Detaching from the Matrix…Small steps to big rewards
We are in a mess. We got this way because people forgot that the power brokers of the world treat life like a chess game, and we think of life like a daily or hourly experience.
It is somewhat amusing to read through the countless posts on various forums on Facebook on the early retirement movement. I use the term “Movement” intentionally because this has become more of a cult that follows a fictional future event. That is not to say that the intentions are bad – it is that often the endpoint is flawed.
I realize I’m not going to make friends with many in the early retirement movement with this episode.
I don’t have any issues with anyone trying to live frugally, save lots of money and create a nestegg. But to do this for some early retirement, is lunacy – particularly based on the strategies that are being bandied about these days.
Let’s look at two fundamental different strategies that people can adopt for their financial freedom (I’m sure there are others and I’m specifically excluding anything that has a pension associated, since that provides its own perpetual income stream, but they are becoming less and less common these days):
1. The accumulation model
2. The financial sustainability model
The idea here is to amass capital and hold it. Like squirrels that collect nuts for the winter. The more capital you have, the more you can put it to work for you. The idea is that if you have enough capital, then the interest that you can make from it should be enough to cover your living costs for the rest of your life.
The amount of capital that you have to save will be based on a number of factors:
a. The safe withdraw level
b. Your costs of living
d. Your lifestyle risk factors
e. How many people in your family that you have to cover financially
f. Taxes and tax policy
A simple example:
Mary has a job earning $100,000. She lives frugally and is able to save 50% of her income. She takes that money and puts it in a number of traditional and tax advantaged investments (Roth IRAs, Passive index funds – eg. Vanguard, etc.). The economy has been good, favorable interest rates has allowed equities to grow at 15% annually. Year 1 she has $50K, Year 2 she has $107.5K, Year 3 she has $170K, etc. By about year 10, her savings are at $1.2 million. Now she wants to quit her job and retire. She’s been working towards this goal for 10 years. She is now 38 years old, and expects to live until the ripe old age of 90 (that’s another 52 years of life). Her calculations are that a safe withdrawal rate of 4% on her money (remember she’s earning 15% here), would give her about $45K per year of income, and based on her 50% savings rate, that means she would be able to live the same quality of life without a job.
Financial Sustainability Model
This concept is that you begin to acquire assets that pay you to own them. Think of this like a dividend. This is often referred to as “cashflow” but that term has been butchered over time, so I use the term “smart income”.
Unlike savings, assets can be purchased with borrowed money. So this means you don’t have to save as much as Mary to do this, although you need some capital to begin. The simplest asset class to invest in here would be rental real estate, so we’ll use it as our example.
The amount of capital required will be a portion of the cost of the real estate:
a. If you purchase a $300K rental property, you will likely need 20% downpayment ($60K)
b. You get a mortgage of 15 years
c. You expect a 4% asset appreciation
d. You continue to save like Mary, at $50K per year but invest that into the real estate by purchasing 1 additional rental property per year, for 5 years
e. The tenant rents pay down the mortgages, and you fund any overage of costs with your own money
A not so simple example:
John has a job earning $100,000. He lives frugally and is able to save 50% of his income. He takes that money and uses it as downpayment to acquire rental properties. The rental market is stable, but grows at 5% per year. The property market is stable and grows at 4% per year. Year 1 he saves money only. In Year 2 he acquires $300K of rental property, putting a $100K downpayment on the purchase. This yields $2000 a month in rents. His mortgage is a low interest 15 year loan, at 3.125% and his payments per month are $1,400 + $300 prop tax + $150 insurance. The rental income covers his mortgage payment + costs entirely. He also gets a 3% depreciation tax benefit from the property. By year 3, his property is now worth $312K, and he owes $190K (he has $122K equity now). He continues to save his money at $50K, adds it together with a refinancing on the first property and secures a 2nd property at the same pricing, puts in tenants and then repeats. Over the next 5 years, he continues this practice. By the end of year 5, he has accumulated $1.5 million in real estate, which has grown at 4% per year in value, and as rents have increased he has taken the surplus cashflow and invested it back against the principal of the real estate. This has reduced his overall 15 year mortgages to 10 years, so by the end of year 10, he now has half of the properties paid off ($750K in value), and within another 5 years he will have them all paid off. With a modest assumption of asset appreciation, he is sitting on about $2 million in real estate value that he owns freehold. This yields him about $15K in monthly income, that adjusts for inflation as rents go up.
