapers on Amazon, etc. You insert yourself in that supply chain and you make money.
If you are doing this and enjoying it, why stop? You can always leave for a while and travel. Maybe your endeavors are location independent, so you can support a perpetual traveling lifestyle with this. With the Internet there are plenty of opportunities to do that.
Or you can have someone attend to your things in your absence back home. Hire a property manager, etc. It will never be done as good as you can, but it will still be done.
If you don’t need to make a lot of money, you find yourself eligible for things like the ACA, FAFSA, etc. which before you were excluded from because you made too much money. You are no longer in the IRS radar for audit because you don’t make as much now, so there isn’t as much to take.
And most importantly you are running an enterprise of your own to make you money - a business. That means your business can enjoy the fruits of travel hacking with credit cards, the tax deductions that you never were able to get as a W2 employee, and that you are in control here. If you fall sick and have to go to hospital, the type of operation you have can run while you are not in it. You transcend normal business by taking advantage the teachings of people like Michael Gerber’s eMyth methods to not fall prey to becoming an employee of your own business, but a puppet master of it. Like the stock market (in the good times) you make money when you sleep, but unlike the stock market (in the bad times), you don’t lose money. Your life is attending to your assets.
It is a bit of a change from social norms. I was at my physical therapists office the other day and a patient sparked up a conversation with me that started with.... “So what do you do?”. That’s a hard thing to answer. My therapist knows me because we’ve had that conversation and he thinks of me as a “renassaince man”. So he intervened with something like, “He’s going to have a hard time answering that question”. I did. I don’t know what I “do” because the whole goal of financial sustainability is not to “do” but to “own”. But I don’t want to come across like some elitist, so I just gave them my card and said, “It is all here at www.beunconstrained.com”. I hope they took to heart that breaking free of social norms is the only way.
But in that same manner, breaking free of FIRE norms may be the only way to achieve the goals of being unconstrained for the long term. Financial sustainability is designed to challenge FI teachings - not to say that the goals of being independent are wrong. They are 100% right, admirable and a path all FI followers should embrace. But you have to ask yourself exactly why you are doing what you are doing, and whether the mechanics of assumptions of other’s teachings may or may not apply to your specific case. I’m laying out a set of alternatives here based on real asset purchases and a more hands-on business approach to income generation, that doesn’t require a lot of time but doesn’t force you to entrust your treasure to a third party, central bank, etc. where you are just likely to fall victim to meta-economic issues that have historically wiped out those with treasure before.
Remember the gold miners that found gold, but were slaughtered on their way back to the bank? Or the bank gets robbed and all depositors lose their savings?
Don’t be that guy here.
Until next time, keep up the good fight.