So let’s compare the results. After 10 years, Mary has an income of $45K per year. After 10 years, John has an income of $90K, but after another 10 years, John’s income rises to $200K based on more of the mortgages paid off by the tenants. John’s income is inflation hedged as rents go up. Mary’s is not.
The downside of John’s approach is that he is more “hands on” with his investments, hasn’t deferred it to a counter party. But his entire time invested in managing the real estate is 10% of the time he would normally have at a job. He’s engaged in the process. Mary is 100% hands off with her investments. Maybe moving some funds around in the equities market, but she’s not trading like a day trader here. She has deferred all of the management to passive index funds or money market funds.
They are both exposed to market dynamics. The equity market can crash (has done at least 3 times in the past 20 years), and Mary’s only experience with it has been through bull market cycles. She has not yet experienced a longer term bear market, which is normal and typical in stocks. John’s playing a more cautious game here and not seeing the returns that Mary is seeing in the bull market cycles, but unlike stock markets the real estate market cycles don’t change as actively and since he is only focused on rents, he doesn’t care what the net asset value of his real estate is once he stops acquiring properties.
Mary is more liquid and fluid. She can live anywhere in the world. John is more fixed geographically while he is managing his properties, but he could take a 10% reduction in income and give the properties to a property manager to take care of for him and he would then be free to travel, etc.
Now there are some key differences between these approaches. Both would work and allow you to “retire early”.
But the differences are the John’s approach is more of a business approach to his asset portfolio. While he is the property manager, he is more actively involved in the day to day operations of things. Because it isn’t a huge time investment, he may not consider it “work” in the traditional sense (ie. Employment). And since it is his assets that he is managing, then he can get more excited about the process.
Mary’s approach is not business like at all. She’s 100% hands-free of everything. Much like someone who retires from a career. The idea of spending all of your waking hours playing golf, living on a beach, etc. is really the focus in Mary’s mind.
John, since he has an active income stream coming from his investments, may elect to speculate or invest in other things. He has the cashflow to do that. Mary is more conservative and less likely to take on risk.
You see, there are different psychological traits between Mary & John. The results reflect that. The adage, “There is no progress without risk” does apply to both, but less to Mary. She’s living with risk but not having to deal with it each day. If the markets don’t return anything as economies to into recession, she still has this massive nestegg that she can draw down on.
But with 50 years of life left in her, she’s assuming that the $1.2 million that she has will last her 26 years of time, assuming it makes nothing. The theory is that market cycles don’t last more than 6 years between moving bull to bear, and bear to bull.
A simple comedic example of this is the scene of Dr. Evil in Austin Powers: International Man of Mystery movie.
Yes, “one meeellion dollars” is not what it once was.
But with that said, the problem is that Mary didn’t factor in that her annual costs of living are rising at 5%. We call that inflation, but it comes in different forms. Her $ is devaluing because of central bank/govt policy. Plus her costs are just going up all the time. Her grocery store bills are higher, he medical insurance goes up, her gas in her car is more expensive. With a 5% annual inflation rate, this means in 20 years all of her money is gone. Without doing a tricky math exercise, I’d make a guess that her assumed 26 years of safety is really more likely 12 years, so she really can’t afford the market to treat her bad for very long.
Sure, there are good years and bad years. She’s just re-investing the surplus in the good years, to have extra years of stress free retirement in the bad years.
But there is little wiggle room here because life throws you curve-balls:
1. Unexpected medical events
2. Death in the family
4. Economic collapse
7. Government bail-ins
8. Taxation increases
9. Climate events
It is hard to predict the future. We know that. Look at the difference between life in 2019 vs. life in 2021 and that’s a perfect example. These “black swan” events come thick & fast.
That’s not to say that we have to look at life from a doom & gloom perspective. But we have to be careful. We are taking away our ability to earn income from toil here, and that means you are making some very big and often dangerous assumptions.
And this is where an entirely different angle on the end-goal of retirement comes into play.
The stress of retirement
If you have had a career working, you are used to habits of commutes, work place, peers, the boss, deadlines, goals, etc. These things are generally accepted as part of worklife. Sure, companies demand more than they should. But ultimately if you don’t like your job, you can get another one. No one typically works in the same job all through their working life.
But what (other than money) do we get out of work? We get the most important thing – ego validation. We get a sense of being needed, and a place to provide service. This is important. It defines who we are – our identity. It is why when you meet someone for the first time, often the question, “So what do you do?” comes up. That’s because we identify people with the jobs or career choices that they make. There is often a stark difference in perception when someone says, “I’m a doctor” or “I’m a lawyer” or “I’m a sous-chef” or “I work at Walmart”. You define a set of assumptions based on the answers to these questions.
The same is true of the owner of that title. They define a personal sense of who they are from what they do.
However when you take that away, it changes things. Now when you meet someone new and they ask, “What do you do?”, and you answer “I’m retired”. The question likely goes to, “So what did you do when you were working?” like now your identity is based on your history, not your current or future self.
You no longer have the association with the work mates that you used to have. Since you don’t see them everyday since you quit the job, there is a void of people to fill it. But the problem is that everyone else has a job, so you have a harder time finding social circles that work to your open schedule.
The bigger problem, however, is the personal stress & anxiety of change that we go through. I’ve spoken about this as being a critical part of life’s journey. The fact that the Boeing corporation’s study of pension funds for workers showed that the lifespan of someone who retires at 55 averaged out to 83 years old, but someone that retired 10 years later, only seemed to get 2 years of life after retirement. That’s a story that parallel’s my own father’s plight who died at 67, 2 years after retiring at 65.
In looking for answers to this, I stumbled upon this article written 3 years ago in Forbes Magazine by Robert Laura, entitled “Why is retirement so stressful?”
To quote portions from his article, which was based on a study called the “Holmes and Rahe Stress Scale”, which puts the stress of retirement in the top 10 life stresses that we all will likely face, with #1 being Death of a Spouse.
To quote his article, “I hate to be the bearer of bad news, but retirement doesn’t always turn out the way people think. Primarily because this stage of life can intersect with an avalanche of activity that causes a massive amount of stress, worry and anxiety. As a result, people can often suffer in silence as they try to figure out what’s going on.”
Being able to do this early has a far higher chance of transcending it, but the later in life that you leave it, the more likely it may manifest into health related issues (ie. Heart attack, stroke, etc.).
It is hard enough to realize that entropy will turn us all to dust at some point. And that as the years we have left reduce down, we must all go through the psychological adjustments to this. We can’t change time. We just try and get through it. But if you are worrying about money, that’s not a stress free retirement.
So this is where I tell you to run away from retirement.
Now I’m not telling you to get depressed that you can’t quit your job, etc. I’m just saying that the traditional perspective on what retirement is, can be toxic. So we have to change the dynamic here. And the earlier in life that you do this, the more likely you will have a better outcome.
If you don’t have to retire because you did like John did, and bought income producing assets, and embrace business & capitalism since we all proudly live in a so-called “free market” (well we don’t, but let’s pretend for now), then maybe you can be engaged with the business of you, and actively participate in it. Then when someone meets you for the first time and asks, “What do you do?” you can answer “I manage a portfolio of rental properties”. Sounds good – successful, and guess what. They won’t dismiss you as odd and an outcast, or a has-been of society.
But more importantly, knowing that your income is relatively safe, able to adjust upwards with inflation, and that your assets are not reducing in value as you have to draw down against them, but your rental income (smart income) is flowing all the time…. Well that’s empowering. That’s often addictive. I have friends that started with a few properties, loved it and now have 80 of them. I use properties all over the world as a way to protect my capital by using different countries and their economics because they change in different cycles. I can go and visit or live in my properties in other countries, or just AirBnB them for income if I want.
And if the day comes that I’m sick of managing them, or even don’t want to give them to a property manager, I can sell them, and take all the cash and do what Mary’s doing. But I can leave that until my 60s or 70s if I want, as an “end game” for this. It is just that I don’t really want it to end.
Sure, I hate getting phone calls at 3AM when a tenant’s water heater blows up. Or when their air conditioner goes out in the middle of summer. But the amount of time as a percentage of the annual rental income flow that these things happen are minor. I can be pro-active to these things too, and the more focused I am on what is going on, the more likely I can act ahead of time and avoid the 3AM phone calls.
That’s what a business person would do. Be pro-active to attending to your assets.
But you still have the choice. Sure, you pay capital gains tax (or whatever tax rates your sale of property puts you in) when you sell them. So there is an exit tax in all of this. The same, however, would be true of selling equities. I just prefer to never kill the goose that is laying the golden eggs.
I’ve even expanded my real estate endeavors to property development, sub-dividing land and building from scratch to effectively grown my own real estate rather than buying up front. I’ll likely sell off the house/land packages for this, but what an adventure. Something I didn’t expect to be doing at this point in my life, but it keeps me focused, active and engaged. And to do this in a foreign country is even more exciting. I can afford to do this because I have the rental properties taking care of my day to day expenses.
If an opportunity came along for Mary, would she be able to engage with it? Or would she be worried that her nestegg could be at risk which could destroy the perception of the stress free life she had planned for the next 50 years? So she passes on the opportunity.
And this brings me to the most important and final point in all of this.
You cannot predict the future. People get married, divorced, face health challenges, death of a family member, have kids, kids grow up, kids need college (apparently), braces, etc. Climate change deals you a horrible blow to your home, wars, pandemics, etc. all the things I’ve listed out earlier in this episode.
Those of us who are nimble and can navigate in these choppy waters are more likely able to stop the ship from sinking. But those of us who gave up on income generation, assuming our nestegg would take care of us, are least able to avoid being a victim to life’s challenges. Most of those that I speak with who took the blue pill of the early retirement movement, are thinking “unicorns & rainbows” with life. Often this naivety comes with youth, but the truth is that the perception that in your 20s you are invincible is quickly destroyed when you get knocked down hard in your 30s or 40s. And to create a total life strategy on money that comes from early perception of how things will play out in the future, makes no sense to me.
I would never have been able to predict the things I went through in my life when I was 20. I could never have predicted I would move to the other side of the world, be married, divorced and re-married. Nearly killed in a massive car accident. Carried the injuries from that for 25 years. Became a US citizen, then a Mexican permanent resident. I would never have predicted I would be buying land and developing property internationally. I would never have predicted I would own a portfolio of rental properties that would provide me income to live off for the rest of my life. I would never have predicted I would fall in love with my wife of nearly 25 years, and have a wonderful daughter I’m proud of. I would never have predicted the 2008 GFC, or the demise of my home country. I would never have predicted to live through a pandemic.
You can’t predict life and the best strategy I can suggest is that you have a nimble way to earn money that keeps you active, and able to duck & weave as life throws its challenges at you.
There is nothing perfect here. But the one thing I know is that you become a victim to something when you take away all of your weaponry to fight it. If that weaponry is income, and you are doing the whole life retirement strategy based on a nestegg model, I don’t think it will end well for you. Maybe in your 60s or 70s, or if you have $10 million or more, but not based on the assumptions I’ve read & listened to in the early retirement movement.
No, I’m not trying to burst your bubble of be a “Debbie Downer” for the day. But groupthink isn’t an answer to having a solid strategy that works. Just surrounding yourself with like minded thinkers who all took the blue pill of the early retirement movement isn’t a great idea. Just as the same groupthink of our social mantra that government and society has been teaching you – well that doesn’t work either.